In liability lawsuits (e.g., patent infringement), a plaintiff demands compensation from a defendant, and the parties often negotiate a settlement to avoid a costly trial. Liability insurance creates bargaining leverage for the defendant in this settlement negotiation. We study the characteristics of monopoly and equilibrium contracts in settings where this leverage effect is a substantial source of value for insurance. Our results show that under adverse selection, a monopolist offers at most two contracts, which underinsure low-risk types and may inefficiently induce high-risk types to litigate. In a competitive market, only a pooling equilibrium with underinsurance may exist.
Lemus, Jorge, Emil Temnyalov, and John L. Turner.
"Liability Insurance: Equilibrium Contracts under Monopoly and Competition."
American Economic Journal: Microeconomics,
Market Structure, Pricing, and Design: Perfect Competition
Market Structure, Pricing, and Design: Monopoly
Asymmetric and Private Information; Mechanism Design
Economics of Contract: Theory
Insurance; Insurance Companies; Actuarial Studies
Tort Law and Product Liability; Forensic Economics