Risk Aversion, Negotiation, and Claims Settlement Strategies

Abstract

We examine the optimal claims settlement strategy for a liability insurer negotiating with classes of claimants who differ in risk attitude and negotiating skill. Our model demonstrates that a profit-maximizing insurer will be systematically less generous in claims payment to claimants who are more risk averse and who experience greater negotiating costs. We test our theory empirically using the 1997 Insurance Research Council automobile claims data. Following the existing literature we use claimant gender and age to identify classes of claimants with different risk preferences and negotiating costs. Empirical analysis is consistent with systematically less generous claims payment to claimants in these classes.

Keywords: risk aversion, negotiation, automobile insurance, claim settlement

JEL Classification: J14, J16