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

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  • Annette Hofmann

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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  • Annette Hofmann, 2007. "Internalizing externalities of loss prevention through insurance monopoly: an analysis of interdependent risks," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 32(1), pages 91-111, June.
    • Handle: RePEc:kap:geneva:v:32:y:2007:i:1:p:91-111
    DOI: 10.1007/s10713-007-0004-2
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    6. Annette Hofmann & Nicos A. Scordis, 2018. "Challenges in Applying Risk Management Concepts in Practice: A Perspective," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 21(2), pages 309-333, September.
    7. Michael Fakoya, 2014. "Forced internalization of external environmental cost: experience of a South African Company," Environment, Development and Sustainability: A Multidisciplinary Approach to the Theory and Practice of Sustainable Development, Springer, vol. 16(3), pages 797-807, June.
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    9. Grislain-Letrémy, Céline, 2012. "Assurance et prévention des catastrophes naturelles et technologiques," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/9073 edited by Villeneuve, Bertrand.
    10. Lili Bao & Zhengyu Gu, 2014. "A Study of the Deficit of the Third Party Liability Compulsory Insurance of Motor Vehicle," Accounting and Finance Research, Sciedu Press, vol. 3(1), pages 116-116, February.

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    More about this item

    Keywords

    Externalities; Insurance monopoly; Nash equilibrium; Social welfare; C70; D62; G22;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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