An Examination of Adverse Selection in the Public Provision of Insurance

Abstract

Using a unique data set from Florida's residual property insurer, we test for adverse selection in the public provision of homeowners' insurance in Florida. We find a significant relationship between the losses and deductible choices of insureds in Florida's residual homeowners' insurance market. This relationship provides strong evidence of the existence of an adverse selection problem in Florida's residual property insurance market. While this relationship is important to Florida regulators (and taxpayers) specifically, a finding of an adverse selection problem in residual markets in general has implications more broadly for government providers of insurance as an adverse selection problem in these settings will impact the public policy debates and decisions involving these markets.

Residential property insurance and markets: Florida's QUASR data

“…In terms of market failure and disruption, Hurricane Andrew (1992) was a major event for the Florida property insurance market. The Florida legislature responded in 1995 with a series of legislative solutions designed in part to stabilize the insurance market and provide mechanisms for releasing information to market participants and other stakeholders (Dumm et al, 2013). The Florida Hurricane Catastrophe Fund was created to improve market stability while the disclosure and audit requirements of the Florida Commission on Hurricane Loss Projection Methodology and the Quarterly Supplemental Report (QUASR) are examples of the latter objective.…”

Citizens and the Florida residential property market: how to return to an insurer of last resort

“…Dumm et al (2017Dumm et al ( , 2020 consider the behavioral aspects of the demand for homeowners insurance and conclude that near-term loss experience tends to affect the demand for insurance, whereas with the passage of time, the demand for insurance lessens in urgency and importance. Dumm et al (2013) uses Citizens data to show that policyholders with a higher likelihood of loss tend to choose a lower deductible and, as a result, may adversely select against an insurer. This result has implications for rating as well as for a residual market insurer.…”

Asymmetric Information in the Home Insurance Market

“…From standard textbook models, we know that in insurance markets characterized by asymmetric information, a theoretically robust equilibrium result is that high‐risk agents acquire more insurance than low‐risk agents (Rothschild and Stiglitz, ). In recent years, several studies have empirically investigated this prediction using data from various insurance markets including, for example, Chiappori and Salanié (), Finkelstein and Poterba (), Cohen (), Chiappori, Jullien, Salanié, and Salanié (), Finkelstein and McGarry (), Bolhaar, Lindeboom, and van der Klaauw (), Dumm, Eckles, and Halek (), Spindler, Winter, and Hagmayer (), Su and Spindler (), Olivella and Vera‐Hernández (), and Zavadil (Forthcoming)…”

“…To the best of our knowledge, one previous study has addressed asymmetric information in the home insurance market—Dumm, Eckles, and Halek (). They study the residual homeowner market in Florida and find evidence of adverse selection.…”

“…In their analysis of the homeowners market in Florida, Dumm, Eckles, and Halek () do not report that gender is used as a tariff variable. In the market we consider here, however, women were found to be more risky and the tariff reflected this risk difference until January 1, 2004 (where gender was removed due to the tariff reform).…”