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Insurance law and incomplete contracts

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  • Jean‐Marc Bourgeon
  • Pierre Picard

Abstract

We analyze how insurance law can mitigate moral hazard by allowing insurers to reduce or cancel coverage in some circumstances. We consider an incomplete contract setting in which the insurer may obtain information related to the policyholder's behavior through a costly audit of the circumstances of the loss. Court decisions are based on a standard of proof such as the balance of probabilities. We show that an optimal insurance law brings efficiency gains compared to the no‐audit case. We also highlight the conditions under which the burden of proof should be on the insured, provided that insurers are threatened with sanctions for bad faith.

Suggested Citation

  • Jean‐Marc Bourgeon & Pierre Picard, 2020. "Insurance law and incomplete contracts," RAND Journal of Economics, RAND Corporation, vol. 51(4), pages 1253-1286, December.
    • Handle: RePEc:bla:randje:v:51:y:2020:i:4:p:1253-1286
    DOI: 10.1111/1756-2171.12356
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