Abstract
AbstractGovernment‐subsidized insurance is ubiquitous, yet estimation of demand in such markets remains challenging. The premium charged for a given deductible is determined by actuarial construction; thus, observed choice‐pairs are endogenous leading to biased estimation under standard econometric approaches. A theoretical model and simulation study are developed, and a new identification strategy proposed. An empirical application using Federal Crop Insurance Program—a $100 billion/year program—data reveals that demand is quite elastic after accounting for this endogeneity. Mistreatment of such endogeneity is likely partly responsible for pervasive faulty findings of inelastic insurance demand in related applications. Policy implications are also discussed.
Highlights
Government subsidized insurance is ubiquitous, yet estimation of demand in such markets remains challenging
We show that when multiple deductible levels are available, the near universal approach of estimating demand elasticities with observed coverage on premium rates via OLS will result in severely biased demand elasticities
Weiss, Tennyson, and Regan (2010), find that accounting for rate endogeneity resulting from regulations can have profound empirical impacts when evaluating incentive distortions in insurance markets, but do not deal with the more fundamental issue at stake related to the fact that fair premium rates vary in response systematically to the deductible purchased as a matter of actuarial construction
Summary
Government subsidized insurance is ubiquitous, yet estimation of demand in such markets remains challenging. The United States Government Accountability Office (GAO) recently released a report which concluded--based on elasticity estimates in the literature--that demand for crop insurance in the U.S is inelastic, and subsequently inferred that subsidization could be cut, and insured paid rates increased substantially without significantly affecting program participation (GAO, 2014). Weiss, Tennyson, and Regan (2010), find that accounting for rate endogeneity resulting from regulations can have profound empirical impacts when evaluating incentive distortions in insurance markets, but do not deal with the more fundamental issue at stake related to the fact that fair premium rates vary in response systematically to the deductible purchased as a matter of actuarial construction
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