Contracts as Insurance and More on Insurance

Suppose I agree to sell you 1000 widgets by July 1, my factory burns down and there is no way I could have foreseen or prevented the fire. I am unable to fulfill the contract, can I be held liable for the losses incurred by the buyer? Yes, if as part of the contract I was implicitly insuring the you the buyer for any losses incurred if I am unable to fulfill my contractual obligations.

Preventable loss—a loss that can be prevented at a cost that is less then the cost incurred by the loss itself. This definition is an economic one for there are losses that could physically be prevented, but where prevention of the losses would be economically inefficient. Example some super-fund cancer prevention expenditures.

Preventable loss—Expected cost of the loss equals p x loss, where p is the probability of loss, loss, is the dollar value of the loss, this product is compared to the cost of preventing the loss.

Contracts should assign the risk associated with hazards such as fire to the party that is the lowest cost preventor of the risk and/or the party that most can easily and cheaply insure for the risk—these will likely be the same individuals. Why? The transaction costs associated with bearing the loss is part of the determination, as well, this cost is primarily a function of pooling risk property of the law of large numbers.

Another example of implicit insurance is implied warranty. If a product fails even if the manufacturer is not the cause of the failure, the manufacturer can often most cheaply insure that risk—usually by self insurance. The consumer than pays a higher price for the product which covers the implicit "insurance premium."

Discuss the example involving drilling for water.

Example of the house that burned down during construction. Should the contractor bear the cost or should the owner of the house be required to compensate the contractor for costs already incurred? The question is who is the lowest cost bearer for this type of risk, who can most easily, at the lowest cost avoid the risk and/or insure for the risk?

Why are insurance contracts usually construed against the insurer? Hint—part of the answer relates to the costs of reducing ambiguities in the contracts.

Doctrine of insurable interest.


Fraud, Duress and Undue Bargaining Power

Laidlaw v. Organ and the treaty of Ghent. This case deals with the issue of the value of costly information and who has the right to capture that value. Different rules of law will effect the incentives to produce such information, further, the production of this type of information can yield social benefits. Explain. How is this problem different from insider trading situations?

Are take-it or leave-it contracts evidence of bargaining power asymmetries?