Implications of Incomplete Performance for Optimal Insurance

We investigate the demand for insurance when contracts are subject, with positive probability, to two distinct types of incomplete performance. When partial performance means payment of some fraction of the indemnity under full performance, the latter exhibits a disappearing deductible. When partial performance is due to insufficient financial capacity, optimal insurance contracts, for any given level of financial capacity, offer full marginal coverage above a deductible. For either type of non-performance, the optimal deductible under full performance is positive when insurance is offered at an actuarially fair price. Copyright (c) The London School of Economics and Political Science 2004.