Modeling Competition and Market Equilibrium in Insurance: Empirical Issues
In the last decade or so, numerous papers have been devoted to empirical investigations based on contract theory. Many contributions use insurance data, and specifically files provided by firms. A typical paper would analyze the relationship between individual characteristics, the contracts chosen and the corresponding “outcome,” as measured by claims. The natural next step in this research agenda is to model empirically market equilibrium on insurance markets. Empirical models of competitive insurance markets are important in many respects. First, such models are an indispensable first step for the empirical analysis of existing markets. The discussion of optimal pricing strategies or the definition of new insurance contract would greatly benefit from such models. From a policy perspective, the design of any regulation requires estimating its likely impact on the market allocation. For instance, while a ban on specific pricing options (based, say, on gender or age) is often advocated on ethical grounds, a precise assessment of its impact on insurance markets is needed before any decision is made; and an empirical model is required to provide such an assessment.
From a purely theoretical perspective, any description of insurance markets that aims at a modicum of realism needs to come to terms with a host of complex features (horizontal differentiation of products, unobserved heterogeneity of preferences, frictions of various types), the theoretical analysis of which may be forbiddingly complex. A simple model that can be solved or at least numerically simulated may, in that case, be particularly helpful. Finally, a tractable model of insurance equilibrium can be used to run experiments, which should help us understand individual behavior in such strategic settings as competition under asymmetric information. On the other hand, modeling insurance markets raises several theoretical and empirical issues, starting, of course, with the well-known pitfalls in modeling equilibrium in contracts. The goal of the present paper is to discuss these problems and summarize the knowledge acquired so far. We successively discuss modeling of the demand side, the supply side, and the equilibrium itself.
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- American Economic Review
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- March 3, 2015