Abstract
Upper limits in property insurance contracts can result directly from the consumer's demand for them. They are demanded because the consumer has options to convert or move out of damaged property rather than merely to restore it to its previous condition and occupy it. In the absence of transactions costs, finding the optimum upper limit is equivalent to finding the insurable interest. When real estate transactions are costly, binding upper limits are demanded, but they may be higher than the upper limits that an insurer should impose to ensure incentive compatibility and mitigate moral hazard. Moreover, the concept of insurable interest divides to become two distinct concepts: the upper limit of legitimate demand, and the upper limit that the prudent insurer would use.
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