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Second-Best Insurance Contract Design in an Incomplete Market

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  • Gollier, Christian
  • Schlesinger, Harris

Abstract

The optimal form of insurance contracts for multiple risks is examined. A well-known result in the literature is that, under fairly general conditions, an insurance policy with a deductible for aggregate losses is optimal. Real-world markets, however, are typically incomplete in that they require separate contracts for separate loss exposures. For instance, insurable damage to one's home is not generally allowed to affect the insurance indemnity for (unrelated) insurable damage to one's automobile. We show that separate deductibles are second-best optima in this setting. We compare the indemnity provided in this second-best setting with first-best solutions. The effect of second-best contracts on the individual's total insurance demand is also examined. Copyright 1995 by The editors of the Scandinavian Journal of Economics.

Suggested Citation

  • Gollier, Christian & Schlesinger, Harris, 1995. " Second-Best Insurance Contract Design in an Incomplete Market," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(1), pages 123-135, March.
  • Handle: RePEc:bla:scandj:v:97:y:1995:i:1:p:123-35
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    Cited by:

    1. Neil A. Doherty & Christian Laux & Alexander Muermann, 2015. "Insuring Nonverifiable Losses," Review of Finance, European Finance Association, vol. 19(1), pages 283-316.
    2. Laux, Christian, 2008. "Corporate insurance design with multiple risks and moral hazard," CFS Working Paper Series 2008/54, Center for Financial Studies (CFS).
    3. Cohen Alma, 2006. "The Disadvantages of Aggregate Deductibles," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 6(1), pages 1-28, April.
    4. Malamud, Semyon & Rui, Huaxia & Whinston, Andrew, 2016. "Optimal reinsurance with multiple tranches," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 71-82.
    5. Moore, Kristen S. & Young, Virginia R., 2006. "Optimal insurance in a continuous-time model," Insurance: Mathematics and Economics, Elsevier, vol. 39(1), pages 47-68, August.
    6. Ryle Perera, 2013. "Optimal investment, consumption–leisure, insurance and retirement choice," Annals of Finance, Springer, vol. 9(4), pages 689-723, November.
    7. Michael Breuer, 2005. "Multiple Losses, "EX ANTE" Moral Hazard, and the Implications for Umbrella Policies," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 72(4), pages 525-538.
    8. Diana SOARE (DUMITRESCU) & Alexandru URSACHE & Olivia Georgiana NITA, 2015. "Aspects of Decisions in the Field of Insurance," Romanian Statistical Review Supplement, Romanian Statistical Review, vol. 63(10), pages 22-26, October.
    9. Carole Bernard & Shaolin Ji & Weidong Tian, 2013. "An optimal insurance design problem under Knightian uncertainty," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 36(2), pages 99-124, November.
    10. Bovenberg, A.L. & Hansen, M. & Sorensen, P.B., 2008. "Individual savings accounts for social insurance : Rationale and alternative designs," Other publications TiSEM 72e236b0-ad63-4bea-a314-6, Tilburg University, School of Economics and Management.

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