Moral Hazard and Background Risk in Competitive Insurance Markets

10 Pages Posted: 8 Oct 2008

See all articles by James A. Ligon

James A. Ligon

University of Alabama

Paul D. Thistle

University of Nevada, Las Vegas - Department of Finance

Abstract

We examine the effect of background risk on competitive insurance markets with moral hazard. If policy-holders have non-negative prudence, then background risk does not decrease effort and, when effort increases, expands the set of feasible policies. However, the effect of background risk on equilibrium is indeterminate. We analyse the choice between stock and mutual insurance; mutual insurance is equivalent to a fair policy plus background risk. Our results imply that competitive insurance markets with moral hazard should be dominated by stock insurers.

Suggested Citation

Ligon, James A. and Thistle, Paul D., Moral Hazard and Background Risk in Competitive Insurance Markets. Economica, Vol. 75, Issue 300, pp. 700-709, November 2008. Available at SSRN: https://ssrn.com/abstract=1280422 or http://dx.doi.org/10.1111/j.1468-0335.2007.00650.x

James A. Ligon (Contact Author)

University of Alabama ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States
205-348-6313 (Phone)
205-348-0590 (Fax)

Paul D. Thistle

University of Nevada, Las Vegas - Department of Finance ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States
702-895-3856 (Phone)
702-895-4650 (Fax)

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