Mark J. Browne

Information Asymmetries and Adverse Selection in the Market for Individual Medical Expense Insurance

Introduction Both theoretical and empirical studies have found that adverse selection in an insurance market reduces consumption of insurance by low risk insureds. The theoretical works of Akerlof (1970), Rothschild and Stiglitz (1976), Miyazaki (1977), and Wilson (1977) describe separating equilibria, where high risks purchase a policy with higher coverage than the policy that is purchased by low risks. Miyazaki extends the separating model to allow cross-policy subsidization, resulting in a wealth transfer from low risks to high risks. In addition to a separating equilibrium, Wilson describes a pooling model where high and low risks purchase the same policy so that low risks actually subsidize the insurance purchases of high risks. The empirical evidence generally supports the predictions of these theoretical models. Beliveau (1981) found that adverse selection leads to reduced insurance consumption by low risks in the life insurance market, and Dahlby (1983) and Puelz (1990) found similar results in the automobile insurance market. Browne and Doerpinghaus (1993) found evidence of adverse selection in the market for private supplemental medical insurance for the elderly. In another study, Browne (1992a) found that low risk individuals had less complete coverage in the individual medical insurance market than in the group market, where adverse selection is believed to be less problematic. Additionally, Browne found evidence that low risks subsidize the insurance consumption of high risks in the individual medical insurance market. His results could be explained by the presence of adverse selection or by low risks receiving more coverage in the group market than they would choose if they were purchasing insurance on their own in the individual market. His study does not address whether Miyazakis separating model or Wilsons pooling model better characterizes the individual medical insurance market. This study extends empirical investigation of the individual medical insurance market and directly tests whether there is reduced consumption of insurance by low risks, whether a separating or pooling model best characterizes the market, and whether cross-subsidization from low to high risks occurs. The Data, the Model and Hypotheses The Data and Potential Tests The data used in the study are from the National Medical Care Expenditure Survey (NMCES) conducted during 1977 and 1978.(1) Only families for which the primary insured had nongroup, individually purchased medical expense insurance and for which complete insurance policy data are available are included for analysis. The data contain extensive demographic information on those insured, including age, sex, marital status, income, and geographic location. In addition, the data contain information on any activity limitations that the insured may have as well as a measure of self-reported health status.(2) In the study, insureds are classified as being low risk if the self-reported health status of family members is excellent, good, or fair, and they are classified as high risk if the self-reported health status of any family member is poor.(3) The health status data were collected ex ante in the first of the five rounds of interviews conducted during the two-year period covered by the study so that health status information does not reflect the insureds revised expectations based on actual claims history during the covered period.(4) Using the demographic data, the activity limitation variable, and the self-reported health status variable allows for not only a test of risk-induced insurance purchase but isolation of the component of risk (self-reported health status) about which insurers are by definition asymmetrically informed.(5) Demographic and health status information from the sample are summarized in Table 1. TABULAR DATA OMITTED Detailed data on the policies purchased by individuals (such as policy premiums, deductible amounts, out-of-pocket maximum limits, and policy coverage limits) allow for measurement of the completeness of coverage provided by each insurance policy. …

Economic and Market Predictors of Insolvencies in the Property-Liability Insurance Industry

This article identifies a set of factors exogenous to individual property-liability insurers that are statistically related to the overall rate of insurer insolvencies. This approach represents a departure from the methodologies of prior studies which have focused primarily on firm-specific characteristics in assessing insolvency risk. The study uses quarterly data for the period 1970 through 1990. The empirical results support the hypothesis that economic and insurance market variables are important predictors of property-liability insurer failure rates. The sensitivity of the insurer insolvency rate to two of the insurance market factors is particularly striking: A 10 percent reduction in the number of property-liability insurers results in an 82 percent reduction in the insolvency rate, all else equal. A reduction of five points in the combined ratio results in an 18 percent reduction in the insolvency rate.

ECONOMIC AND MARKET PREDICTORS OF INSOLVENCIES IN THE LIFE-HEALTH INSURANCE INDUSTRY

This study identifies factors exogenous to individual insurers that are statistically related to the overall rate of life-health insurer insolvencies. This is a departure from the methodologies of prior studies, which have focused primarily on firm-specific characteristics in assessing insolvency risk. Empirical analysis is based on quarterly data from 1972 through 1994. Results indicate that life-health insurer insolvencies are positively related to increases in long-term interest rates, personal income, unemployment, the stock market, and to the number of insurers, and negatively related to real estate returns. Findings support the hypothesis that economic and market variables are important predictors of life-health insurer failure rates.

