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Consumption vs. Production of Insurance

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  • Tomas Philipson
  • George Zanjani

Abstract

Many forms of insurance are produced by groups themselves rather than purchased in the market. For example, coverage for workers compensation provided by employers is often produced by the employer, in the sense that the employer bears some or all of the financial risk associated with the insurance. This paper generalizes the theory of insurance to analyze what factors determine whether groups produce insurance internally by self-insuring or consume it by purchasing coverage in the market. The" theory makes cross-sectional predictions on which firms will choose to produce insurance, as well as how prices and loss experience will vary with the production decision; the theory also predicts which lines of insurance are likely to be associated with internal production and those in which coverage will be provided entirely by the market. Furthermore, the time-series properties of claims under various degrees of internal" production are analyzed, revealing a more pronounced lag structure for claims under partial risk-bearing than under full self-insurance or market insurance. These predictions are generated by a fundamental diseconomy of scale that offsets the standard scale economy associated with risk-pooling. The tradeoff facing a group in its make-or-buy decision is that self-insurance rewards self-protection but forgoes the pooling of risk" with members outside the group.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6225.

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Date of creation: Oct 1997
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Handle: RePEc:nbr:nberwo:6225

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  1. Topel, Robert H, 1983. "On Layoffs and Unemployment Insurance," American Economic Review, American Economic Association, American Economic Association, vol. 73(4), pages 541-59, September.
  2. Martin Gaynor & Paul Gertler, 1995. "Moral Hazard and Risk Spreading in Partnerships," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 591-613, Winter.
  3. Ruser, John W, 1991. "Workers' Compensation and Occupational Injuries and Illnesses," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 9(4), pages 325-50, October.
  4. Milton Harris & Bengt Holmstrom, 1981. "A Theory of Wage Dynamics," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 488, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Zeckhauser, Richard, 1970. "Medical insurance: A case study of the tradeoff between risk spreading and appropriate incentives," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(1), pages 10-26, March.
  6. Scholz, John T & Gray, Wayne B, 1990. " OSHA Enforcement and Workplace Injuries: A Behavioral Approach to Risk Assessment," Journal of Risk and Uncertainty, Springer, Springer, vol. 3(3), pages 283-305, September.
  7. Sloan, Frank A. & Bovbjerg, Randall A. & Githens, Penny B., 1992. "Insuring Medical Malpractice," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780195069594, October.
  8. Lars Peter Hansen & Ellen R. McGrattan & Thomas J. Sargent, 1994. "Mechanics of forming and estimating dynamic linear economies," Staff Report, Federal Reserve Bank of Minneapolis 182, Federal Reserve Bank of Minneapolis.
  9. Bruce, Christopher J & Atkins, Frank J, 1993. "Efficiency Effects of Premium-Setting Regimes under Workers' Compensation: Canada and the United States," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 11(1), pages S38-69, January.
  10. Topel, Robert H, 1984. "Experience Rating of Unemployment Insurance and the Incidence of Unemployment," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 27(1), pages 61-90, April.
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