GGeeoorrggiiaa SSttaattee UUnniivveerrssiittyy SScchhoollaarrWWoorrkkss @@ GGeeoorrggiiaa SSttaattee UUnniivveerrssiittyy Risk Management and Insurance Dissertations Department of Risk Management and Insurance Summer 8-1-2010 EEssssaayyss oonn AAddvveerrssee SSeelleeccttiioonn aanndd MMoorraall HHaazzaarrdd iinn IInnssuurraannccee MMaarrkkeett Jian Wen Central University of Finance and Economics Follow this and additional works at: https://scholarworks.gsu.edu/rmi_diss Part of the Insurance Commons RReeccoommmmeennddeedd CCiittaattiioonn Wen, Jian, "Essays on Adverse Selection and Moral Hazard in Insurance Market." Dissertation, Georgia State University, 2010. doi: https://doi.org/10.57709/1433102 This Dissertation is brought to you for free and open access by the Department of Risk Management and Insurance at ScholarWorks @ Georgia State University. It has been accepted for inclusion in Risk Management and Insurance Dissertations by an authorized administrator of ScholarWorks @ Georgia State University. For more information, please contact [email protected]. Permission to Borrow In presenting this dissertation as a partial fulfillment of the requirements for an advanced degree from Georgia State University, I agree that the Library of the University shall make it available for inspection and circulation in accordance with its regulations governing materials of this type. I agree that permission to quote from, or to publish this dissertation may be granted by the author or, in his/her absence, the professor under whose direction it was written or, in his absence, by the Dean of the Robinson College of Business. Such quoting, copying, or publishing must be solely for scholarly purposes and does not involve potential financial gain. It is understood that any copying from or publication of this dissertation which involves potential gain will not be allowed without written permission of the author. Student’s Name: Jian Wen 1 Notice to Borrowers All dissertations deposited in the Georgia State University Library must be used only in accordance with the stipulations prescribed by the author in the preceding statement. The author of this dissertation is: Name: Jian Wen Address: 39 South College Rd, Haidian District Beijing, China, 100081 The director of this dissertation is: His/Her Name: Martin F. Grace Department: Risk Management and Insurane Department Address: PO Box 4036, Georgia State University Atlanta, GA 30302 2 ESSAYS ON ADVERSE SELECTION AND MORAL HAZARD IN INSURANCE MARKET BY JIAN WEN A Dissertation Submitted in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy in the Robinson College of Business of Georgia State University GEORGIA STATE UNIVERSITY ROBINSON COLLEGE OF BUSINESS 2010 3 Copyright by Jian Wen 2010 4 ACCEPTANCE This dissertation was prepared under the direction of the candidate’s Dissertation Committee. It has been approved and accepted by all members of that committee, and it has been accepted in partial fulfillment of the requirements for the degree of Doctor in Philosophy in Business Administration in the Robinson College of Business of Georgia State University. H. Fenwick Huss Dean Robinson College of Business Dissertation Committee: Dr. Martin F. Grace (Chair) Dr. Robert W. Klein Dr. Mary Beth Walker Dr. Zhiyong Liu 5 ABSTRACT ESSAYS ON ADVERSE SELECTION AND MORAL HAZARD IN INSURANCE MARKET By JIAN WEN July 30, 2010 Committee Chair: Dr. Martin F. Grace Major Department: Department of Risk Management and Insurance Essay One examines the asymmetric information problem between primary insurers and reinsurers in the reinsurance industry and contributes uniquely to the separation of adverse selection from moral hazard, if both are present. A two-period principal-agent model is set up to identify the signals of adverse selection and moral hazard generated by the actions of the primary insurer and to provide a basis for corresponding hypotheses for empirical testing. Using data from the National Association of Insurance Commissioners (NAIC) and A.M. Best Company, the empirical tests show that the problem of adverse selection exists in the reinsurance market between the affiliated insurers and non-affiliated reinsurers, and even between closely related affiliated insurers and reinsurers. There is no evidence indicating the presence of moral hazard in the reinsurance market. To address the issue of soaring property insurance premiums and coverage availability in states that are subject to hurricane risks, state and federal governments have not only regulated the private insurance market but have also intervened directly into markets by establishing government-funded insurance programs. With coexisting public and private insurance 6 mechanisms and price regulation, the risk of cross subsidization and a subsequent moral hazard problem may arise. By using data from the Florida Citizens Insurance Corporation, the Florida Hurricane Catastrophe Fund, the Flood Insurance and the private homeowner insurance market in Florida from 1998 to 2007, the second essay examines the moral hazard problems arising from government regulation and involvement in the private insurance sector. In sum, the provision of national flood insurance is found to be positively related to the population growth in the state of Florida, which shows that state immigrants can take advantage of the lower cost of flood insurance when relocating in higher-risk areas. Further, we find that national flood insurance and the catastrophe fund complement the development of the private insurance sector, while the residual market hinders the development of private property insurance market. 7 Essay One Distinguishing Different Effects of Asymmetric Information: Evidence from Property and Liability Reinsurance Market 8 Abstract This essay examines the asymmetric information problem between primary insurers and reinsurers in the reinsurance industry and contributes uniquely to the separation of adverse selection from moral hazard, if both are present. A two-period principal-agent model is set up to identify the signals of adverse selection and moral hazard generated by the actions of the primary insurer and to provide a basis for corresponding hypotheses for empirical testing. Using data from the National Association of Insurance Commissioners (NAIC) and A.M. Best Company, the empirical tests show that the problem of adverse selection exists in the reinsurance market between the affiliated insurers and non-affiliated reinsurers, and even between closely related affiliated insurers and reinsurers. There is no evidence indicating the presence of moral hazard in the reinsurance market. 9