Moral Hazard and Background Risk in Competitive Insurance Markets

James A. Ligon and Paul D. Thistle

Economica, 2008, vol. 75, issue 300, 700-709

Abstract: We examine the effect of background risk on competitive insurance markets with moral hazard. If policy‐holders have non‐negative prudence, then background risk does not decrease effort and, when effort increases, expands the set of feasible policies. However, the effect of background risk on equilibrium is indeterminate. We analyse the choice between stock and mutual insurance; mutual insurance is equivalent to a fair policy plus background risk. Our results imply that competitive insurance markets with moral hazard should be dominated by stock insurers.

Date: 2008
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https://doi.org/10.1111/j.1468-0335.2007.00650.x

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