On Three Standard Results in the Theory of Insurance Demand

Abstract

This article re-examines three standard results in the theory of insurance demand: (i) full coverage with a fair premium and partial coverage with an unfair premium; (ii) insurance is an inferior good under decreasing absolute risk aversion (DARA) and (iii) insurance may be a Giffen good under DARA. It has been shown recently that (i) holds for the class of insurance policies whose maximum coverage fully covers the potential loss. We show that whether (i) holds beyond this class of policies is indeterminate. In addition, we employ a unified framework to investigate the effects of changes in initial wealth and price. In particular, we show that both (ii) and (iii) hold for a certain class of insurance policies which include all commonly-used types of policies. The result also provides a unified treatment of several results in the extant literature.

Keywords: optimal insurance level; coinsurance; deductible insurance; upper-limit insurance; changes in initial wealth; changes in price; unified framework