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Correlated Risks: A Conflict of Interest Between Insurers and Consumers and Its Resolution

Author

Listed:
  • Patrick Eugster

    () (Socioeconomic Institute, University of Zurich)

  • Peter Zweifel

    () (Socioeconomic Institute, University of Zurich)

Abstract

This contribution starts out by noting a conflict of interest between consumers and insurers. Consumers face positive correlation in their assets (health, wealth, wisdom, i.e. skills), causing them to demand a great deal of insurance coverage. Insurers on the other hand eschew positively correlated risks. It can be shown that insurance contributes to a reduction of their asset volatility only if unexpected deviations of payments from expected value correlate negatively across lines of insurance. Analyzing deviations from trend in aggregate insurance payments, one finds the following for the United States and Switzerland. Private U.S. but not Swiss insurance has a hedging effect for consumers, while both social insurance schemes expose consumers to excess asset volatility. In the insurance systems of both countries, the private component fails to offset deviations in the social component (and vice versa). As to the supply of insurance, cointegration analysis indicates the absence of common trends. Therefore, insurance companies could offer combined policies to the benefit of consumers, hedging their underwriting risks both domestically and internationally.

Suggested Citation

  • Patrick Eugster & Peter Zweifel, 2006. "Correlated Risks: A Conflict of Interest Between Insurers and Consumers and Its Resolution," SOI - Working Papers 0604, Socioeconomic Institute - University of Zurich.
  • Handle: RePEc:soz:wpaper:0604
    as

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    File URL: http://www.econ.uzh.ch/static/wp_soi/wp0604.pdf
    File Function: First version, 2006
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Insurance; Portfolio Theory; International Diversification; Combined Contracts;

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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