DP1644 | Imperfect Tests and Natural Insurance Monopolies

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30/05/1997

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Abstract

This paper considers a housing insurance market in which buildings have different damage probabilities. Insurers use imperfect tests to find out about buildings? damage types. The insurance market is a natural monopoly. If more than one insurer is active, high risk house owners continue to apply to insurers until they are eventually assigned to a low-risk class. First we show that the natural insurance monopoly need not be sustainable. Then we show that in the equilibrium industry structure the incumbent may accommodate entry even when the natural monopoly is sustainable. The theoretical findings are thus able to explain recent observations from Germany and Switzerland where housing insurance damage rates and prices went up drastically after the transition from state monopolies to competitive environments.