The design of an optimal insurance contract for irreplaceable commodities

Rachel J. Huang, Larry Y. Tzeng

Research output: Contribution to journalArticlepeer-review

3 Scopus citations

Abstract

This paper discusses optimal insurance contract for irreplaceable commodities. To describe the dual impacts on individuals when a loss occurs to the insured irreplaceable commodities, we use a state-dependent and bivariate utility function, which includes both the monetary wealth and sentimental value as two arguments. We show that over (full, partial) insurance is optimal when a decrease in sentimental value will increase (not change, decrease, respectively) the marginal utility of monetary wealth. Moreover, a non-zero deductible exists even without administration costs. Furthermore, we demonstrate that a positive fixed reimbursement is optimal if (1) the premium is actuarially fair, (2) the monetary loss is a constant, and (3) the utility function is additively separable and the marginal utility of money is higher in the loss state than in the no-loss state. We also characterize comparative statics of fixed-reimbursement insurance under an additively separable preference assumption.

Original languageEnglish
Pages (from-to)11-21
Number of pages11
JournalGENEVA Risk and Insurance Review
Volume31
Issue number1
DOIs
StatePublished - Jul 2006

Keywords

  • Deductible
  • Fixed-reimbursement insurance
  • Irreplaceable commodities
  • Optimal insurance contract

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