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Insuring the uninsurable: brokers and incomplete insurance contracts

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  • Doherty, Neil A.
  • Muermann, Alexander

Abstract

How do markets spread risk when events are unknown or unknowable and where not anticipated in an insurance contract? While the policyholder can 'hold up' the insurer for extra contractual payments, the continuing gains from trade on a single contract are often too small to yield useful coverage. By acting as a repository of the reputations of the parties, we show the brokers provide a coordinating mechanism to leverage the collective hold up power of policyholders. This extends both the degree of implicit and explicit coverage. The role is reflected in the terms of broker engagement, specifically in the ownership by the broker of the renewal rights. Finally, we argue that brokers can be motivated to play this role when they receive commissions that are contingent on insurer profits. This last feature questions a recent, well publicized, attack on broker compensation by New York attorney general, Elliot Spitzer.

Suggested Citation

  • Doherty, Neil A. & Muermann, Alexander, 2005. "Insuring the uninsurable: brokers and incomplete insurance contracts," CFS Working Paper Series 2005/24, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:200524
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    File URL: https://www.econstor.eu/bitstream/10419/25461/1/515325678.PDF
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    References listed on IDEAS

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    1. Bond, Eric W. & Crocker, Keith J., 1997. "Hardball and the soft touch: The economics of optimal insurance contracts with costly state verification and endogenous monitoring costs," Journal of Public Economics, Elsevier, vol. 63(2), pages 239-264, January.
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    5. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    6. Jean-Baptiste, Eslyn L. & Santomero, Anthony M., 2000. "The Design of Private Reinsurance Contracts," Journal of Financial Intermediation, Elsevier, vol. 9(3), pages 274-297, July.
    7. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
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    Cited by:

    1. Tajudeen Olalekan Yusuf, 2011. "Brokers' incentives and conflicts of interest in the control of opportunism," Journal of Risk Finance, Emerald Group Publishing, vol. 12(3), pages 168-181, May.
    2. Qin Lian & Harris Schlesinger, 2012. "Insurance Contract Design When the Insurer Has Private Information on Loss Size," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(4), pages 1039-1050, December.

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    More about this item

    Keywords

    Incomplete Insurance Contracts; Brokerage; Contingent Commissions; Reputation;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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