Abstract
This paper extends the classic expected utility theory analysis of optimal insurance contracting to the case where the insurer has a positive probability of total default and the buyer and insurer have divergent beliefs about this probability. The optimal marginal indemnity above the deductible is smaller (greater) than one if the buyer's assessment of default risk is more pessimistic (optimistic) than the insurer's. As an application of the model, we consider the market for reinsurance against catastrophic property loss and propose an expected utility theory explanation for the increasing and concave marginal indemnity schedule observed in this market.
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Cummins, J.D., Mahul, O. Optimal Insurance With Divergent Beliefs About Insurer Total Default Risk. Journal of Risk and Uncertainty 27, 121–138 (2003). https://doi.org/10.1023/A:1025680924004
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DOI: https://doi.org/10.1023/A:1025680924004