Testing for Adverse Selection in Insurance Markets

This article reviews and evaluates the empirical literature on adverse selection in insurance markets. It focuses on empirical work that seeks to test the basic coverage–risk prediction of adverse selection theory—that is, that policyholders who purchase more insurance coverage tend to be riskier. The analysis of this body of work, it is argued, indicates that whether such a correlation exists varies across insurance markets and pools of insurance policies. Discuss various reasons why a coverage–risk correlation may not be found in some pools of insurance policies. The presence of a coverage–risk correlation can be explained either by moral hazard or adverse selection, and discusses methods for distinguishing between them. Finally, reviews the evidence on learning by policyholders and insurers.

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