Free riding and insurer carbon-linked investment

ABSTRACT

The paper develops a two-insurer contingent claim framework to evaluate their equities. One insurer conducts carbon-linked investment, while the other conducts conventional (non-carbon-linked) investment. The free-riding issue becomes essential because of the carbon-emission externality. We show that the life insurance policyholders are free riders when either the return of carbon-linked or the conventional investment increases. But the cost burden of policyholder protection is the reduced insurer interest margin. The results also apply to the increased carbon-linked investment volatility and the different coronavirus COVID-19 impacts on the two-insurer interest margins. In the soundness test, we show that insurance stability at the cost of insurer profits is less significant when the carbon-linked investor's barrier increases. Free riding would be intimately relevant to insurance and carbon-emission environments in the barrier option model.