Insurance Contracts Designed by Competitive Pooling

Pradeep Dubey and John Geanakoplos

August 2001

We build a model of competitive pooling and show how insurance contracts emerge in equilibrium, designed by the invisible hand of perfect competition. When pools are exclusive, we obtain a unique separating equilibrium. When pools are not exclusive but seniority is recognized, we obtain a different unique equilibrium: the pivotal primary-secondary equilibrium. Here reliable and unreliable households take out a common primary insurance up to its maximum limit, and then unreliable households take out further secondary insurance.

Keywords: Competitive pooling, insurance contracts, adverse selection, signalling, seniority, equilibrium refinement