Second-Best Insurance Contract Design in an Incomplete Market
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.
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Volume (Year): 97 (1995)
Issue (Month): 1 (March)
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