Dynamic Inefficiencies in Insurance Markets: Evidence from long-term care insurance

We examine whether unregulated, private insurance markets efficiently provide insurance against reclassification risk (the risk of becoming a bad risk and facing higher premiums). To do so, we examine the ex-post risk type of individuals who drop their long-term care insurance contracts relative to those who are continually insured. Consistent with dynamic inefficiencies, we find that individuals who drop coverage are of lower risk ex-post than individuals who were otherwise-equivalent at the time of purchase but who do not drop out of their contracts. These findings suggest that dynamic market failures in private insurance markets can preclude the efficient provision of insurance against reclassification risk.