NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Welfare Cost of Asymmetric Information: Evidence from the U.K. Annuity Market

Liran Einav, Amy Finkelstein, Paul Schrimpf

NBER Working Paper No. 13228
Issued in July 2007
NBER Program(s):   AG   HC   IO   PE

Much of the extensive empirical literature on insurance markets has focused on whether adverse selection can be detected. Once detected, however, there has been little attempt to quantify its importance. We start by showing theoretically that the efficiency cost of adverse selection cannot be inferred from reduced form evidence of how "adversely selected" an insurance market appears to be. Instead, an explicit model of insurance contract choice is required. We develop and estimate such a model in the context of the U.K. annuity market. The model allows for private information about risk type (mortality) as well as heterogeneity in preferences over different contract options. We focus on the choice of length of guarantee among individuals who are required to buy annuities. The results suggest that asymmetric information along the guarantee margin reduces welfare relative to a first-best, symmetric information benchmark by about £127 million per year, or about 2 percent of annual premiums. We also find that government mandates, the canonical solution to adverse selection problems, do not necessarily improve on the asymmetric information equilibrium. Depending on the contract mandated, mandates could reduce welfare by as much as £107 million annually, or increase it by as much as £127 million. Since determining which mandates would be welfare improving is empirically difficult, our findings suggest that achieving welfare gains through mandatory social insurance may be harder in practice than simple theory may suggest.

download in pdf format
   (1796 K)

email paper

The NBER Bulletin on Aging and Health provides summaries of publications like this.  You can sign up to receive the NBER Bulletin on Aging and Health by email.

This paper is available as PDF (1796 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w13228

Users who downloaded this paper also downloaded these:
Mishkin Asymmetric Information and Financial Crises: A Historical Perspective
Cutler, Finkelstein, and McGarry w13746 Preference Heterogeneity and Insurance Markets: Explaining a Puzzle of Insurance
Finkelstein and McGarry w9957 Private Information and its Effect on Market Equilibrium: New Evidence from Long-Term Care Insurance
Einav, Finkelstein, and Cullen w14414 Estimating Welfare in Insurance Markets Using Variation in Prices
Freedman and Jin w16855 Learning by Doing with Asymmetric Information: Evidence from Prosper.com
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us