On the efficiency of self-protection with spillovers in risk.

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]