Full Insurance, Bayesian Updated Premiums, and Adverse Selection |
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Authors: | Richard Watt and Francisco J. Vazquez |
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Affiliation: | (1) Departamento de An´lisis Económico, Universidad Autónoma de Madrid, 28049 Madrid, Spain;(2) C.U. Francisco de Vitoria, Ctra. Pozuelo-Majadahonda Km. 1,800, 28223 Pozuelo de Alarcón, Madrid, Spain |
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Abstract: | In the classic Rothschild-Stiglitz model of adverse selection in a competitive environment, we analyse a no-claims bonus type contract (bonus-malus). We show that, under full insurance coverage, if the insurance company applies Bayes's rule to learn about client probability types over time and uses this information in premium calculations for contract renewals, then there exist conditions under which all client types strictly prefer the Bayesian updating contract to the classic Rothschild-Stiglitz separating equilibrium. |
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Keywords: | insurance adverse-selection Bayesian learning |
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