Abstract

In standard models of contracts, efficient incentives require the promisor to pay damages for non-performance and the promisee to receive no damages. To give efficient incentives to both parties, we propose a novel contract requiring the promisor to pay damages for nonperformance to a third party, not to the promisee. In exchange for the right to damages, the third party pays the promisor and promisee in advance before performance or nonperformance occurs. We call this novel contract "anti-insurance" because it strengthens incentives by magnifying risk, whereas insurance erodes incentives by spreading risk. Anti-insurance is based on the general principle that efficient incentives typically require each party to bear the full risk that they jointly create. By improving incentives, anti-insurance contracts can create value and benefit everyone. Anti-insurance could be especially useful in contracts for goods susceptible to consumer misuse (e.g. automobile transmissions) and goods or service contracts requiring buyer's cooperation (e.g. building construction). In some circumstances we recommend allowing sellers to substitute anti-insurance for implied warranties or liability to consumers of defective products.

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