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Internalizing externalities of loss prevention through insurance monopoly: an analysis of interdependent risks

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  • Annette Hofmann

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    Abstract

    When risks are interdependent, an agent’s decision to self-protect affects the loss probabilities faced by others. Due to these externalities, economic agents invest too little in prevention relative to the socially efficient level by ignoring marginal external costs or benefits conferred on others. This paper analyzes an insurance market with externalities of loss prevention. It is shown in a model with heterogenous agents and imperfect information that a monopolistic insurer can achieve the social optimum by engaging in premium discrimination. An insurance monopoly reduces not only costs of risk selection, but may also play an important social role in loss prevention. Copyright The Geneva Association 2007

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    File URL: http://hdl.handle.net/10.1007/s10713-007-0004-2
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    Bibliographic Info

    Article provided by Springer in its journal THE GENEVA RISK AND INSURANCE REVIEW.

    Volume (Year): 32 (2007)
    Issue (Month): 1 (June)
    Pages: 91-111

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    Handle: RePEc:kap:geneva:v:32:y:2007:i:1:p:91-111

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    Web page: http://www.springerlink.com/link.asp?id=102897

    Related research

    Keywords: Externalities; Insurance monopoly; Nash equilibrium; Social welfare; C70; D62; G22;

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    1. Shavell, Steven, 1979. "On Moral Hazard and Insurance," The Quarterly Journal of Economics, MIT Press, vol. 93(4), pages 541-62, November.
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    7. Kunreuther, Howard & Heal, Geoffrey, 2003. " Interdependent Security," Journal of Risk and Uncertainty, Springer, vol. 26(2-3), pages 231-49, March-May.
    8. Avery, Christopher & Heymann, S Jody & Zeckhauser, Richard, 1995. "Risks to Selves, Risks to Others," American Economic Review, American Economic Association, vol. 85(2), pages 61-66, May.
    9. von Ungern-Sternberg, Thomas, 1996. "The limits of competition: Housing insurance in Switzerland," European Economic Review, Elsevier, vol. 40(3-5), pages 1111-1121, April.
    10. Richard J. Arnott & Joseph E. Stiglitz, 1983. "Moral Hazard and Optimal Commodity Taxation," NBER Working Papers 1154, National Bureau of Economic Research, Inc.
    11. Felder, Stefan, 1996. "Fire insurance in Germany: A comparison of price-performance between state monopolies and competitive regions," European Economic Review, Elsevier, vol. 40(3-5), pages 1133-1141, April.
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