Availability Crises in Insurance Markets: Optimal Contracts with Asymmetric Information and Capacity Constraints

Neil A. Doherty, Lisa Lipowski Posey

Research output: Contribution to journalArticle

14 Citations (Scopus)

Abstract

Insurance markets sometimes exhibit "crises" in which prices rise dramatically and coverage is unavailable or is rationed at the new prices. A recent explanation for such crises is the "capacity constraint" model of Gron and Winter. Crises usually follow sudden and large depletions in insurers' equity or surplus. The capacity constraint model argues that frictional costs in replacing surplus, and limited liability, give rise to a kinked insurance supply function and that crises arise from discontinuous short term adjustments around the kink. While this model explains much about liability insurance crises, it still leaves unexplained their most prominent feature; that insurance is rationed or unavailable. We follow their insight in looking to equity shocks and capital market frictions to explain crises and combine this with a model of optimal risk sharing contracts under the information conditions characteristic of this market. We use implicit long term contracts with truth telling constraints to address information asymmetries and this allows us to model crises that exhibit rationing. Our model is tested in the market most dramatically affected by such crises in the 1980's, the general liability insurance market.

Original languageEnglish (US)
Pages (from-to)55-80
Number of pages26
JournalJournal of Risk and Uncertainty
Volume15
Issue number1
DOIs
StatePublished - Jan 1 1997

Fingerprint

Optimal contract
Capacity constraints
Insurance market
Asymmetric information
Equity
Insurance
Surplus
Liability insurance
Depletion
Winter
Capital markets
Limited liability
Costs
Information asymmetry
Truth-telling
Insurer
Market frictions
Rationing
Optimal risk sharing
Long-term contracts

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

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Availability Crises in Insurance Markets : Optimal Contracts with Asymmetric Information and Capacity Constraints. / Doherty, Neil A.; Posey, Lisa Lipowski.

In: Journal of Risk and Uncertainty, Vol. 15, No. 1, 01.01.1997, p. 55-80.

Research output: Contribution to journalArticle

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