Internalizing externalities of loss-prevention through insurance monopoly: An analysis of interdependent risks

Annette Hofmann

No 16, Working Papers on Risk and Insurance from University of Hamburg, Institute for Risk and Insurance

Abstract: When risks are interdependent, loss-prevention activities of one agent influence the risks faced by others. The social return to an investment in loss-prevention is greater than the private return. From a perspective of social welfare, the market allocation is not optimal and leads to under-investment in prevention allround. This article considers consumer welfare under conditions of interdependent risks and demonstrates that a monopolistic insurer can internalize the arising externalities by setting appropriate prevention incentives through insurance premiums. A monopoly insurance solution reduces not only costs of risk selection, but can also play an important role in loss-prevention.

Keywords: externalities; insurance monopoly; Nash equilibrium; social welfare (search for similar items in EconPapers)
JEL-codes: C70 D62 G22 (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (1)

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