Asymmetric Information Problems in Taiwan's Automobile Insurance Market: The Effect of Policy Design on Loss Characteristics

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ABSTRACT

This article investigates asymmetric information problems for the automobile insurance market in Taiwan. Using panel data for the comprehensive automobile insurance coverage from 1995 to 1999, this article analyzes how types of coverage, deductible amounts, and experience ratings have affected the adverse selection and moral hazard problems in Taiwan's automobile insurance market. The empirical results provide partial evidence to demonstrate that the loss frequency and loss ratio were reduced by the addition of self-selection mechanisms in policies with different levels of coverage. In addition, the deductible amounts, experience ratings, and better control of underwriting and claims processing were shown possibly to have decreased potential losses from adverse selection and moral hazard problems.

INTRODUCTION

Asymmetric information has been one of the major topics in insurance research since Rothschild and Stiglitz (1976) and Shavell (1979) pioneered the development of the theoretical framework of moral hazard and adverse selection for insurance. Their work inspired a number of other researchers in the area of insurance theory over the past two decades-e.g., Miyazaki, 1977; Wilson, 1977; Radner, 1981; Holmstrom, 1982; Dionne, 1983; Rubinstein and Yarri, 1983; Crocker and Snow, 1986; Cooper and Hayes, 1987; Arnott and Stiglitz, 1988; Hellwig, 1988; Hosios and Peters, 1989; Hoy, 1989; Mookerjee and Png, 1989; Abreu, Pearce, and Stacchetti, 1990. The theoretical literature has identified many insightful concepts (such as incomplete coverage, commitment, renegotiation, and self-selection mechanisms) for understanding asymmetric information in the insurance market. Moreover, several more recent papers (including Dahlby, 1983; Dionne and Doherty, 1994; Puelz and Snow, 1994; and Chiappori and Salanie, 1997) have used data from automobile insurance to conduct further empirical tests to investigate whether asymmetric information problems exist in each insurance market.

On the other hand, adverse selection and moral hazard problems are also well recognized by insurers in real practice. In addition, insurance companies have developed many provisions-such as deductibles, co-insurance, and experience ratings-to reduce possible losses caused by adverse selection and moral hazard problems. For example, insurers may design different types of insurance coverages and deductible amounts with different costs to sort out the varying risk levels of the insured. Insurers have also used experience ratings in automobile insurance and workers compensation to control potential problems of asymmetric information.

In Taiwan, it has been widely believed that comprehensive automobile insurance coverage has long suffered from very severe asymmetric information problems. Insurance companies in Taiwan have developed several methods to overcome these problems. To explore these problems with empirical evidence, I have collected panel data for automobile insurance from 1995 to 1999 to account for how different types of coverage, deductible amounts, and experience rating systems affect adverse selection and moral hazard problems. In addition, I also address how automobile insurers in Taiwan have developed a self-selection mechanism for comprehensive coverage to deal with asymmetric information problems.

The empirical evidence provided in this aricle confirms that there may exist asymmetric information problems in comprehensive automobile insurance coverage in Taiwan. Moreover, the empirical results provide partial evidence to demonstrate that loss frequencies and loss ratios were reduced by self-selection mechanisms included in the contracts with different levels/costs of coverage. In addition, the deductible amounts and experience rating systems were found to decrease possible losses from moral hazard and adverse selection problems.

The next section of this article reviews automobile insurance and comprehensive coverage in Taiwan. …