The Welfare Implications of Moral Hazard and Adverse Selection in Competitive Insurance Markets.

The author models a competitive insurance market with both moral hazard and adverse selection, and analyzes the effect on welfare when both problems are present simultaneously. An examination of the interaction between these two problems leads to two hypotheses: the nature of the equilibrium contracts is such that each problem partially offsets the welfare loss associated with the other and the degree to which this occurs increases as agents become more heterogeneous. Simulation results overwhelmingly support both hypotheses. Copyright 1994 by Oxford University Press.