Optimal Loss Mitigation and Contract Design

Abstract

This work examines the interaction between the premium rates set by an insurer and the incentives of an individual to purchase market insurance and undertake mitigation to reduce the size of a potential loss. A risk-neutral monopolistic insurer prices insurance according to the price-elasticity of demand for coverage. The elasticity of demand is affected by the presence of both mitigation and government intervention. The availability of loss reduction activities increases the consumer's elasticity of demand and lowers the optimal rate charged by the monopolist. Government intervention reduces both expenditures on mitigation and the rate charged by the monopolistic insurer.