EXPLAINING INSURANCE POLICY PROVISIONS VIA ADVERSE SELECTION

In this article, we show that common insurance policy provisions-namel y, deductibles, coinsurance, and maximum limits-can arise as a result of adverse selection in a competitive insurance market. Research on ad verse selection typically builds on the assumption that different risk types suffer the same size loss and differ only in their probability of loss. In this study, we allow the severity of the insurance loss to be random and, thus, generalize the results of Rothschild and Stiglit z [1976] and Wilson [1977]. We characterize the separating equilibrium contracts in a Rothschild-Stiglitz competitive market. By further ass uming a Wilson competitive market, we show that an anticipatory equili brium might be achieved by pooling, and we characterize the optimal po oling contract.