The Effect of Legal Rules on the Value of Economic and Non-Economic Damages and the Decision to File

This study focuses on the economic consequences of tort reform. In particular, we address two issues. First, we test the relationship between tort reforms and claim severity for an automobile liability incident while controlling for a variety of cost drivers including the presence of no-fault rules, and the impact of a plaintiffs attorney. In addition to examining the effect of tort reforms on total claim severity, we also test their effect on economic and non-economic damages separately. Second, we test the proposition that tort reforms, by reducing the damages available at trial, have reduced the likelihood that an injured party will seek legal remedy. Both aspects of this study are examined with individual data from a large sample of insurance claims from 61 insurers. Our results suggest that many of the reforms have had a statistically significantly effect on total damages, non-economic damages and economic damages. Caps on non-economic damages, collateral source rule reforms, and minor reforms impacting prejudgment interest, frivolous suits, and provisions for periodic payments are negatively related to the value of non-economic claims, while joint and several reform is positively related to the value of non-economic claims. We find collateral source rule reforms and minor reforms are negatively related to the value of economic claims. We find that caps on non-economic damages and minor reforms are associated with a decreased probability to file. We do not find any evidence that joint and several or collateral source rule reform is associated with the decision to file.

Don’t They Care? Or, Are They Just Unaware? Risk Perception and the Demand for Long-Term Care Insurance

The potential need for long-term care (LTC) is one of the greatest financial risks faced not only by the elderly but also by their adult children, who often provide care or financial assistance. We investigate adult childrens role in the demand for LTC insurance. Similar to flood insurance, we find that demand for LTC insurance is low due to low risk perception. The more aware adult children are of the risk, the more likely LTC insurance is to be purchased, either by the children themselves on behalf of their parents or by the parents under the influence of their children.

Statutory Rules, Attorney Involvement, and Automobile Liability Claims

The cost associated with an automobile liability incident in the United States has been hypothesized to be related to different tort reform statutes, the presence of no-fault rules, and the impact of a plaintiff s attorney. This article tests these relationships and reports the marginal impact of variables related to liability claims with individual loss data from a representative insurer. Among major tort reforms, our analysis reveals that punitive damage limits, caps on noneconomic damages, and minor reforms (sanctions on frivolous suits or defenses, prejudgment interest, and provisions for structured settlements) are associated with a reduced individual claim severity. Reform of the joint and several liability rule is associated with an increased individual claim severity in this insurance market. Low dollar thresholds and add-on no-fault rules increase liability claim severity, while no statistically significant difference in claim severity is found when the claim is subject to verbal threshold rules relative to tort law. Finally, attorney involvement is associated with a 64 percent increase in the average claim size.

The Effect of Bad-Faith Laws on First-Party Insurance Claims Decisions

This study sets forth the legal distinctions among bad‐faith laws and provides a theoretical foundation for our hypotheses that bad‐faith laws affect both economic and noneconomic damage amounts. We use data that include information about uninsured and underinsured “closed claims”—that is, claims that have either been settled or been paid or closed after trial—under automobile policies from over 60 insurance companies in 38 jurisdictions in 1992. While controlling for multiple other factors that are expected to be associated with the size of settlement payments, we exploit differences in state laws that govern insurer bad faith to examine empirically whether bad‐faith remedies affect the size of settlement payments and the allocation of settlement payments between economic and noneconomic damages. We find a positive correlation between the existence of a bad‐faith remedy and higher settlement payments. This correlation exists for both economic and noneconomic damages.

A Theory of the Demand for Underwriting

We examine the demand for underwriting and its effect on equilibrium in an insurance market in which insureds know their risk type, but insurers do not. Our analysis indicates that a set of policies including one that requires buyers to take an underwriting test can constitute a full coverage Nash equilibrium when perfect classification is possible. We also find that underwriting equilibria, in which low risks obtain greater coverage than they would without underwriting, widely exist in a Wilsonian market with nonmyopic insurers. Our findings provide a potential explanation for why empirical evidence on adverse selection is mixed.

Explaining Insurance Policy Provisions via Adverse Selection

In this article, we show that common insurance policy provisions—namely, deductibles, coinsurance, and maximum limits—can arise as a result of adverse selection in a competitive insurance market. Research on adverse selection typically builds on the assumption that different risk types suffer the same size loss and differ only in their probability of loss. In this study, we allow the severity of the insurance loss to be random and, thus, generalize the results of Rothschild and Stiglitz [1976] and Wilson [1977]. We characterize the separating equilibrium contracts in a Rothschild-Stiglitz competitive market. By further assuming a Wilson competitive market, we show that an anticipatory equilibrium might be achieved by pooling, and we characterize the optimal pooling contract.

Claims Adjudication in the Personal Automobile Insurance Residual Market

Government high-risk insurance plans vary in terms of structure and operation. In automobile insurance, most states have an assigned risk plan (ARP), while a few have a joint underwriting association (JUA). ARPs and JUAs are similar in their purpose: to provide state-mandated automobile insurance coverages to high-risk drivers. They are, however, fundamentally different in their structure and operation. This article analyzes the differences in claims payment practices between these two forms of automobile residual market facility used in the United States. This study predicts that, due to differences in incentives, JUAs result in higher claims payments on the part of insurers. The empirical results are consistent with the prediction.