Disappointment and the Optimal Insurance Contract

Rachel Huang, Pai-Ta Shih and Larry Y Tzeng
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Pai-Ta Shih: Department of Finance, National Taiwan University, Taipei, Taiwan. E-mails: ptshih@management.ntu.edu.tw; tzeng@ntu.edu.tw
Larry Y Tzeng: 1] Department of Finance, National Taiwan University, Taipei, Taiwan. E-mails: ptshih@management.ntu.edu.tw; tzeng@ntu.edu.tw[2] Risk and Insurance Research Center (RIRC), National Cheng-Chi University, Taipei, Taiwan.

The Geneva Risk and Insurance Review, 2012, vol. 37, issue 2, 258-284

Abstract: This paper studies the optimal insurance contract under disappointment theory. We show that, when the individuals anticipate disappointment, there are two types of optimal insurance contract. The first type contains a deductible and a coinsurance above the deductible. We find that zero marginal cost is just a sufficient but not a necessary condition for a zero deductible. The second type has no deductible and the optimal insurance starts with full coverage for small losses and includes a coinsurance above an upper value of the full coverage.

Date: 2012
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