Insurance Demand I: Decisions Under Risk Without Diversification Possibilities
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Throughout this chapter, the economic agent is assumed to dispose of two instruments of risk management only, viz. purchasing insurance coverage or exerting preventive effort. The possibility of coping with uncertainty through a diversification of assets is therefore neglected. This alternative is available to enterprises and their owners and will be treated in Chap. 4. Section 3.1 refers to the risk utility function derived in Sect. 2.2.2 and presents the expected utility maximization hypothesis which is used to resolve the decision making problem under uncertainty. With this, the groundwork is laid for developing the basic model of insurance demand in Sect. 3.2. It predicts the choice of full coverage if the potential purchaser of insurance is charged the so-called fair premium, i.e. a premium that just covers the expected value of the loss insured.