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This paper evaluates the potential value of a weather index insurance for the agriculture sector in an high income country (Germany). In our theoretical analysis we model an index insurance, a loss-based insurance market as well as a combination of both kinds of insurance and compare the resulting expected utility of a risk averse crop farmer. To find a suitable index, we conduct a panel estimation and evaluate the link between different weather variables and losses of crop farmers in Germany. Following our estimation, mean temperatures in summer have the highest potential for an valuable index insurance. Finally, we simulate the theoretical model using the results from the estimation and using different thresholds for the definition of a NatCat. According to this simulation, index-insurance is more attractive for the lower and more frequently occurring losses and loss-based insurance is more attractive for rare high losses. A combination of both kinds of insurance could be optimal for intermediate cases. [ABSTRACT FROM AUTHOR]

We provide a comprehensive analysis of the impact of probability weighting on optimal insurance demand in a unified framework. We identify decreasing relative overweighting as a new local condition on the probability weighting function that is useful for comparative static analysis. We discuss the effects of probability weighting on coinsurance, deductible choice, insurance demand for low-probability, high-impact risks versus high-probability, low-impact risks, and insurance demand in the presence of nonperformance risk. Probability weighting can make better or worse predictions than expected utility depending on the insurance demand problem at hand. [ABSTRACT FROM AUTHOR]

In 2015, the China Insurance Regulatory Commission initiated a liberalization reform in the automobile insurance industry to grant insurers more discretion in policy design, underwriting, and ratemaking. The deregulation intended to increase competition and choices for the consumer, yet there was little scientific evidence on how the insurance market responded to the reform. This article examines the effectiveness of this deregulation reform in China. Leveraging a large industry dataset of more than 7 million automobile insurance policies from 63 major automobile insurers operating in China, we study policyholders' switching behavior among insurance providers. To better understand the heterogeneity in the impact of deregulation on market performance and consumer choice, we further analyze the switching pattern among different types of insurers according to the insurer's size, the company's business structure, the jurisdiction's market power, and the customer's risk type. Overall, the empirical results suggest that the reform has met its original goal, leading to higher market competition, and more diversified consumer choices. We further confirm that the average premium dropped significantly after the reform for all three jurisdictions implementing the reform, yet the insurers' pricing strategy was risk type dependent, i.e., the average premium for the high-risk customers increased, while the average premium for the low-risk customers decreased substantially. [ABSTRACT FROM AUTHOR]

Organizational form in insurance has been widely studied in the prior literature. Although researchers have recognized sub-types of stock insurers, mutuals have always been considered as a single homogeneous category. To the extent that mutual sub-types behave differently, considering all mutuals the same can result in misleading conclusions. The present study aims to remedy this gap in the literature by considering the full range of mutual firm types. Mutuals are classified as family-controlled, association-controlled, and pure mutuals with various sub-types within each group. We analyze corporate governance among mutual sub-types in the U.S. property–casualty (P–C) insurance industry by studying CEO turnover, particularly nonroutine turnover. Multinomial probit analysis is used to test for relationships between mutual sub-types and turnover. The principal finding is that all mutuals are not the same. The probability of nonroutine CEO turnover is lowest for family-controlled, non-association mutuals and highest for association-controlled mutuals. Non-association mutuals with family-member CEOs have the lowest turnover rates among all ownership types. Thus, future research should utilize more detailed organizational form categories than the traditional literature. [ABSTRACT FROM AUTHOR]

This article analyzes the effects of compulsory insurance on the demand for self-insurance. We show that although a risk lover invests neither in insurance nor in self-insurance when insurance is voluntary, she invests in self-insurance when insurance is compulsory. On the contrary, when insurance is mandatory, a risk averter would substitute self-insurance for insurance. Economic policy implications of these antagonistic effects on self-insurance are discussed. [ABSTRACT FROM AUTHOR]

