Neil A. Doherty, Harris Schlesinger; Rational Insurance Purchasing: Consideration of Contract Nonperformance*, The Quarterly Journal of Economics, Volume 105, I

With asymmetric information, full commitment to long-term contracts may permit markets to approach first-best allocations. However, commitment can be undermined by opportunistic behavior, notably renegotiation. We reexamine commitment in insurance markets. We present an alternative model (which extends Laffont and Tirole's procurement model to address uncertainty and competition), which involves semipooling in the first period followed by separation. This and competing models (e.g., single-period models and no-commitment models) have different predictions concerning temporal patterns of insurer profitability. A test using California data suggests that some automobile insurers use commitment to attract selective portfolios comprising disproportionate numbers of low risks.

This paper examines the theory of optimal insurance purchasing in the presence of uninsurable background risk. Existing theorems concerning the optimal level of insurance and the optimal form of an insurance contract are shown to hold only under restricted market and risk assumptions. In particular, conditions sufficient for the optimality of full coverage or sufficient for the optimality of deductible policies depend on the correlation between insurable and uninsurable risks. These results may provide a partial explanation why existing theory is often contradicted by observable behavior.

This paper examines the theory of optimal insurance purchasing in the presence of uninsurable background risk. Existing theorems concerning the optimal level of insurance and the optimal form of an insurance contract are shown to hold only under restricted market and risk assumptions. In particular, conditions sufficient for the optimality of full coverage or sufficient for the optimality of deductible policies depend on the correlation between insurable and uninsurable risks. These results may provide a partial explanation why existing theory is often contradicted by observable behavior.