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Bargaining Power and Efficiency in Insurance Contracts

Listed author(s):
  • John Quiggin

    ()

    (School of Economics, University of Queensland, Brisbane, Queensland 4072, Australia.)

  • Robert G Chambers

    ()

    (Department of Agricultural and Resource Economics, University of Maryland, College Park, Maryland 20742, USA.)

Insurance contracts are frequently modelled as principal–agent relationships. The purpose of this paper is to examine the interaction between differential bargaining power and the efficiency of insurance contracts. The analysis is undertaken in a framework of state-contingent production, which allows us to consider, as separate choices, the level of effort committed by the client and the riskiness of the equilibrium state-contingent production vector. Our central result is that, in the presence of hold-up problems, the exercise of monopoly power by insurers leads clients to undertake socially costly self-protection, leading to suboptimal levels of insurance. Clients can exploit information asymmetries to offset the bargaining power of the insurer, but this process is also socially costly. Hence, competitive markets for insurance will yield a Pareto-superior outcome to the constrained Pareto-optimum reached in markets where insurers have monopoly power. More generally, in a bargaining situation, an increase in the bargaining power of clients will increase social welfare. The Geneva Risk and Insurance Review (2009) 34, 47–73. doi:10.1057/grir.2008.15

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Article provided by Palgrave Macmillan & International Association for the Study of Insurance Economics (The Geneva Association) in its journal The Geneva Risk and Insurance Review.

Volume (Year): 34 (2009)
Issue (Month): 1 (June)
Pages: 47-73

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Handle: RePEc:pal:genrir:v:34:y:2009:i:1:p:47-73
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  1. Quiggin, John, 2002. "Risk and Self-Protection: A State-Contingent View," Journal of Risk and Uncertainty, Springer, vol. 25(2), pages 133-145, September.
  2. Ehrlich, Isaac & Becker, Gary S, 1972. "Market Insurance, Self-Insurance, and Self-Protection," Journal of Political Economy, University of Chicago Press, vol. 80(4), pages 623-648, July-Aug..
  3. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
  4. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  5. Viaene, Stijn & Veugelers, Reinhilde & Dedene, Guido, 2002. "Insurance bargaining under risk aversion," Economic Modelling, Elsevier, vol. 19(2), pages 245-259, March.
  6. Quiggin, John & Chambers, Robert G., 1998. "A state-contingent production approach to principal-agent problems with an application to point-source pollution control," Journal of Public Economics, Elsevier, vol. 70(3), pages 441-472, December.
  7. Lewis, Tracy & Nickerson, David, 1989. "Self-insurance against natural disasters," Journal of Environmental Economics and Management, Elsevier, vol. 16(3), pages 209-223, May.
  8. David M. G. Newbery, 1977. "Risk Sharing, Sharecropping and Uncertain Labour Markets," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 585-594.
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