DP12855 Financing Insurance

Author(s): Adriano A. Rampini, S. Viswanathan
Publication Date: April 2018
Keyword(s): Collateral, Financial constraints, household finance, Insurance, Risk management
JEL(s): D91, E21, G22
Programme Areas: Financial Economics, Development Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12855

Insurance has an intertemporal aspect as insurance premia have to be paid upfront. We argue that the financing aspect of insurance is key to understanding basic insurance patterns. In a model with limited enforcement, we show that insurance is globally monotone increasing in household net worth and income, incomplete, and precautionary. These results hold in economies with income risk, durable goods and collateral constraints, and durable goods price risk that affects asset values, under quite general conditions. In equilibrium, insurers are financial intermediaries with collateralized loans as assets and diversified portfolios of insurance claims as liabilities. Collateral scarcity lowers the interest rate, reduces insurance, and increases inequality.