Optimal Mandates and The Welfare Cost of Asymmetric Information: Evidence from the U.K. Annuity Market

Much of the extensive empirical literature on insurance markets has focused on whether adverse selection can be detected. Once detected, however, there has been little attempt to quantify its welfare cost, or to assess whether and what potential government interventions may reduce these costs. To do so, we develop a model of annuity contract choice and estimate it using data from the U.K. annuity market. The model allows for private information about mortality risk as well as heterogeneity in preferences over different contract options. We focus on the choice of length of guarantee among individuals who are required to buy annuities. The results suggest that asymmetric information along the guarantee margin reduces welfare relative to a first best symmetric information benchmark by about $127 million per year, or about 2 percent of annuitized wealth. We also fi nd that by requiring that individuals choose the longest guarantee period allowed, mandates could achieve the first-best allocation. However, we estimate that other mandated guarantee lengths would have detrimental e¤ects on welfare. Since determining the optimal mandate is empirically difficult, our fi ndings suggest that achieving welfare gains through mandatory social insurance may be harder in practice than simple theory may suggest

Beyond Statistics: The Economic Content of Risk Scores

"Big data" and statistical techniques to score potential transactions have transformed insurance and credit markets. In this paper, we observe that these widely-used statistical scores summarize a much richer heterogeneity, and may be endogenous to the context in which they get applied. We demonstrate this point empirically using data from Medicare Part D, showing that risk scores confound underlying health and endogenous spending response to insurance. We then illustrate theoretically that when individuals have heterogeneous behavioral responses to contracts, strategic incentives for cream-skimming can still exist, even in the presence of "perfect" risk scoring under a given contract. (JEL C55, G22, G28, H51, I13)National Institute on Aging (R01 AG032449