INSURER CONTRACT NONPERFORMANCE IN A MARKET WITH ADVERSE SELECTION

In this study we examine the impact of insurer contract nonperformance upon Wilson's adverse selection equilibrium where consumers exhibit c onstant absolute risk aversion. When the market equilibrium retains it s original form (i.e., pool or separation), premiums and coverage leve ls generally fall, although the change in coverage level for good risk s is ambiguous when the equilibrium is separating. When the market equ ilibrium changes form, the change in premium and coverage levels is ge nerally ambiguous, although one can determine that good risk premiums go down when the equilibrium shifts from pooling to separating and tha t bad risk premiums and coverage levels go down when the equilibrium s hifts from separating to pooling. Interestingly, we find that although the introduction of insurer default risk makes good risks worse off, this is not necessarily true for bad risks. Bad risks can be better of f because the decrease in the price differential between types can mak e pooling relatively more attractive to good risks in the presence of default risk.