Working Paper: CEPR ID: DP1644
Authors: Winand Emons
Abstract: This paper considers a housing insurance market in which buildings have different damage probabilities. Insurers use imperfect tests to find out about buildings? damage types. The insurance market is a natural monopoly. If more than one insurer is active, high risk house owners continue to apply to insurers until they are eventually assigned to a low-risk class. First we show that the natural insurance monopoly need not be sustainable. Then we show that in the equilibrium industry structure the incumbent may accommodate entry even when the natural monopoly is sustainable. The theoretical findings are thus able to explain recent observations from Germany and Switzerland where housing insurance damage rates and prices went up drastically after the transition from state monopolies to competitive environments.
Keywords: insurance; imperfect tests; natural monopoly; sustainability; inefficient entry
JEL Codes: 042; 043; L12; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Imperfect tests (C52) | Natural monopoly (D42) |
| Investment costs below threshold (G31) | Sustainable natural monopoly (D42) |
| Investment costs exceed threshold (G31) | Unsustainable natural monopoly (D42) |
| Sustainable natural monopoly (D42) | Incumbent can charge price that prevents profitable entry (L11) |
| Unsustainable natural monopoly (D42) | Inefficient entry and higher damage rates (F12) |
| Competition introduced (L13) | Incumbent sets high price (D49) |
| Incumbent sets high price (D49) | Entrant undercuts price (D41) |
| Entrant undercuts price (D41) | Higher prices for consumers (D49) |