Davies, B. and Watt, R. (2017). “Bundling and Insurance of Independent Risks.” Working Papers in Economics 17/05, University of Canterbury.
Risky prospects can often by disaggregated into several identifiable, smaller risks. In such cases, at least two modes of insurance are available: either (i) the disaggregated risks can be insured independently or (ii) the aggregate risk can be insured as one. We identify (ii) as risk bundling prior to insurance and (i) as separate, or unbundled, insurance. We investigate whether (i) or (ii) is preferable among consumers, insurers and the insurance market as a whole using numerical simulations. Our simulations reveal that separate contracts provide the socially optimal form of insurance when the insurer is able to charge the profit-maximising premia and has perfect information. Under asymmetric information with respect to consumers’ risk aversion, we find that separation is again the dominant method of insurance in terms of the market share it represents.