CONSUMER RISK PERCEPTIONS AND INFORMATION IN INSURANCE MARKETS WITH ADVERSE SELECTION

Standard models of adverse selection in insurance markets assume polic yholders know their loss distributions. This study examines the nature of equilibrium and the equilibrium value of information in competitiv e insurance markets where consumers lack complete information regardin g their loss probabilities. We show that additional private informatio n is privately and socially valuable. When the equilibrium policies se parate types, policyholders can deduce the underlying probabilities fr om the contracts, so it is information on risk type, rather than loss probability per se, that is valuable. We show that the equilibrium is ''as if'' policyholders were endowed with complete knowledge if, and o nly if, information is noiseless and costless. If information is noisy , the equilibrium depends on policyholders' prior beliefs and the amou nt of noise in the information they acquire.