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Dynamic Prevention in Short‐Term Insurance Contracts

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  • M. Martin Boyer
  • Karine Gobert

Abstract

This article looks at the dynamic properties of insurance contracts when insurers have a better technology at preventing catastrophic losses than the insured. When the prevention technology is irreversible and its benefits last for all future periods although its cost is borne in the period in which it is made, a hold‐up problem occurs because the insured can change insurer after his initial insurer has invested in prevention. Investment in prevention is then delayed compared to the first best outcome. When the audit cost must be incurred by the insured when he wants to change insurer, the incumbent insurer has an informational advantage so that he can keep his client over the entire investment horizon, even though long‐term contracts are not possible. This does not avoid the delay in investment, however.

Suggested Citation

  • M. Martin Boyer & Karine Gobert, 2008. "Dynamic Prevention in Short‐Term Insurance Contracts," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(2), pages 289-312, June.
    • Handle: RePEc:bla:jrinsu:v:75:y:2008:i:2:p:289-312
    DOI: 10.1111/j.1539-6975.2008.00261.x
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