Insurance Contract Design When the Insurer Has Private Information on Loss Size

12 Pages Posted: 22 Nov 2012

See all articles by Qin Lian

Qin Lian

Portland State University

Harris Schlesinger

University of Alabama; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: December 2012

Abstract

This article examines the optimal indemnity contract in an insurance market, when the insurer has private information about the size of an insurable loss. Both parties know whether or not a loss occurred, but only the insurer knows the true value of the loss and/or to what extent the losses are covered under the policy. The insured may verify the insurer's loss estimate for a fixed auditing cost. The optimal contract reimburses the auditing costs in addition to full insurance for losses less than some endogenous limit. For losses exceeding this limit, the contract pays a fixed indemnity and requires no monitoring. The optimal contract is compared with the contracts obtained in cases where it is only the insured who can observe the loss size.


Suggested Citation

Lian, Qin and Schlesinger, Harris, Insurance Contract Design When the Insurer Has Private Information on Loss Size (December 2012). Journal of Risk and Insurance, Vol. 79, Issue 4, pp. 1039-1050, 2012, Available at SSRN: https://ssrn.com/abstract=2179381 or http://dx.doi.org/10.1111/j.1539-6975.2011.01460.x

Qin Lian (Contact Author)

Portland State University ( email )

United States
5037253728 (Phone)

Harris Schlesinger

University of Alabama ( email )

P.O. Box 870244
200 Alston Hall, Box 870224
Tuscaloosa, AL 35487
United States
205-348-7858 (Phone)
205-348-0590 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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