Facilitating Consumer Learning in Insurance Markets—What Are the Welfare Effects?

We model a monopoly insurance setting where initially uninformed consumers can privately learn their accident risks at a cost c. We then ask: What are the welfare effects of a policy that reduces the cost c? We show that if c is sufficiently small (c < c∗), the optimal contract is such that the consumer gathers information. For such low values of the cost, both insurer and consumer benefit from a policy that reduces c further. For c> c∗, marginally reducing c hurts the insurer and weakly benefits the consumer. Paradoxically, a reduction in c that is “successful, ” meaning that the consumer gathers information after the reduction but not before it, can hurt both parties. The reasons for this are that, after the reduction, (i) the cost is actually incurred and (ii) the contracts can be more distorted