Strategic Demand for Insurance

Abstract

We focus on the corporate demand for insurance under duopoly. We consider the case in which firms purchase insurance in order to enhance their competitiveness. We show that a higher level of corporate insurance makes a firm more aggressive and its competitor less aggressive in the output market (strategic effect). The optimal coverage of insurance is determined by comparing the strategic effect of insurance and the cost of insurance. The optimal coverage is positive if the strategic effect is greater than the cost of insurance. An interesting implication is that a risk-neutral firm may purchase actuarially unfair insurance. The main strategic effect of insurance comes from the fact that firms purchase insurance before they produce outputs. Insurance makes firms more aggressive due to the limited risk costs of firms. Copyright The Journal of Risk and Insurance, 2006.

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