SSE/EFI Working Paper Series in Economics and Finance
Does Adverse Selection Matter? Evidence from a Natural Experiment
Abstract: The empirical evidence of adverse selection in insurance
markets is mixed. The problem in assessing the extent of adverse selection
is that private information, on which agents act, is generally unobservable
to the researcher, which makes it difficult to distinguish between adverse
selection and moral hazard. Unique micro data, from a dental insurance
natural experiment, is here used to provide a direct test of selection. All
agents in a population were stratified into different risk classes, and
were unexpectedly given the opportunity to insure their dental care costs.
The setup of the insurance makes it possible to observe a proxy for private
information. Interestingly, results differ across risk classes. Within
high-risk classes, there is evidence of adverse selection and within
low-risk classes, the results, surprisingly, indicate an advantageous
selection. This dual selection can explain the limited empirical evidence
for adverse selection in insurance markets in the literature: the two
effects may balance out on the aggregate level. The paper also presents a
model of insurance choice that can harbor both adverse and advantageous
selection. The pattern in the data is explained by differences in the
effectiveness of prevention across high and low risk classes.
Keywords: Asymmetric information; Adverse Selection; Advantageous Selection; Health Insurance; (follow links to similar papers)
JEL-Codes: D81; D82; G22; I11; (follow links to similar papers)
38 pages, November 10, 2004
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