Medical insurance with rank-dependent utility |
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Authors: | Matthew J Ryan Rhema Vaithianathan |
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Institution: | (1) School of Economics, Australian National University, Canberra, ACT 0200, AUSTRALIA (e-mail: matthew.ryan@anu.edu.au) , AU;(2) Economics Programme, RSSS, Australian National University, Canberra, ACT 0200, AUSTRALIA (e-mail: rhema@coombs.anu.edu.au) , AU |
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Abstract: | Summary. A well-known result in the medical insurance literature is that zero co-insurance is never second-best for insurance contracts
subject to moral hazard. We replace the usual expected utility assumption with a version of the rank-dependent utility (RDU)
model that has greater experimental support. When consumers exhibit such preferences, we show that zero co-insurance may in
fact be optimal, especially for low-risk consumers. Indeed, it is even possible that the first-best and second-best contracts
are identical. In this case, there is no “market failure”, despite the informational asymmetry. We argue that these RDU results are in
better accord with the empirical evidence from US health insurance markets.
Received: February 26, 2001; revised version: October 4, 2002
RID="*"
ID="*"The authors would particularly like to thank Simon Grant, John Quiggin, Peter Wakker and an anonymous referee for valuable
comments and suggestions on earlier drafts. The paper has also benefitted from the input of seminar audiences at The Australian
National University, University of Auckland, University of Melbourne and University of Sydney. Ryan also gratefully acknowledges
the financial support of the ARC, through Grant number A000000055.
Correspondence to:R. Vaithianathan |
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Keywords: | and Phrases: Health insurance Rank-dependent expected utility Co-insurance Inverse-S transformation |
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