Design of an Optimal Indemnity Contract: Fixed Payment Contract vs. Variable Payment Contract

Using a game theory approach, this paper analyzes the reason why insurers offer different payment contracts (fixed payment contract and variable payment contract). The main results of our research can be briefly described as follows. If the level of the insurance premium is the same through rigid regulation, then the insurer will certainly choose fixed payment contract because the insurer does not need to monitor the policyholder’s claim. In contrast, if the level of the insurance premium can be set voluntarily, which contract is advantageous for the insurer is ambiguous because the variable payment contract can set a higher insurance premium because of the removal of payoff uncertainty.