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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.

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  • M. Martin Boyer, 2004. "Overcompensation as a Partial Solution to Commitment and Renegotiation Problems: The Case of Ex Post Moral Hazard," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 71(4), pages 559-582, December.
    • Handle: RePEc:bla:jrinsu:v:71:y:2004:i:4:p:559-582
    DOI: 10.1111/j.0022-4367.2004.00104.x
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    Cited by:

    1. Dionne, Georges, 2012. "The empirical measure of information problems with emphasis on insurance fraud and dynamic data," Working Papers 12-10, HEC Montreal, Canada Research Chair in Risk Management.
    2. Dionne, Georges, 1998. "La mesure empirique des problèmes d’information," L'Actualité Economique, Société Canadienne de Science Economique, vol. 74(4), pages 585-606, décembre.
    3. M. Martin Boyer, 2007. "Resistance (to Fraud) Is Futile," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 74(2), pages 461-492, June.
    4. 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.
    5. M. Martin Boyer & Richard Peter, 2020. "Insurance Fraud in a Rothschild–Stiglitz World," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 87(1), pages 117-142, March.
    6. Jean-Marc Bourgeon & Pierre Picard, 2014. "Fraudulent Claims and Nitpicky Insurers," American Economic Review, American Economic Association, vol. 104(9), pages 2900-2917, September.
    7. Picard, Pierre, 2009. "Costly risk verification without commitment in competitive insurance markets," Games and Economic Behavior, Elsevier, vol. 66(2), pages 893-919, July.
    8. Georges Dionne & Kili C. Wang, 2011. "Does Opportunistic Fraud in Automobile theft Insurance Fluctuate with the Business Cycle ?," Cahiers de recherche 1121, CIRPEE.
    9. Georges Dionne & Kili Wang, 2013. "Does insurance fraud in automobile theft insurance fluctuate with the business cycle?," Journal of Risk and Uncertainty, Springer, vol. 47(1), pages 67-92, August.
    10. Pierre Picard & Kili C Wang, 2016. "Collusion in Vertical Relationships: The Case of Insurance Fraud in Taiwan," Working Papers hal-01385502, HAL.
    11. M. Martin Boyer & Pierre-Thomas Léger, 2001. "Inflation as a Strategic Response," CIRANO Working Papers 2001s-26, CIRANO.
    12. Pierre Picard, 2012. "Economic Analysis of Insurance Fraud," Working Papers hal-00725561, HAL.
    13. M. Martin Boyer & Philippe d'Astous, 2023. "Tax compliance and firm response to electronic sales monitoring," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 56(4), pages 1430-1468, November.
    14. Boyer, Martin, 2001. "Les clauses de valeur à neuf sont-elles optimales?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 77(1), pages 53-74, mars.
    15. Pierre Picard & Kili Wang, 2015. "INSURANCE FRAUD THROUGH COLLUSION BETWEEN POLICYHOLDERS AND CAR DEALERS: THEORY AND EMPIRICAL EVIDENCE Pierre PICARD," Working Papers hal-01140590, HAL.

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