La Crema A Case Study of Mutual Fire Insurance.pdf

La Crema: A Case Study of Mutual Fire Insurance¤ Antonio Cabralesy Antoni Calvó-Armengolz Matthew O. Jacksonx This Draft: December 12, 2000 Abstract We analyze a mutual …re insurance mechanism used in Andorra, which is called La Crema in the local language. This mechanism relies on households’ announced property values to determine how much a household is reimbursed in the case of a …re and how payments are apportioned among other households. The only Pareto e¢cient allo- cation reachable through the mechanism requires that all households honestly report the true value of their property. However, such hon- est reporting is not an equilibrium except in the extreme case where the property values are identical for all households. Nevertheless, as the size of the society becomes large, the bene…ts from deviating from truthful reporting vanish, and all of the non-degenerate equilibria of the mechanism are nearly truthful and approximately Pareto e¢cient. Keywords: insurance, contract theory, mechanism design, truthful revelation. JEL Classi…cation: A13, C72, D64, D80 ¤We are grateful to Luis Corchón and Joel Sobel for their comments. We also gratefully acknowledge the …nancial support of Spain’s Ministry of Education under grant PB96-0302 and the Generalitat de Catalunya under grant 1999SGR-00157 and the National Science Foundation under grant SES-9986190. yDepartment of Economics, Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005 Barcelona, Spain. Email: antonio.cabrales@econ.upf.es. zDepartment of Economics, Universidad Carlos III, C/ Madrid 126, 28903 Getafe (Madrid), Spain and CERAS-ENPC, 28 rue des Saints-Pères, 75007 Paris, France. Email: ancalvo@eco.uc3m.es xDivision