Investments in self-protection technologies such as vaccines, prophylactics, or smoke detectors often have positive externalities—with the benefits of such investments spilling over onto others by reducing the levels of risk they face. The availability of insurance contracts can exacerbate the inefficiencies associated with these risk spillovers, as purchasing a formal insurance contract substitutes for an individual's self-protection efforts, but does not induce any of the positive spillovers associated with those efforts. Using a simple model of the insurance and self-protection decisions for a market of individuals with heterogeneous self-protection costs and risk spillovers, we show that competitive insurance markets and markets served by a perfectly price discriminating monopolist always feature overinsurance and underinvestment in self-protection relative to socially efficient levels. Markets served by a non-price-discriminating monopolist, on the other hand, may feature socially efficient levels of insurance and self-protection, and, if they do not, can feature either underinvestment or overinvestment in self-protection. [ABSTRACT FROM AUTHOR]

We show that if losses are larger than wealth, then individuals with the option of declaring bankruptcy will not insure if the loss probability is above a threshold. In an insurance market with adverse selection, if the high risks' loss probability is above the threshold, then no trade occurs at the Rothschild–Stiglitz equilibrium. Active trade in insurance requires cross-subsidization. When a subset of individuals with significant costs of bankruptcy and default is included in the market, then the equilibrium outcome always involves positive levels of insurance coverage for some individuals, but the parameters of the model determine whether all types receive coverage, or whether null contracts are received by both high and low risks with no bankruptcy costs or just the low risks from that group. [ABSTRACT FROM AUTHOR]

A central issue in dynamic contracting is the type of inter-temporal pricing pattern. Some insurance products exhibit a highballing (front-loaded) pattern and others a lowballing (back-loaded) pattern, while still others are flat. We develop a unified competitive dynamic insurance model with asymmetric learning to investigate the impact of insurer commitment on the equilibrium inter-temporal pricing pattern. The model predicts that the equilibrium contract exhibits highballing under one-sided commitment and lowballing under no commitment. We then use a unique empirical setting of two products from one insurer, eliminating heterogeneity in firm, market, time horizon, and learning environment, to isolate the role of insurer commitment in determining the pricing pattern. Consistent with our theoretical predictions, we find that (i) the dynamic contracts exhibit a highballing pattern in loaner's personal accident insurance, a one-sided commitment scenario, and (ii) a lowballing pattern in group critical illness insurance, a no-commitment scenario. [ABSTRACT FROM AUTHOR]

Insurance markets all over the world are subject to taxes, which can be collected through various tax schemes. The most commonly used tax schemes in non-life insurance include taxes on the premium income as well as taxes on corporate profits. The mix of those taxes differs substantially across regions. In Europe, for instance, premium taxes are at much higher levels than those in the United States. This paper shows that the particular mix of taxes matters for insurance companies' solvency levels and insurance premiums, even when the expected tax revenue is fixed. The analysis provides comparative statics that reveal which combination of premium taxation and corporate taxation maximizes welfare. Numerical examples suggest that relatively high premium tax rates are welfare optimal. In general, a low volatility of insurance claims, a strong reaction of insurance demand to insurer default risk, as well as substantial agency issues between shareholders and management make corporate taxation more favorable in comparison to premium taxation. [ABSTRACT FROM AUTHOR]

This paper addresses the urbanization of areas exposed to natural disasters and studies its dependency on land-use and insurance policies. In practice, we observe simple policies, consisting of a prohibited red zone and a zone without insurance tariff differentiation. Even if there are fixed damages per dwelling, the red-zone policy is relatively efficient; it implements the optimal land-use if the losses are proportional to the surface used. The main results are on the effects redefining the optimal red zone as the climate or the population changes. We expose plausible cases in which the red zone grows with a growing population. [ABSTRACT FROM AUTHOR]

We analyze the design of optimal medical insurance under ex post moral hazard, i.e., when illness severity cannot be observed by insurers and policyholders decide for themselves on their health expenditures. The trade-off between ex ante risk sharing and ex post incentive compatibility is analyzed in an optimal revelation mechanism under hidden information and risk aversion. The optimal contract provides partial insurance at the margin, with a deductible when insurers’ rates are affected by a positive loading, and it may also include an upper limit on coverage. The potential to audit the health state leads to an upper limit on out-of-pocket expenses. [ABSTRACT FROM AUTHOR]

As the world confronts unprecedented global aging, academics and policymakers are growing increasingly aware of the need for better risk management tools to handle the demographic transition. It is therefore imperative to identify innovative insurance and financial market products that can enrich the range of options for households, firms, and governments facing the challenge of an aging population. After outlining thoughts on how rising longevity might shape financial markets, we discuss opportunities for the finance and insurance industries in this arena. We also highlight how policymakers could respond to improve efforts to better manage risk. [ABSTRACT FROM AUTHOR]

