Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market

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  • JPJames Poterba
    James Poterba
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Abstract
In this paper, we investigate the importance of adverse selection in insurance markets. We use a unique data set, consisting of all annuity policies sold by a large U.K. insurance company since the early 1980s, to analyze mortality differences among individuals who purchased different types of policies. We find systematic relationships between ex-post mortality and annuity policy characteristics, such as whether the annuity will make payments to the estate in the event of an untimely death and whether the payments from the annuity rise over time. These mortality patterns are consistent with the presence of asymmetric information in the annuity market. We find no evidence of substantive mortality differences, however, across annuities of different size, even though models of insurance market equilibrium with asymmetric information would predict such differences. We also find that the pricing of various features of annuity contracts is consistent with the self-selection patterns we find in mortality rates. Our results therefore suggest that selection may occur across many specific features of insurance contracts and that the absence of selection on one contract dimension does not preclude its presence on others. This highlights the importance of considering the detailed features of insurance contracts when testing theoretical models of asymmetric information.

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