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Internalizing externalities of loss-prevention through insurance monopoly: An analysis of interdependent risks

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  • Hofmann, Annette

Abstract

When risks are interdependent, loss-prevention activities of one agent influence the risks faced by others. The social return to an investment in loss-prevention is greater than the private return. From a perspective of social welfare, the market allocation is not optimal and leads to under-investment in prevention allround. This article considers consumer welfare under conditions of interdependent risks and demonstrates that a monopolistic insurer can internalize the arising externalities by setting appropriate prevention incentives through insurance premiums. A monopoly insurance solution reduces not only costs of risk selection, but can also play an important role in loss-prevention.

Suggested Citation

  • Hofmann, Annette, 2005. "Internalizing externalities of loss-prevention through insurance monopoly: An analysis of interdependent risks," Working Papers on Risk and Insurance 16, University of Hamburg, Institute for Risk and Insurance.
    • Handle: RePEc:zbw:hzvwps:16
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    More about this item

    Keywords

    externalities; insurance monopoly; Nash equilibrium; social welfare;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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