Equilibrium and Strategic Communication in the Adverse Selection Insurance Model

Abstract

Shows equilibrium always exists (Rothschild-Stiglitz-Wilson model) when firms enforce policy exclusivity via strategic (profit-maximizing) communication of client purchases. Strategic communication induces two equilibrium types: partial communication of purchase information or non-communication which exhibits a lemon effect (low-risk purchase no insurance). Nonetheless, Jaynes' configuration (Jaynes; Beaudry & Poitevin) allocating both risk-types a low-coverage pooling contract and high-risk supplementary expensive coverage always characterizes equilibrium including Perfect Bayesian Equilibrium in Hellwig's two-stage framework where inter-firm informational asymmetries impose additional "competitive" features. Adverse selection induces salient features of financial markets: Bertrand-Edgeworth competition, latent contracts, strategic exclusivity-policy cancellation tactics, market institutions for sharing information.

Keywords: Adverse selection, Insurance, Communication of information, Pooling contract

JEL Classification: D82, G22