Private Information and Insurance Rejections
Econometrica · 2013 · Volume 81 · Issue 5
Abstract
Across a wide set of nongroup insurance markets, applicants are rejected based on observable, often high-risk, characteristics. This paper argues that private information, held by the potential applicant pool, explains rejections. I formulate this argument by developing and testing a model in which agents may have private information about their risk. I first derive a new no-trade result that theoretically explains how private information could cause rejections. I then develop a new empirical methodology to test whether this no-trade condition can explain rejections. The methodology uses subjective probability elicitations as noisy measures of agents' beliefs. I apply this approach to three nongroup markets: long-term care, disability, and life insurance. Consistent with the predictions of the theory, in all three settings I find significant amounts of private information held by those who would be rejected; I find generally more private information for those who would be rejected relative to those who can purchase insurance, and I show it is enough private information to explain a complete absence of trade for those who would be rejected. The results suggest that private information prevents the existence of large segments of these three major insurance markets.
Keywords
Private information, adverse selection, insurance
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