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

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.

[1]  H. Kunreuther,et al.  Interdependent Security , 2003 .

[2]  N. Doherty.  Some Fundamental Theorems of Risk Management , 1975 .

[3]  Courtenay C. Stone,et al.  EXTERNALITIES, LIABILITY AND THE COASE THEOREM:A MATHEMATICAL ANALYSIS , 1973 .

[4]  T. Ungern-Sternberg,et al.  Efficient Monopolies: The Limits of Competition in the European Property Insurance Market , 2004 .

[5]  J. Schiller.  Versicherungsbetrug als ökonomisches Problem: Eine vertragstheoretische Analyse , 2004 .

[6]  K. Arrow,et al.  Uncertainty and the welfare economics of medical care. 1963. , 2001, Journal of health politics, policy and law.

[7]  Karl Epple,et al.  The transition from monopoly to competition: The case of housing insurance in Baden-Wurttemberg , 1996 .

[8]  H. Kunreuther,et al.  IDS Models of Airline Security , 2005 .

[9]  J. Stiglitz,et al.  Moral Hazard and Optimal Commodity Taxation , 1983 .

[10]  Steven Shavell,et al.  On Liability and Insurance , 1982 .

[11]  M. Intriligator,et al.  Externalities and compulsary vaccinations , 1991 .

[12]  Optimales Vertragsdesign bei moralischem Risiko in der Rückversicherung , 2003 .

[13]  T. Ungern-Sternberg,et al.  The limits of competition: Housing insurance in Switzerland , 1995 .

[14]  Thomas von Ungern-Sternberg.  State Intervention on the Market for Natural Damage Insurance in Europe , 2003 .

[15]  Jörg Schiller.  The Impact of Insurance Fraud Detection Systems , 2003 .

[16]  Vernon L. Smith,et al.  Optimal Insurance Coverage , 1968, Journal of Political Economy.

[17]  I. Ehrlich,et al.  Market Insurance, Self-Insurance, and Self-Protection , 1972, Journal of Political Economy.

[18]  Andreas Richter,et al.  The design of liability rules for highly risky activities: Is strict liability the better solution? , 2001 .

[19]  Luis E. Ortiz,et al.  Algorithms for Interdependent Security Games , 2003, NIPS.

[20]  G. Skogh.  Public insurance and accident prevention , 1982 .

[21]  Kangoh Lee.  Wealth Effects on Self-Insurance and Self-Protection against Monetary and Nonmonetary Losses , 2005 .

[22]  Andreas Richter,et al.  Tax arbitrage in the German insurance market , 2002 .

[23]  R. Zeckhauser,et al.  Risks to selves, risks to others. , 1995, The American economic review.

[24]  Jstor.  The journal of conflict resolution , 1957 .

[25]  J. Pratt.  RISK AVERSION IN THE SMALL AND IN THE LARGE11This research was supported by the National Science Foundation (grant NSF-G24035). Reproduction in whole or in part is permitted for any purpose of the United States Government. , 1964 .

[26]  J. Mirrlees.  An Exploration in the Theory of Optimum Income Taxation an Exploration in the Theory of Optimum Income Taxation L Y 2 , 2022 .

[27]  Stefan Felder,et al.  Fire insurance in Germany: A comparison of price-performance between state monopolies and competitive regions , 1996 .

[28]  H. Schlesinger,et al.  Insurance Markets with Loss-Prevention Activity: Profits, Market Structure, and Consumer Welfare , 1986 .

[29]  Andreas Richter,et al.  Improving risk allocation through cat bonds , 2002 .

[30]  Eric W. Bond,et al.  Smoking, Skydiving, and Knitting: The Endogenous Categorization of Risks in Insurance Markets with Asymmetric Information , 1991, Journal of Political Economy.

[31]  J. Mossin.  Aspects of Rational Insurance Purchasing , 1968, Journal of Political Economy.

[32]  M. Boyer,et al.  Série Scientifique Scientific Series 2003 s-70 Merging Automobile Insurance Regulatory Bodies : The Case of Atlantic Canada , 2003 .

[33]  Wertorientierte Steuerung von Lebensversicherungsunternehmen mittels stochastischer Prozesse , 2006 .

[34]  M. Nell,et al.  Erklärungsansätze für vertragswidriges Verhalten Versicherungsnehmern aus Sicht der ökonomischen Theorie , 2002 .

[35]  Mario Jametti,et al.  Assessing the Efficiency of an Insurance Provider—A Measurement Error Approach , 2003 .

[36]  Andreas Richter,et al.  Catastrophic Events as Threats to Society: Private and Public Risk Management Strategies , 2005 .

[37]  Andreas Richter,et al.  When Prices Hardly Matter: Incomplete Insurance Contracts and Markets for Repair Goods , 2009 .

[38]  S. Shavell.  On Moral Hazard and Insurance , 1979 .

[39]  Andreas Richter,et al.  The design of liability rules for highly risky activities—Is strict liability superior when risk allocation matters? , 2003 .