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Optimal Insurance with Divergent Beliefs about Insurer Total Default Risk

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  • Cummins, J David
  • Mahul, Olivier

Abstract

This paper extends the classic expected utility theory analysis of optimal insurance contracting to the case where the insurer has a positive probability of total default and the buyer and insurer have divergent beliefs about this probability. The optimal marginal indemnity above the deductible is smaller (greater) than one if the buyer's assessment of default risk is more pessimistic (optimistic) than the insurer's. As an application of the model, we consider the market for reinsurance against catastrophic property loss and propose an expected utility theory explanation for the increasing and concave marginal indemnity schedule observed in this market. Copyright 2003 by Kluwer Academic Publishers

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  • Cummins, J David & Mahul, Olivier, 2003. "Optimal Insurance with Divergent Beliefs about Insurer Total Default Risk," Journal of Risk and Uncertainty, Springer, vol. 27(2), pages 121-138, October.
    • Handle: RePEc:kap:jrisku:v:27:y:2003:i:2:p:121-38
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    References listed on IDEAS

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    1. J. David Cummins & Martin F. Grace & Richard D. Phillips, 1998. "Regulatory solvency prediction in property-liability insurance: risk-based capital, audit ratios, and cash flow simulation," Working Papers 98-20, Federal Reserve Bank of Philadelphia.
    2. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1, March.
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    11. David Cummins & Christopher Lewis & Richard Phillips, 1999. "Pricing Excess-of-Loss Reinsurance Contracts against Cat as trophic Loss," NBER Chapters, in: The Financing of Catastrophe Risk, pages 93-148, National Bureau of Economic Research, Inc.
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