Individuals tend to seek insurance to pass some risks on to the insurer when they expect large losses in the use of assets. The insurer can make his activity sustainable by pooling risks. If individuals can be expected to bear a greater fraction of the loss due to failure, they will be more diligent in the use of assets and reduce risks for which they are responsible. Similarly, efficient insurance policies may motivate individuals to reduce some forms of systemic risk especially when they are predictable. However, the increase in costs, associated with risks and the fulfillment of covenants designed to reduce them, invariably increases costs, reduces the equilibrium insurance coverage, and increases premiums. The residual systemic risk that cannot be absorbed by these policies and the necessity to generate wider and superior insurance service are at the basis of the call for regulation of the insurance business. The attempt made in this study is to examine the nature of efficient insurance in the presence of both types of risk, regulatory policy, and individual adaptations to them. Sharing risks through self-selection, optimal regulatory oversight, and insurance policies designed on such a basis can be efficient and offer a fairly wide coverage only against some individual-specific and limited systemic risks. In several contexts systemic risks and their origin cannot be predicted in advance. Efficient design of insurance to counter such risks may never really be possible since it is an ex ante specification.
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