Advantageous selection without moral hazard

Abstract

Advantageous selection occurs when the agents most eager to buy insurance are also the cheapest ones to insure. Hemenway (1990) links it to differences in risk-aversion among agents, implying different prevention efforts, and finally different riskinesses. We argue that it may also appear when agents share the same attitude towards risk, and in the absence of moral hazard. Using a standard asymmetric information setting satisfying a single-crossing property, we show that advantageous selection may occur when several contracts are offered, or when agents also face a non-insurable background risk, or when agents face two mutually exclusive risks that are bundled together. We illustrate this last effect in the context of life care annuities, a product bundling long-term care insurance and annuities, by constructing a numerical example based on Canadian survey data.

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Reference

Philippe De Donder, Marie-Louise Leroux, and François Salanié, “Advantageous selection without moral hazard”, TSE Working Paper, n. 22-1334, May 2022, revised April 25, 2023.