The Strategic Role of Insurance: The Warranty Case

Abstract

We consider a model in which risk-neutral firms purchase liability insurance to guarantee their warranty policies. We show that the firms that have no problem in fulfilling their warranty policies have strong incentives to purchase liability insurance. Firms purchase insurance because doing so enhances their competitive powers. This paper complements the literature on corporate demand for insurance by emphasizing the strategic role of insurance. This paper is also related to the literature on the demand for liability insurance under the negligence rule. We show that firms may purchase liability insurance according to their strategic purpose, even though they take due care under the negligence rule.