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Optimal Insurance in a Monopoly: Dual Utilities with Hidden Risk Attitudes

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  • Mario Ghossoub
  • Bin Li
  • Benxuan Shi

Abstract

We consider a monopoly insurance market with a risk-neutral profit-maximizing insurer and a consumer with Yaari Dual Utility preferences that distort the given continuous loss distribution. The insurer observes the loss distribution but not the risk attitude of the consumer, proxied by a distortion function drawn from a continuum of types. We characterize the profit-maximizing, incentive-compatible, and individually rational menus of insurance contracts, show that equilibria are separating, and provide key properties thereof. Notably, insurance coverage and premia are monotone in the level of risk aversion; the most risk-averse consumer receives full insurance $(\textit{efficiency at the top})$; the monopoly absorbs all surplus from the least-risk averse consumer; and consumers with a higher level of risk aversion induce a higher expected profit for the insurer. Under certain regularity conditions, equilibrium contracts can be characterized in terms of the marginal loss retention per type of consumer, and they consist of menus of layered deductible contracts, where each such layered structure is determined by the risk type of the consumer. In addition, we examine the effect of a fixed insurance provision cost on equilibria. We show that if the fixed cost is prohibitively high, then there will be no $\textit{ex ante}$ gains from trade. However, when trade occurs, separating equilibrium contracts always outperform pooling equilibrium contracts, and they are identical to those obtained in the absence of fixed costs, with the exception that only part of the menu is excluded. The excluded contracts are those designed for consumers with relatively lower risk aversion, who are less valuable to the insurer. Finally, we characterize incentive-efficient menus of contracts in the context of an arbitrary type space.

Suggested Citation

  • Mario Ghossoub & Bin Li & Benxuan Shi, 2025. "Optimal Insurance in a Monopoly: Dual Utilities with Hidden Risk Attitudes," Papers 2504.01095, arXiv.org.
  • Handle: RePEc:arx:papers:2504.01095
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    References listed on IDEAS

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    1. Gur Huberman & David Mayers & Clifford W. Smith Jr., 1983. "Optimal Insurance Policy Indemnity Schedules," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 415-426, Autumn.
    2. Jerez, Belen, 2003. "A dual characterization of incentive efficiency," Journal of Economic Theory, Elsevier, vol. 112(1), pages 1-34, September.
    3. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
    4. Virginia R. Young & Mark J. Browne, 2000. "Equilibrium in Competitive Insurance Markets Under Adverse Selection and Yaari's Dual Theory of Risk," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 25(2), pages 141-157, December.
    5. Ghossoub, Mario & He, Xue Dong, 2021. "Comparative risk aversion in RDEU with applications to optimal underwriting of securities issuance," Insurance: Mathematics and Economics, Elsevier, vol. 101(PA), pages 6-22.
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    Cited by:

    1. Ka Chun Cheung & Sheung Chi Phillip Yam & Fei Lung Yuen & Yiying Zhang, 2025. "Optimal design of reinsurance contracts with a continuum of risk assessments," Papers 2504.17468, arXiv.org, revised Jan 2026.
    2. Maria Andraos & Mario Ghossoub, 2026. "Incentive Pareto Efficiency in Monopoly Insurance Markets with Adverse Selection," Papers 2602.09967, arXiv.org.

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