Can an Optimal Insurance Contract Violate the Principle of Indemnity?
Date Issued
2001-11-07
Date
2001-11-07
Author(s)
Huang, Jui-Ching
Tzeng, L.Y.
Wang, Chau-Chang
DOI
20060927122729757463
Abstract
The principle of indemnity is well-accepted in the field of insurance and is also commonly
assumed in the literature of optimal contract design. However, should this principle be imposed
on all insurance contracts without exceptions? Does there exist an insurance contract that is
optimal for both the insurer and the insured even as the principle of indemnity is violated? The
answer is yes. This paper demonstrates that in the insurance market there do exist contracts
in which optimality is accompanied by a violation of the indemnity principle if the insurer and
insured have deviant beliefs in loss distribution. We further use retrospective rating as an example
to explain why an insurance contract, violating the principle of indemnity, commonly exists in
commercial insurance, especially where moral hazard and adverse selection is less severe.
Subjects
optimal insurance contract
deviant beliefs
retrospective rating
moral
hazard
hazard
adverse selection
Publisher
臺北市:國立臺灣大學財務金融學系
Type
report
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