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

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  • Annette Hofmann

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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

Suggested Citation

  • 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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    References listed on IDEAS

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    Cited by:

    1. Ellis, Randall P. & Jiang, Shenyi & Manning, Willard G., 2015. "Optimal health insurance for multiple goods and time periods," Journal of Health Economics, Elsevier, vol. 41(C), pages 89-106.
    2. 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.
    3. 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, March.

    More about this item

    Keywords

    Externalities; Insurance monopoly; Nash equilibrium; Social welfare; C70; D62; G22;

    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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