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Separation Without Mutual Exclusion in Financial Insurance

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  • Stephens, Eric

    ()
    (University of Alberta, Department of Economics)

  • Thompson, James

    ()
    (University of Waterloo)

Abstract

In traditional economic models of insurance, sellers typically employ a non-linear pricing scheme to elicit type information from buyers. In financial insurance contracts, such a policy is not possible since contracts are non-exclusive. In addition, counterparty risk in financial contracts can be particularly problematic relative to traditional insurance. Accordingly, we relax the standard assumption of contract exclusivity and allow the insured to contract with many sellers, some of which may be unstable. In contrast to the traditional insurance model, we show that separation of risk types among insured parties can be achieved with linear pricing when there is aggregate counterparty risk. This result is shown to collapse when contracts are cleared through a central counterparty, suggesting that such an arrangement can create opacity.

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Bibliographic Info

Paper provided by University of Alberta, Department of Economics in its series Working Papers with number 2012-8.

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Length: 20 pages
Date of creation: 01 Apr 2012
Date of revision:
Handle: RePEc:ris:albaec:2012_008

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Keywords: insurance; separation; mutual exclusion; counterparty risk;

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  1. Richard D. Phillips & J. David Cummins & Franklin Allen, 1996. "Financial Pricing of Insurance in the Multiple Line Insurance Company," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 96-09, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Stephens, Eric & Thompson, James, 2011. "CDS as Insurance: Leaky Lifeboats in Stormy Seas," Working Papers 2011-9, University of Alberta, Department of Economics.
  3. Villeneuve, Bertrand, 2003. "Mandatory pensions and the intensity of adverse selection in life insurance markets," Economics Papers from University Paris Dauphine, Paris Dauphine University 123456789/5363, Paris Dauphine University.
  4. James R. Thompson, 2010. "Counterparty Risk in Financial Contracts: Should the Insured Worry about the Insurer?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 125(3), pages 1195-1252, August.
  5. Doherty, Neil A & Schlesinger, Harris, 1990. "Rational Insurance Purchasing: Consideration of Contract Nonperformance," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 243-53, February.
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