Can Multi-Peril Insurance Policies Mitigate Adverse Selection?

Abstract

The objective of this paper is to pursue an intuitive idea: for a consumer who represents an “unfavorable” health risk but an “excellent risk” as a driver, a multi-peril policy could be associated with a reduced selection effort on the part of the insurer. If this intuition should be confirmed, it will serve to address the decade-long concern with risk selection both in the economic literature and on the part of policy makers. As an illustrative example, a two-peril model is developed in which consumers deploy effort in search of a policy offering them maximum coverage at the current market price while insurers deploy effort designed to stave off unfavorable risks. Two types of Nash equilibria are compared: one in which the insurer is confronted with high-risk and low-risk types, and another one where both types are a “better risk” with regard to a second peril. The difference in the insurer’s selection effort directed at high-risk and low-risk types is indeed shown to be lower in the latter case, resulting in a mitigation of adverse selection.

Keywords

• adverse selection
• risk selection
• consumer search effort
• insurer selection effort