2ND-BEST INSURANCE CONTRACT DESIGN IN AN INCOMPLETE MARKET

The optimal form of insurance contracts for multiple risks is examined . A well-known result in the literature is that, under fairly general conditions, an insurance policy with a deductible for aggregate losses is optimal. Real-world markets, however, are typically incomplete in that they require separate contracts for separate loss exposures. For instance, insurable damage to one's home is not generally allowed to a ffect the insurance indemnity for (unrelated) insurable damage to one' s automobile. We show that separate deductibles are second-best optima in this setting. We compare the indemnity provided in this second-bes t setting with first-best solutions. The effect of second-best contrac ts on the individual's total insurance demand is also examined.