Understanding Basis Risk in Insurance Contracts

15 Pages Posted: 14 Feb 2007

See all articles by Dana A. Kerr

Dana A. Kerr

University of Southern Maine; St. Mary's University of San Antonio

Abstract

There is a tremendous amount of resources being tied up in litigation between insurance companies and policyholders over things like the extent of coverage for various loss scenarios or allegedly bad faith delays in settlement payments. The fact that policyholders formally dispute insurer coverage positions or claims payment strategies gives credibility to the idea that mismatches exist between what policyholders expect insurance policies to cover and what the insurance contracts actually provide as loss indemnification. This mismatch essentially represents insurance basis risk, the analysis of which can more accurately reflect the value and overall efficiency of insurance contracts and suggest factors that may influence policyholder dissatisfaction and consequently insurance contract disputes. This article takes a detailed look at insurance basis risk and finds that subjectivity plays a prominent role in its definition. Using Bayesian inference, it is shown how factors can affect the magnitude of insurance basis risk depending on the individual situation in which the mismatch between losses and coverage exists.

Suggested Citation

Kerr, Dana A., Understanding Basis Risk in Insurance Contracts. Risk Management & Insurance Review, Vol. 9, No. 1, pp. 37-51, March 2006, Available at SSRN: https://ssrn.com/abstract=963020 or http://dx.doi.org/10.1111/j.1540-6296.2006.00083.x

Dana A. Kerr (Contact Author)

University of Southern Maine ( email )

P.O. Box 9300
Portland, ME 04104-9300
United States

St. Mary's University of San Antonio ( email )

One Camino Santa Maria
San Antonio, TX 78228
United States

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