Optimal Insurance with Counterparty Default Risk
41 Pages Posted: 6 Jul 2010 Last revised: 30 Apr 2012
Date Written: April 15, 2012
We study the design of optimal insurance contracts when the insurer can default on its obligations. In our model default arises endogenously from the interaction of the insurance premium, the indemnity schedule and the insurer's assets. This allows us to understand the joint effect of insolvency risk and background risk on optimal contracts. The results may shed light on the aggregate risk retention schedules observed in catastrophe reinsurance markets, and can assist in the design of (re)insurance programs and guarantee funds.
Keywords: insurance demand, default risk, catastrophe risk, limited liability, incomplete markets
JEL Classification: D52, D81, G22
Suggested Citation: Suggested Citation