Adverse selection with endogenous information in insurance markets

TLDR

Models of adverse selection assume that risk type is known to the consumer but not to the insurer. The study investigates why consumers seek information and what incentives drive information gathering that leads to adverse selection. The authors analyze equilibria under varying information costs and benefits to characterize when adverse selection arises. They find that information generally has zero or negative social value, but its private value is non‑negative only when insurers cannot observe consumer information or consumers can conceal it, and they discuss welfare implications for genetic and HIV testing policies.

Abstract

Models of adverse selection assume that risk type is known to the consumer but not to the insurer. Many analyses suggest that information has zero social value and negative prior value. Why then would consumers become informed? What is the incentive to gather information and why does adverse selection arise? We show that the private value of information is non-negative only if insurers cannot observe consumers' information status, or if consumers can conceal their informational status. We examine the existence and characterization of equilibria under different configurations of information costs and benefits. Finally, we examine some welfare implications of the endogenous information model for public policy regarding genetic testing and for state regulations concerning HIV testing.