Optimal Insurance Policy Indemnity Schedules With Policyholders’ Limited Liability and Background Risk

Annette Hofmann, Ole V. Häfen and Martin Nell

Journal of Risk & Insurance, 2019, vol. 86, issue 4, 973-988

Abstract: This article makes two contributions to the insurance literature by studying optimal insurance policy indemnity schedules with policyholders’ limited liability and background risk. First, generalizing a prominent approach by Huberman, Mayers, and Smith (1983), it is shown that a welfare subsidy in the case of a ruinous loss may make the insurance premium “overly fair” for nonbankrupting losses and full insurance for this event becomes optimal. Second, introducing correlated background risk into this limited liability framework relativizes or even turns results by Doherty and Schlesinger (1983) as to the impact of background risk on optimal coverage into its opposite.

Date: 2019
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