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Institute
Mutual insurance companies and stock insurance companies are different forms of organized risk sharing: policyholders and owners are two distinct groups in a stock insurer, while they are one and the same in a mutual. This distinction is relevant to raising capital, selling policies, and sharing risk in the presence of financial distress. Up-front capital is necessary for a stock insurer to offer insurance at a fair premium, but not for a mutual. In the presence of an owner-manager conflict, holding capital is costly. Free-rider and commitment problems limit the degree of capitalization that a stock insurer can obtain. The mutual form, by tying sales of policies to the provision of capital, can overcome these problems at the potential cost of less diversified owners.
We study optimal investment in self-protection of insured individuals when they face interdependencies in the form of potential contamination from others. If individuals cannot coordinate their actions, then the positive externality of investing in self-protection implies that, in equilibrium, individuals underinvest in self-protection. Limiting insurance coverage through deductibles or selling “at-fault” insurance can partially internalize this externality and thereby improve individual and social welfare. JEL Classification: C72, D62, D80