Econometrica: Sep, 1979, Volume 47, Issue 5

Insurance and Individual Incentives in Adaptive Contexts

https://doi.org/0012-9682(197909)47:5<1195:IAIIIA>2.0.CO;2-J
p. 1195-1208

W. Kip Viscusi

Opportunities for individual learning in multi-period insurance contexts introduce fundamental economic aspects not present in conventional static models. Using a two-period model in which there are two states (accident and no accident), it is shown that more precise prior probability assessments lead to increased insurance coverage and reduced self-protection. These dynamic adverse incentive problems can be diminished by merit rating, which has a backwards influence on earlier actions. Self-protection and insurance purchases in the initial period respond in opposite fashion to changes in insurance pricesin the second period, the interest rate, and parameters of the prior probability assessment.