Optimal insurance design under background risk with dependence

In this paper, we revisit the problem of optimal insurance under a general criterion that preserves stop-loss order when the insured faces two mutually dependent risks: background risk and insurable risk. According to the local monotonicity of conditional survival function, we derive the optimal contract forms in different types of interval. Because the conditional survival function reflects the dependence between background risk and insurable risk, the dependence structure between the two risks plays a critical role in the insured’s optimal insurance design. Furthermore, we obtain the optimal insurance forms explicitly under some special dependence structures. It is shown that deductible insurance is optimal and the Mossin’s Theorem is still valid when background risk is stochastically increasing in insurable risk, which generalizes the corresponding results in Lu et al. (2012). Moreover, we show that an individual will purchase no insurance when the sum of the two risks is stochastically decreasing in insurable risk.