Insuring Nonverifiable Losses

Abstract

Insurance contracts are often complex and difficult to verify outside the insurance relation. We show that standard one-period insurance policies with an upper limit and a deductible are the optimal incentive-compatible contracts in a competitive market with repeated interaction. Optimal group insurance policies involve a joint upper limit and individual deductibles; insurance brokers can play a role implementing such contracts for their clients. Our model provides new insights and predictions about the determinants of insurance.