Monday, May 25, 2015

Hyperbolic discounting, forgotten once again

Lemons or Cherries? Asymmetric Information in the German Private Long-term Care Insurance Market

Is there adverse or advantageous selection in german private long-term care insurance market?. This is the question that addresses this article:
There are two predominant theories as to the effects of asymmetric information on the purchase of insurance. One theory, known as the “lemons principle”, concentrates on adverse selection, and suggests that high-risk agents choose to purchase more insurance coverage than do low-risk agents.1 A testable prediction of adverse selection theory is that risk occurrence is positively correlated with insurance coverage.
The second theory as to the effects of asymmetric information concentrates on advantageous selection. This theory is also called “cherry picking”.2 Advantageous selection stresses the role of individuals’ risk aversion and argues that more risk-averse agents are both more willing to purchase insurance and more cautious.3 In the presence of advantageous selection, insurance coverage and risk occurrence are negatively correlated.
The conclusion is:
Although individuals’ self-assessment of poor health predicts their future care needs very well, such assessments are not necessarily reflected in insurance demand.
The dominating effect of adverse selection in the German private LTC insurance market gives support to the conventional claim that asymmetric information distorts market efficiency and results in lack of insurance demand.
In fact, these results are irrelevant as long as the effect of hyperbolic discounting has not been taken into account. Therefore, although it has been published in a widely read journal, you can skip it without any implication.


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