Information asymmetry, ex ante moral hazard, and uninsurable risk in liability coverage: Evidence from China's automobile insurance market

Abstract

We make use of a unique data set to test for information asymmetry, as well as distinguish ex ante moral hazard from adverse selection in different types of third-party liability claims in automobile insurance policies: that is, those with bodily injury (BI) versus those with only property damage (PD). We find that the degree of information asymmetry is higher in liability claims with BI than those with only PD. Yet, the ex ante moral hazard only exists in liability claims with PD. We use a theoretical model to propose that the difference we find between the two types of claims in ex ante moral hazard is related to uninsurable risk embedded in BI claims. We confirm this finding in another sensitivity test comparing claims from new cars and nonnew cars. Altogether, these results suggest policy reforms leading to a better pricing mechanism in the automobile insurance industry in China.