Equity Risk, Conversion Risk, and the Demand for Insurance

The paper studies optimal property insurance in the presence of equity risk and conversion risk. Equity risk is randomness of the value of a property. It tends to raise demand for conventional insurance on the property. In contrast, conversion risk is randomness in the value the property would have if, after severe damage, it were converted to the highest-valued use. It is distinct from equity risk because the current use is typically not the one that has highest value. Conversion risk may raise or lower the demand for property insurance. Insurance contracts that fail to address conversion tend to undermine the orderly disposition of obligations and reduce the gains from reallocation of risks through insurance.