Underinsurance Caused by Uninsurable Losses in the Public Goods and Personal Assets

Fan-chin Kung (kungf@ecu.edu) and Haiyong Liu (liuh@ecu.edu)
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Fan-chin Kung: Department of Economics, East Carolina University
Haiyong Liu: Department of Economics, East Carolina University

Review of Economics & Finance, 2019, vol. 15, 14-22

Abstract: A significant portion of flood damages were not covered by insurance, and policies are devised to promote insurance coverage. There are, however, rational reasons for why households may not purchase full insurance facing risks. We discuss optimal underinsurance when there are uninsurable losses in the public goods or personal assets. In a first-best allocation, households will fully restore the damaged public goods after a natural hazard and purchase full insurance. When public goods restoration is not available, the Samuelson condition holds in expected utility, and households purchase insurance less than their wealth loss. Also, when there are uninsurable losses in personal assets, that optimal insurance purchase is less than the wealth loss. We provide a model based on households' choices of coverage and deductibles in insurance purchases. This model can be used to estimate households' risk preferences towards natural hazards.

Keywords: Underinsurance; Flood insurance; Public goods and risk; Estimating risk preferences; Uninsurable loss (search for similar items in EconPapers)
JEL-codes: D81 G22 H44 (search for similar items in EconPapers)
Date: 2019
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