With recent research suggesting a behavioral explanation for changes in demand for insurance (e.g., Volkman-Wise (2015)), we study homeowners' demand for windstorm insurance in the wake of losses. In particular, we examine the representative heuristic's impact on the demand for homeowners' insurance, which provides coverage for windstorm losses, in Florida (U.S.). Under this paradigm, individuals underweight prior probabilities and overweight posterior probabilities. This results in an over (under)-weighting of the probability of a loss from a disaster in the event (absence) of a disaster. Using data for new homeowners' insurance, purchases in Florida's residual market between 2005 and 2007 (a period of high hurricane activity), we find, subsequent to losses, the demand for coverage limits and the number of policies sold both increase. Further, we find that this effect attenuates as the losses become further away in time. That is, more recent losses have a stronger effect on demand. This attenuation of the demand is also consistent with the representative heuristic. [ABSTRACT FROM AUTHOR]

We analyze whether allowing the choice between full tort and limited tort coverage can serve as a screening mechanism in automobile insurance markets with asymmetric information. We show that limited tort policies create an externality on the market. Using a model of price competition where menus of contracts can be offered, and drivers choose their level of safety effort, we show that there can exist a separating equilibrium where low risks choose full tort contracts and high risks choose limited tort contracts. There also can exist pooling equilibria at the full tort or the limited tort contracts. We show that equilibria without limited tort policies and equilibria that include limited tort policies are mutually exclusive. We also show that, relative to an exclusively full tort system, a choice system is no worse and leads to a Pareto improvement if a separating or limited tort pooling equilibrium is obtained. [ABSTRACT FROM AUTHOR]

Building on the model of insurance contracting with hidden knowledge of risk class introduced by Rothschild and Stiglitz (1976), we assume that insurance applicants fail to reduce compound lotteries. In contrast with the adverse selection equilibrium identified by Rothschild and Stiglitz, in which coverage and expected claims frequency are positively correlated, we show that an advantageous selection equilibrium is possible, with coverage and expected claims frequency being negatively correlated. Whereas previous theories explain advantageous selection by adding a hidden action or a second dimension of hidden knowledge, our analysis shows that advantageous selection can arise solely as a consequence of insurance applicants' attitude toward bearing compound risks. [ABSTRACT FROM AUTHOR]

Using the representative agent approach as in Kaplow (Am Econ Rev 82:1013–1017, 1992b), this paper shows that providing tax deductions for the individual’s net losses is socially optimal when the insurer faces the risk of insolvency. We further show that the government should adopt a higher tax deduction rate for net losses when the insurer is insolvent than when the insurer is solvent. Thus, tax deductions for net losses could be used to provide an insurance for individuals against the insurer’s risk of insolvency. These findings could also be used to explain why a government provides supplementary public insurance or government relief. Finally, we discuss that, if the individuals are heterogeneous in terms of loss severity, loss probability, or income level, providing a tax deduction for the individual’s net losses may not always achieve a Pareto improvement, and cross subsidization should be taken into consideration. [ABSTRACT FROM AUTHOR]

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. [ABSTRACT FROM AUTHOR]

Durables like cars or houses are a substantial component in the balance sheets of households. These durables are exposed to risk and can be insured in the market. We build a dynamic model in which agents have three possibilities to cope with the risk exposure of the durable stock: (i) purchase of market insurance, (ii) buffer-stock saving of the riskless asset or (iii) adjustment of the durable stock. We calibrate our model to the US economy and find a small role for market insurance. [ABSTRACT FROM AUTHOR]

Adverse selection is often blamed for the malfunctioning of the annuities market. We simulate the impact of adverse selection on the consumption allocation of annuitants under alternative parameter values, and explore the resulting welfare implications. We show that, for most parameter values, the welfare losses associated with equilibriums that are subject to adverse selection correspond to a loss of wealth of around one percent in a first-best equilibrium. These losses are smaller than the corresponding losses associated with equilibriums with no access to an annuity market by an order of magnitude of ten. The existence of substitutes for annuities such as a bequest motive or a social security system intensifies the adverse selection but reduces its welfare impact. [ABSTRACT FROM AUTHOR]