Working Paper: NBER ID: w16738
Authors: Li Gan; Feng Huang; Adalbert Mayer
Abstract: A positive correlation between insurance coverage and ex post risk can be an indicator for private information in insurance markets. However, this test fails if agents have heterogeneous risk attitudes. We propose a new test that conditions on unobserved types of individuals who differ in their risks preferences. This makes it possible to detect asymmetric information without direct evidence of private information - even if agents have heterogeneous risk attitudes. We apply our technique to the market for long-term care insurance. Finkelstein and McGarry (2006) provide direct evidence for the existence of private information in this market. At the same time they fail to find a positive correlation between insurance coverage and ex post risk. Our method indicates the existence of private information, without using direct evidence of private information. Our methodology is applicable to other insurance markets and markets where proxies for private information are not available.
Keywords: private information; insurance markets; heterogeneous demand; asymmetric information
JEL Codes: D82; G22; I11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| asymmetric information in insurance markets (D82) | positive correlation between ex post risk and insurance purchases (G52) |
| heterogeneous risk attitudes (D81) | failure of positive correlation between ex post risk and insurance purchases (G52) |
| timid individuals (C92) | more likely to purchase insurance (G52) |
| timid individuals (C92) | less likely to utilize insurance (G52) |
| bold individuals (Y60) | less likely to purchase insurance (G52) |
| bold individuals (Y60) | more likely to utilize insurance (G52) |
| timid type (Y20) | more likely to purchase insurance (G52) |
| timid type (Y20) | less likely to enter a nursing home (J14) |
| positive correlation between error terms in nursing home and insurance models (C21) | evidence of private information in long-term care insurance market (G52) |