Underinsurance Caused by Uninsurable Losses in the Public Good and Personal Assets
9 Pages Posted: 13 Apr 2019
Date Written: September 20, 2018
A significant portion of flood damages were not covered by insurance, and policies are devised to promote insurance coverage. There are, however, rational reasons for why households may not purchase full insurance facing risks. We discuss optimal underinsurance when there are uninsurable losses in the public good or personal assets. In a first-best allocation, households will fully restore the damaged public good after a natural hazard and purchase full insurance. When public good restoration is not available, the Samuelson condition holds in expected utility, and households purchase insurance less than their wealth loss. Also, when there are uninsurable losses in personal assets, that optimal insurance purchase is less than the wealth loss. We provide a model based on households' choices of coverage and deductibles in insurance purchases, that can be used to estimate their risk preferences towards natural hazards.
Keywords: Underinsurance, flood insurance, public good and risk, estimating risk preferences, uninsurable loss
JEL Classification: D81, H44, G22
Suggested Citation: Suggested Citation