Working Paper: NBER ID: w5669
Authors: John Cawley; Tomas Philipson
Abstract: This paper tests restrictions implied by the canonical theory of insurance under asymmetric information using ideal data that contains the self-perceived and actual mortality risk of individuals, as well as the price and quantity of their life insurance. We report several findings which are hard to reconcile with the canonical theory. First, we find a striking independence of self-perceived risk and the price of insurance. Second, we find strong evidence of the opposite type of non-linear pricing than predicted by theory: the theory predicts that prices rise with quantity, but we find that they fall. Third, we find that risk is negatively correlated with the quantity of insurance purchased although the theory predicts a positive correlation. Fourth, we find that a substantial fraction of individuals hold multiple insurance contracts, which casts doubt on the prediction that unit prices rise with quantity because multiple small contracts dominate a large one in such a case. Lastly, we test the accuracy of the self-perceived risk of the insured through estimating the induced profits they imply. We conclude by discussing the robustness of these results and the questions they raise for future theoretical models.
Keywords: asymmetric information; insurance; adverse selection; life insurance; mortality risk
JEL Codes: D82; G22; I13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| self-perceived mortality risk (J17) | price of insurance (G52) |
| quantity of insurance purchased (G52) | price of insurance (G52) |
| risk (D81) | quantity of insurance purchased (G52) |
| quantity of insurance purchased (G52) | unit prices (P22) |
| actual mortality risk (J17) | profits estimated using actual risks (G22) |
| self-perceived mortality risk (J17) | profits estimated using self-perceived risks (D81) |