Multidimensional Screening in Insurance Markets with Adverse Selection

Bundled coverage of different losses and distinct perils, along with differential deductibles and policy limits, are common elements of insurance contracts offered in homeowners, automobile, and commercial insurance markets. We show that these practices allow insurers to implement multidimensional screening of insurance applicants who possess hidden knowledge of their risks of loss, and thereby to reduce the externality cost of adverse selection. Competitive forces drive insurers to exploit multidimensional screening and enhance the efficiency of insurance contracting. We also find that efficient multidimensional screening allows competitive insurance markets to attain pure strategy Nash equilibria over a wider range of applicant pools, providing an avenue for insurers to circumvent the nonexistence problem identified by Rothschild and Stiglitz (1976)