Impact of background risk on self-insurance against health loss

Abstract

This paper introduces two-period model for optimal self-insurance against health loss in the future in the case when there are two independent sources of risk, one of them is non-insurable. We prove that the impact of introduction of background risk on self- insurance depends on the timing. If background risk is contemporaneous with decision- making then it reduces demand for self-insurance; if background risk concerns the future then it increases demand for self-insurance. The result depends on signs of the third partial derivatives of the bivariate utility function. We also provide economic interpretation of the result.

Keywords

• self-insurance
• background risk
• risk-aversion