Insurance Contract Design When the Insurer Has Private Information on Loss Size |
| |
| Authors: | Qin Lian Harris Schlesinger |
| |
| Institution: | Qin Lian is Assistant Professor of Finance at Louisiana Tech University. Harris Schlesinger is Professor of Finance and the Samford Chair of Insurance at the University of Alabama. The second author can be contacted via e‐mail: hschlesi@cba.ua.edu. The authors thank Keith Crocker, Georges Dionne (the editor), Pierre Picard, and two anonymous referees for helpful comments on an earlier version of this article. |
| |
| Abstract: | This article examines the optimal indemnity contract in an insurance market, when the insurer has private information about the size of an insurable loss. Both parties know whether or not a loss occurred, but only the insurer knows the true value of the loss and/or to what extent the losses are covered under the policy. The insured may verify the insurer's loss estimate for a fixed auditing cost. The optimal contract reimburses the auditing costs in addition to full insurance for losses less than some endogenous limit. For losses exceeding this limit, the contract pays a fixed indemnity and requires no monitoring. The optimal contract is compared with the contracts obtained in cases where it is only the insured who can observe the loss size. |
| |
| Keywords: | |
|
|
