The Econometric SocietyEdited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262
Econometrica: Sep, 2013, Volume 81, Issue 5
https://doi.org/10.3982/ECTA10931
p. 1713-1762
Nathaniel Hendren
Across a wide set of nongroup insurance markets, applicants are rejected based on observable, often high‐risk, characteristics. This paper argues that private information, held by the potential applicant pool, explains rejections. I formulate this argument by developing and testing a model in which agents may have private information about their risk. I first derive a new no‐trade result that theoretically explains how private information could cause rejections. I then develop a new empirical methodology to test whether this no‐trade condition can explain rejections. The methodology uses subjective probability elicitations as noisy measures of agents' beliefs. I apply this approach to three nongroup markets: long‐term care, disability, and life insurance. Consistent with the predictions of the theory, in all three settings I find significant amounts of private information held by those who would be rejected; I find generally more private information for those who would be rejected relative to those who can purchase insurance, and I show it is enough private information to explain a complete absence of trade for those who would be rejected. The results suggest that private information prevents the existence of large segments of these three major insurance markets.
Appendix A contains the proof of Theorem 1 and discusses Remark 1. Appendix B provides proofs for the lower bound approach discussed in Section 4.1. Appendix C discusses the data, including details for the covariate specifications and the sample selection. Appendix D discusses the empirical specification for the lower bound estimator, presents the decomposition discussed in Section 6.3, and presents additional robustness checks referred to in Section 6.5. Section E provides details on the specification and estimation of the structural approach referred to throughout Section 7. Finally Section F presents a selection of pages from the LTC underwriting guidelines of Genworth Financial.
This zip file contains the replication files for the manuscript.
