Working Paper: CEPR ID: DP8833
Authors: Johannes Spinnewijn
Abstract: Recent empirical work finds that surprisingly little variation in the demand for insurance is explained by heterogeneity in risks. I distinguish between heterogeneity in risk preferences and risk perceptions underlying the unexplained variation. Heterogeneous risk perceptions induce a systematic difference between the revealed and actual value of insurance as a function of the insurance price. Using a sufficient statistics approach that accounts for this alternative source of heterogeneity, I find that the welfare conclusions regarding adversely selected markets are substantially different. The source of heterogeneity is also essential for the evaluation of different interventions intended to correct inefficiencies due to adverse selection like insurance subsidies and mandates, risk-adjusted pricing and information policies.
Keywords: adverse selection; heterogeneity; risk perceptions; welfare; policy
JEL Codes: D60; D82; D83; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Heterogeneity in risk perceptions (D81) | Systematic difference between revealed and actual value of insurance (G22) |
| Heterogeneity in risk perceptions (D81) | Individuals' decisions about insurance value (G52) |
| Nonwelfarist heterogeneity (D69) | Welfare costs of adverse selection (J32) |
| Policy interventions (insurance subsidies and mandates) (G52) | Welfare implications (D69) |
| Actual value of insurance (G52) | Misestimations of welfare gains and losses (D69) |