Does asymmetric information matter in the early insurance market? Evidence from the auto insurance market†

Abstract

In the late 1960s, the performance of automobile insurance declined dramatically in Japan in spite of rapid growth in the diffusion rate, and the premiums were sharply raised several times in order to improve the situation. This observation indicates the possible presence of adverse selection (death spiral), and provides an ideal situation for assessing informational asymmetry. Using bodily injury liability (BIL) insurance data from 46 Japanese prefectures over the period 1966 to 1975, this article tests two hypotheses of adverse selection: (i) high-risk drivers were more likely to join the BIL insurance market and (ii) sharp premium increases drove low-risk policyholders away. Various empirical analyses show that there is little evidence for either type of adverse selection. We also test whether a risk-misperception hypothesis can explain our results, and find some evidence that the population density have a significantly positive impact on the demand for BIL insurance. † An earlier version of this article was circulated under the title, ‘Does Asymmetric Information Matter in the Early Insurance Market? Evidence from the Japanese bodily injury liability insurance market, 1966–1975