Optimal insurance design in the presence of exclusion clauses

• Published in: Insurance, mathematics & economics mathematics & economics, 2017-09, Vol.76, p.185-195
• Main Authors: Chi, Yichun, Liu, Fangda
• Format: Article
• Language: English
• Subjects: Expected values; Expectile; Insurance contracts; Insurance coverage; Insurance policies; Insurance premiums; Layer insurance; Moral hazard; Optimal insurance with exclusion clauses; Risk exposure; Risk levels; Risk management; Tail value at risk; Value at risk; Wang’s premium principle
• ISSN: 0167-6687; 1873-5959
• DOI: 10.1016/j.insmatheco.2017.07.003

The present work studies the design of an optimal insurance policy from the perspective of an insured, where the insurable loss is mutually exclusive from another loss that is denied in the insurance coverage. To reduce ex post moral hazard, we assume that both the insured and the insurer would pay more for a larger realization of the insurable loss. When the insurance premium principle preserves the convex order, we show that any admissible insurance contract is suboptimal to a two-layer insurance policy under the criterion of minimizing the insured’s total risk exposure quantified by value at risk, tail value at risk or an expectile. The form of optimal insurance can be further simplified to be one-layer by imposing an additional weak condition on the premium principle. Finally, we use Wang’s premium principle and the expected value premium principle to illustrate the applicability of our results, and find that optimal insurance solutions are affected not only by the size of the excluded loss but also by the risk measure chosen to quantify the insured’s risk exposure.