Working Paper: NBER ID: w16723
Authors: Liran Einav; Amy Finkelstein
Abstract: We present a graphical framework for analyzing both theoretical and empirical work on selection in insurance markets. We begin by using this framework to review the "textbook" adverse selection environment and its implications for insurance allocation, social welfare, and public policy. We then discuss several important extensions to this classical treatment that are necessitated by important real world features of insurance markets and which can be easily incorporated in the basic framework. Finally, we use the same graphical approach to discuss the intuition behind recently developed empirical methods for testing for the existence of selection and examining its welfare consequences. We conclude by discussing some important issues that are not well-handled by this framework and which, perhaps not unrelatedly, have been little addressed by the existing empirical work.
Keywords: adverse selection; insurance markets; welfare analysis
JEL Codes: D60; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| adverse selection (D82) | inefficiencies in insurance markets (G52) |
| adverse selection (D82) | downward sloping MC curve (D40) |
| downward sloping MC curve (D40) | underinsurance problem (G52) |
| underinsurance problem (G52) | welfare loss (deadweight loss triangle) (H21) |
| equilibrium price > marginal cost (D41) | fewer individuals insured than socially optimal (G52) |
| advantageous selection (C52) | upward sloping MC curve (D43) |
| upward sloping MC curve (D43) | overinsurance (G52) |
| willingness to pay < expected costs (D11) | underinsurance problem (G52) |
| willingness to pay > expected costs (D11) | overinsurance (G52) |