Pareto-optimal deductibles in property-liability insurance: The case of homeowner insurance in Sweden

The Pareto-optimal sharing of risks in insurance has been treated formally by Borch (1960), Arrow (1971, 1974), and Raviv (1979). In Raviv's analysis, which is the most general, the role of a positive deductible is to economize on the administration costs of insurance. The intuition is that if the price of insurance covers both expected damages recovered plus the expected administrative costs of processing claims, consumers will be unwilling to purchase insurance against small losses where claim-processing costs exceed the value of the risk reduction generated by the insurance. The deductible regulates the division of risk-bearing between the insurer and insured so that the insurer's obligations are restricted to large losses. 1 The deductible is not the only device which might be used for this purpose. Specific contractual or statutory conditions can also restrict the set of events permitting recovery.