Optimal Insurance Policy Indemnity Schedules with Policyholders' Limited Liability and Background Risk
Journal of Risk and Insurance, Forthcoming
16 Pages Posted: 22 Feb 2018
Date Written: January 31, 2018
This paper makes two contributions to the insurance literature by studying optimal insurance policy indemnity schedules with policyholders' limited liability and background risk. First, generalizing a prominent approach by Huberman, Mayers, and Smith (1983), it is shown that a welfare subsidy in the case of a ruinous loss may make the insurance premium "overly fair" for non-bankrupting losses and full insurance for this event becomes optimal. Second, introducing correlated background risk into this limited liability framework relativizes or even turns results by Doherty and Schlesinger (1983) as to the impact of background risk on optimal coverage into its opposite.
Keywords: insurance demand, limited liability, overinsurance
JEL Classification: D02, G22
Suggested Citation: Suggested Citation