Background risk and the performance of insurance markets under adverse selection

Keith J. Crocker, Arthur Snow

Research output: Contribution to journalArticle

4 Scopus citations

Abstract

Background risk can influence the performance of insurance markets that must deal with adverse selection when applicants are risk vulnerable, since they are more averse to bearing the insurable risk as a result of their exposures to background risk. We show that background risk always results in a lower deductible for the incentive constrained contract, and that a broader range of markets attains the stable sequential equilibrium cross-subsidized pair of separating contracts. We conclude that background risk always improves the performance of markets for coverage against (insurable) foreground risks that must deal with adverse selection. We also find, however, that these improvements are never sufficient to offset the cost to insureds of bearing the background risk.

Original languageEnglish (US)
Pages (from-to)137-160
Number of pages24
JournalGENEVA Risk and Insurance Review
Volume33
Issue number2
DOIs
StatePublished - Dec 2008

All Science Journal Classification (ASJC) codes

  • Accounting
  • Business, Management and Accounting (miscellaneous)
  • Finance
  • Economics and Econometrics

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