Variance insurance contracts (Q6199667)

The paper presents a scheme to derive optimal insurance contracts in which the insured maximizes her expected utility, and the insurer limits the variance of his risk exposure while maintaining the principle of indemnity and charging the premium according to the expected value principle. After presenting the main settings of the problem, including a comparison with the Pareto framework, the optimal policy is derived, satisfying the incentive-compatible condition. Then, comparative statics are dealt with, considering the effects of the insured's initial wealth and the variance constraint on insurance demand. Proofs and technical insights are in the Appendices.