When Indemnity Insurance Fails: Parametric Coverage under Binding Budget and Risk Constraints

Benjamin Avanzi, Debbie Kusch Falden and Mogens Steffensen

Papers from arXiv.org

Abstract: In high-risk environments, traditional indemnity insurance is often unaffordable or ineffective, despite its well-known optimality under expected utility. We compare excess-of-loss indemnity insurance with parametric insurance within a common mean-variance framework, allowing for fixed costs, heterogeneous premium loadings, and binding budget constraints. We show that, once these realistic frictions are introduced, parametric insurance can yield higher welfare for risk-averse individuals, even under the same utility objective. The welfare advantage arises precisely when indemnity insurance becomes impractical, and disappears once both contracts are unconstrained. Our results help reconcile classical insurance theory with the growing use of parametric risk transfer in high-risk settings.

Date: 2025-12, Revised 2026-01
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