Optimal insurance design under mean-variance preference with narrow framing (Q6072266)

The authors study an optimal insurance design problem under mean-variance criterion by considering the local gain-loss utility of the net payoff of insurance, namely, narrow framing. The existing results in the literature are extended to the case where the decision maker has mean-variance preference with a constraint on the expected utility of the net payoff of insurance and the premium is determined by the mean-variance premium principle. The authors first show the existence and uniqueness of the optimal solution to the main problem studied in the paper. They find that the optimal indemnity function involves a deductible provided that the safety loading imposed on the ``mean part'' of the premium principle is strictly positive. The main result shows that narrow framing indeed reduces the demand for insurance. The explicit optimal indemnity functions are derived under two special local gain-loss utility functions -- the quadratic utility function and the piecewise linear utility function. As a spin-off result, the Bowley solution is also derived for a Stackelberg game between the decision maker and the insurer under the quadratic local gain-loss utility function. Several numerical examples are presented to further analyze the effects of narrow framing on the optimal indemnity function as well as the interests of both parties.