Internalizing externalities of loss prevention through insurance monopoly: an analysis of interdependent risks |
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| Authors: | Annette Hofmann |
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| Institution: | (1) Institute for Risk and Insurance, University of Hamburg, Hamburg, Germany |
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| Abstract: | When risks are interdependent, an agent’s decision to self-protect affects the loss probabilities faced by others. Due to
these externalities, economic agents invest too little in prevention relative to the socially efficient level by ignoring
marginal external costs or benefits conferred on others. This paper analyzes an insurance market with externalities of loss
prevention. It is shown in a model with heterogenous agents and imperfect information that a monopolistic insurer can achieve
the social optimum by engaging in premium discrimination. An insurance monopoly reduces not only costs of risk selection,
but may also play an important social role in loss prevention.
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| Keywords: | Externalities Insurance monopoly Nash equilibrium Social welfare |
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