INSURABLE INTEREST, OPTIONS TO CONVERT, AND DEMAND FOR UPPER LIMITS IN OPTIMUM PROPERTY INSURANCE

Upper limits in property insurance contracts can result directly from the consumer's demand for them. They are demanded because the consumer has options to convert or move out of damaged property rather than me rely to restore it to its previous condition and occupy it. In the abs ence of transactions costs, finding the optimum upper limit is equival ent to finding the insurable interest. When real estate transactions a re costly, binding upper limits are demanded, but they may be higher t han the upper limits that an insurer should impose to ensure incentive compatibility and mitigate moral hazard. Moreover, the concept of ins urable interest divides to become two distinct concepts: the upper lim it of legitimate demand, and the upper limit that the prudent insurer would use.