Equilibrium Recoveries in Insurance Markets with Limited Liability

25 Pages Posted: 2 Sep 2016 Last revised: 9 Nov 2017

Date Written: November 8, 2017

Abstract

This paper studies optimal insurance in partial equilibrium in case the insurer is protected by limited liability, and the multivariate insured risk is exchangeable. We focus on the optimal allocation of remaining assets in default. We show existence of an equilibrium in the market. In such an equilibrium, we get perfect pooling of the risk in the market, but a protection fund is needed to charge levies to policyholders with low realized losses. If policyholders cannot be forced ex post to pay a levy, we show that the constrained equal loss rule is used in equilibrium. This rule gained particular interest in the literature on bankruptcy problems. Moreover, we show that in absence of a regulator, the insurer will always invest all its assets in the risky technology. We illustrate the welfare losses if other recovery rules are used in case of default; a different recovery rule can substantially effect the profit of the insurer.

Keywords: bankruptcy problems, insurance, limited liability, partial equilibrium, risk shifting

Suggested Citation

Boonen, Tim J., Equilibrium Recoveries in Insurance Markets with Limited Liability (November 8, 2017). Available at SSRN: https://ssrn.com/abstract=2833036 or http://dx.doi.org/10.2139/ssrn.2833036

Tim J. Boonen (Contact Author)

University of Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www.uva.nl/profiel/b/o/t.j.boonen/t.j.boonen.html

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