Optimal Insurance for Prudent Risk Averters and Risk Lovers
36 Pages Posted: 8 Jan 2020
Date Written: December 12, 2019
This paper examines the structure of optimal insurance contracts for a broad class of insureds that includes both risk averters and risk lovers and by assuming that the insureds are prudent. We specify the difference in optimal contract form between risk averters and risk lovers. Treating these decision-makers as a unique group, we show that the optimal insurance form is dual limited stop-loss insurance with an upper limit, which implies that including risk lovers in the group of decision-makers changes the contract in the small loss part. We also consider the situation of contracts with a concave payoff, where the optimal contract form becomes limited change-loss insurance or limited dual change-loss insurance depending on the coefficient of variation of the retained loss. Finally, we derive the form of optimal contracts in the presence of a background risk.
Keywords: Third degree risk, Risk lovers, Dual limited stop-loss insurance, Limited change-loss insurance, Limited dual change-loss insurance, Limited stop-loss insurance, Background risk
JEL Classification: G22
Suggested Citation: Suggested Citation