Working Paper: CEPR ID: DP9774
Authors: Johan N. M. Lagerlöf; Christoph Schottmüller
Abstract: We study a monopoly insurance model with endogenous information acquisition. Through a continuous effort choice, consumers can determine the precision of a privately observed signal that is informative about their accident risk. The equilibrium effort is, depending on parameter values, either zero (implying symmetric information) or positive (implying privately informed consumers). Regardless of the nature of the equilibrium, all offered contracts, also at the top, involve underinsurance. The reason is that underinsurance at the top discourages information gathering. We identify a sorting effect that explains why the insurer wants to discourage information acquisition. Moreover, a public policy that decreases the information gathering costs can hurt both parties. Lower information gathering costs can harm consumers because the insurer adjusts the optimal contract menu in an unfavorable manner.
Keywords: Adverse Selection; Asymmetric Information; Information Acquisition; Insurance; Screening
JEL Codes: D82; I13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lowering information gathering costs (D83) | Exacerbation of informational asymmetries (D82) |
| Exacerbation of informational asymmetries (D82) | Distortion of insurance policies offered (G52) |
| Costs of information gathering (D83) | Insurer's optimal contract menu (G52) |
| Insurer's optimal contract menu (G52) | Underinsurance (G52) |
| Reduction in costs of information gathering (D83) | Harm to both consumers and insurers (G52) |
| Reduction in costs of information gathering (D83) | Alteration of optimal contract menu (D86) |
| Alteration of optimal contract menu (D86) | Lower consumer surplus (D11) |
| Insurer's profit-maximizing behavior (L21) | Less favorable contract terms (L14) |
| Sorting effect (C69) | Underinsurance at all levels of risk (G52) |