Insurance Markets with Loss-Prevention Activity: Profits, Market Structure, and Consumer Welfare

Abstract

This article considers the joint production of insurance protection and loss prevention by insurers. We first examine the loss distribution of consumers that is potentially the most profitable for insurers. Unlike in the preponderance of the insurance literature, which assumes cost-based pricing of insurance policies, we allow the insurer to charge whatever price the market will bear. We then examine the expected-profit-maximizing strategy of assumes cost-based pricing of insurance policies, we allow the insurer to charge whatever price the market will bear. We then examine the expected-profit-maximizing strategy of the insurer in several different market settings. Whether the insurance protection and loss-prevention services can be perfectly bundled plays a key roll in the insurer's pricing decision. We consider consumer welfare under various market settings and demonstrate that a consumer may be better off when the insurance market is monopolistic rather than competitive. Finally, we consider whether monopoly power in the loss-prevention market leads to monopoly power in an otherwise perfectly contestable insurance market. We also show conditions under which a loss-prevention monopolist would increase expected profit by integrating into the insurance market.