Rational Insurance Purchasing: Consideration of Contract Nonperformance

Optimal coverage for incompletely reliable insurance

“…, the difference in marginal utilities in equation (5) While a simple monotonic relationship between the level of coverage and the recovery rate does not emerge, as mentioned by Doherty and Schlesinger (1990), the Proposition shows that there exists a trigger recovery rate under (at, above) which lessthan-full (full, more-than-full) unreliable insurance coverage is optimal. This trigger level t is independent of the attitudes towards risk and of the loss.…”

“…This analysis includes total default risk, 0 = t , examined by Doherty and Schlesinger (1990) as a special case. Note that…”

“…She is endowed with non-random initial wealth w 0 . In the three-state model proposed by Doherty and Schlesinger (1990) …”

“…This paper examines the implications of partial indemnification under nonperformance in the three-state model proposed by Doherty and Schlesinger (1990). We show that there exists a trigger recovery rate under non-performance such that, when sold at a fair price, the optimal unreliable insurance contract displays less-than-full (full, more-than-full) coverage as long as the recovery rate is lower than (equal to, higher than) this trigger rate.…”

“…A notable exception is Doherty and Schlesinger (1990) who address the effect of risk of nonperformance on rational insurance purchases. They show that if default, when it occurs, is always total, less-than-full insurance coverage is always purchased at a fair price.…”