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Pareto optimal insurance policies in the presence of administrative costs

Aase, Knut K.
Working paper
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dpfor2010-7.pdf (205.4Kb)
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http://hdl.handle.net/11250/163997
Utgivelsesdato
2010-08
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  • Discussion papers (FOR) [529]
Sammendrag
In his classical article in The American Economic Review, Arthur

Raviv (1979) examines Pareto optimal insurance contracts when there

are ex-post insurance costs c induced by the indemnity I for loss x.

Raviv’s main result is that a necessary and sufficient condition for the

Pareto optimal deductible to be equal to zero is c0(I) = 0 for all I > 0(or I=0).

We claim that another type of cost function is called for in household

insurance, caused by frequent but relatively small claims. If a

fixed cost is incurred each time a claim is made, we obtain a non-trivial

Pareto optimal deductible even if the cost function does not vary with

the indemnity. This implies that when the claims are relatively small,

it is not optimal for the insured to get a compensation since the costs

outweighs the benefits, and a deductible will naturally occur.

We also discuss policies with an upper limit, and show that the

insurer prefers such contracts, but the insured does not. In Raviv’s

paper it was also shown that policies with upper limits are dominated by policies with no upper limit, when there are ex-post costs to insurance.

We show that the result is right, but the proof is wrong.
Utgiver
Norwegian School of Economics and Business Administration. Department of Finance and Management Science
Serie
Discussion paper
2010:7

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