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Overcompensation as a Partial Solution to Commitment and Renegotiation Problems: The Case of "Ex Post" Moral Hazard

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  • M. Martin Boyer

Abstract

In a Costly State Verification world, an agent who has private information regarding the state of the world must report what state occurred to a principal, who can verify the state at a cost. An agent then has what is called "ex post moral hazard": he has an incentive to misreport the true state to extract rents from the principal. Assuming the principal cannot commit to an auditing strategy, the optimal contract is such that: (1) the agent's expected marginal utility when there is an accident (high- and low-loss states) is equal to his marginal utility when there is no accident; (2) the lower loss is undercompensated, while the higher loss is overcompensated; and (3) the welfare of the agent is greater under commitment than under no-commitment. Result 2 is contrary to the results obtained if the principal can commit to an auditing strategy (higher losses underpaid and lower losses overpaid). The reason is that by increasing the difference between the high and the low indemnity payments, the probability of fraud is reduced. Copyright The Journal of Risk and Insurance, 2004.

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Bibliographic Info

Article provided by The American Risk and Insurance Association in its journal The Journal of Risk and Insurance.

Volume (Year): 71 (2004)
Issue (Month): 4 ()
Pages: 559-582

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Handle: RePEc:bla:jrinsu:v:71:y:2004:i:4:p:559-582

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Cited by:
  1. M. Martin Boyer & Pierre Thomas L├ęger, 2001. "Inflation as a Strategic Response," CIRANO Working Papers 2001s-26, CIRANO.
  2. Georges Dionne & Florence Giuliano & Pierre Picard, 2009. "Optimal Auditing with Scoring: Theory and Application to Insurance Fraud," Management Science, INFORMS, vol. 55(1), pages 58-70, January.
  3. Georges Dionne & Kili C. Wang, 2011. "Does Opportunistic Fraud in Automobile theft Insurance Fluctuate with the Business Cycle ?," Cahiers de recherche 1121, CIRPEE.
  4. Georges Dionne, 2012. "The Empirical Measure of Information Problems with Emphasis on Insurance Fraud and Dynamic Data," Cahiers de recherche 1233, CIRPEE.
  5. Pierre Picard, 2012. "Economic Analysis of Insurance Fraud," Working Papers hal-00725561, HAL.
  6. Jean-Marc Bourgeon & Pierre Picard, 2012. "Fraudulent Claims and Nitpicky Insurers," Working Papers hal-00675106, HAL.

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