DP2269 Competitive Insurance Markets Under Adverse Selection and Capacity Constraints

Author(s):	Roman Inderst, Achim Wambach
Publication Date:	October 1999
Keyword(s):	Asymmetric Information, Capacity Constraints, Competitive Equilibrium, Insurance Markets
JEL(s):	C72, C78, D82, G22
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=2269

Ever since the seminal work by Rothschild and Stiglitz (1976) on competitive insurance markets under adverse selection the equilibrium-non-existence problem has been one of the major puzzles in insurance economics. We extend the original analysis by considering firms that face capacity constraints due to limited capital. Two scenarios are considered: if the demand at any insurer exceeds the capacity: either consumers are rationed, or they are served, but the insurer faces a larger risk of bankruptcy. We show under mild assumptions that a pure strategy equilibrium exists, where every consumer buys his appropriate Rothschild-Stiglitz contract.