Adverse Selection and Insurance Contracting: A Rank-Dependent Utility Analysis

Stiglitz (1977) established three well-known features of monopoly insurance markets subject to adverse selection: (i) at least one market segment is served, despite the informational asymmetry; (ii) there is always some screening of risk classes; and (iii) efficiency is sacrificed to achieve screening. We modify Stiglitz's model, replacing his expected utility assumption on consumer behavior with a version of Quiggin's (1982) rank-dependent utility model that has received strong experimental support. We show that none of the conclusions (i)--(iii) is robust to this revision. In particular, asymmetric information need not lead to any loss in efficiency.