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Testing for Asymmetric Information in the Automobile Insurance Market

The reason for the difference is that Crocker and Snow’s competitive model assumes that all insurers obtain more information from costless categorical discrimination, while we consider the case in which only one insurer is able to costlessly discriminate and become well-informed. Barros (1993) briefly noted that well-informed insurers would be able to earn nonnegative profits in a competitive market where other insurers were not as well-informed of risk types. We extend his analysis by examining welfare, and by considering how the situation changes when there is pooling of different risk types. It is in this latter case that an interesting welfare result arises, in which having a single well-informed insurer may actually lead to a reduction in efficiency. This result, we suggest, is not merely of academic interest, given the advent of patented EDR technologies which will create informational advantages to the patentee. We extend the seminal Rothschild and Stiglitz (1976) model by adding one firm which is well-informed regarding consumer risk type. We consider two different situations: one in which competitive insurers respond to adverse selection with separating contracts, and one in which there is pooling as consumers do not know their own risk type.