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Adverse Selection, Aggregate Uncertainty, and the Role for Mutual Insurance Contracts

Bruce D. Smith and Michael J. Stutzer
The Journal of Business
Vol. 63, No. 4 (Oct., 1990), pp. 493-510
Stable URL: http://www.jstor.org/stable/2353302
Page Count: 18
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Adverse Selection, Aggregate Uncertainty, and the Role for Mutual Insurance Contracts
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Abstract

A model of insurance markets analogous to that of Rothschild and Stiglitz (1976) is considered, with the additional feature that risk-neutral insurers face aggregate (undiversifiable) risk. In the presence of adverse selection and aggregate uncertainty and under a simple nondegeneracy condition on loss probabilities, we show that any equilibrium has the feature that some agents purchase participating policies (from mutual insurers) while others purchase nonparticipating policies (and hence do not share risk with their insurer). Specifically, agents with low loss probabilities signal their type by sharing aggregate risks with their insurer. Some empirical support for this prediction is provided.

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