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Contracting under ex post moral hazard and non-commitment

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  • M. Boyer

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Abstract

This paper characterizes the optimal insurance contract in an environment where an informed agent can misrepresent the state of the world to a principal who cannot credibly commit to an auditing strategy. Because the principal cannot commit, the optimal strategy of the agent is not to tell the truth all the time. Assuming that there are T > 1 possible losses, and that the agent cannot fake an accident (he is constrained only to misreport the size of the loss when a loss occurs), the optimal contract is such that higher losses are over-compensated while lower losses are on average under-compensated. The amount by which higher losses are over-compensated decreases as the loss increases. The optimal contract may then be represented as a simple combination of a deductible, a lump-sum payment and a coinsurance provision. Copyright Springer-Verlag Berlin/Heidelberg 2003

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Bibliographic Info

Article provided by Springer in its journal Review Economic Design.

Volume (Year): 8 (2003)
Issue (Month): 1 (August)
Pages: 1-38

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Handle: RePEc:spr:reecde:v:8:y:2003:i:1:p:1-38

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Keywords: Non-commitment; insurance; ex post moral hazard; contract theory.;

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References

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  1. Dionne, G. & Viala, P., 1992. "Optimal Design of Financial Contracts and Moral Hazard," Cahiers de recherche 9219, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Bond, Eric W. & Crocker, Keith J., 1997. "Hardball and the soft touch: The economics of optimal insurance contracts with costly state verification and endogenous monitoring costs," Journal of Public Economics, Elsevier, vol. 63(2), pages 239-264, January.
  3. Lacker, J.M., 1989. "Optimal Contracts Under Costly State Falsification," Purdue University Economics Working Papers 956, Purdue University, Department of Economics.
  4. Graetz, Michael J. & Reinganum, Jennifer F. & Wilde, Louis L., . "The Tax Compliance Game: Toward an Interactive Theory of Law Enforcement," Working Papers 589, California Institute of Technology, Division of the Humanities and Social Sciences.
  5. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  6. Boyer, M Martin, 2000. " Insurance Taxation and Insurance Fraud," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 2(1), pages 101-34.
  7. Kurz, Mordecai, 1974. "Experimental approach to the determination of the demand for public goods," Journal of Public Economics, Elsevier, vol. 3(4), pages 329-348, November.
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  9. Scotchmer, Suzanne, 1987. "Audit Classes and Tax Enforcement Policy," American Economic Review, American Economic Association, vol. 77(2), pages 229-33, May.
  10. G. Dionne & R. Gagné, 1997. "The non-optimality of deductible contracts against fraudulent claims : an empirical evidence in automobile insurance," THEMA Working Papers 97-23, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  11. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  12. Picard, Pierre, 1996. "Auditing claims in the insurance market with fraud: The credibility issue," Journal of Public Economics, Elsevier, vol. 63(1), pages 27-56, December.
  13. Bond, Eric W & Crocker, Keith J, 1991. "Smoking, Skydiving, and Knitting: The Endogenous Categorization of Risks in Insurance Markets with Asymmetric Information," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 177-200, February.
  14. Sanchez, Isabel & Sobel, Joel, 1993. "Hierarchical design and enforcement of income tax policies," Journal of Public Economics, Elsevier, vol. 50(3), pages 345-369, March.
  15. J. David Cummins & Sharon Tennyson, 1993. "The Tort System "Lottery" and Insurance Fraud," Center for Financial Institutions Working Papers 94-05, Wharton School Center for Financial Institutions, University of Pennsylvania.
  16. Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
  17. Khalil, Fahad & Parigi, Bruno M, 1998. "Loan Size as a Commitment Device," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 135-50, February.
  18. Chang, Chun, 1990. "The dynamic structure of optimal debt contracts," Journal of Economic Theory, Elsevier, vol. 52(1), pages 68-86, October.
  19. Spence, Michael & Zeckhauser, Richard, 1971. "Insurance, Information, and Individual Action," American Economic Review, American Economic Association, vol. 61(2), pages 380-87, May.
  20. Harrison, Glenn W, 1989. "Theory and Misbehavior of First-Price Auctions," American Economic Review, American Economic Association, vol. 79(4), pages 749-62, September.
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Citations

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Cited by:
  1. Bénédicte Coestier & Nathalie Fombaron, 2003. "L'audit en assurance," THEMA Working Papers 2003-41, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  2. M. Martin Boyer, 2004. "On the Use of Hierarchies to Complete Contracts when Players Have Limited Abilities," CIRANO Working Papers 2004s-41, CIRANO.
  3. Schiller, Jörg, 2004. "Versicherungsbetrug als ökonomisches Problem: Eine vertragstheoretische Analyse," Working Papers on Risk and Insurance 13, University of Hamburg, Institute for Risk and Insurance.
  4. J Fran�ois Outreville, 2010. "The Geneva Risk and Insurance Review 2009: In Quest of Behavioural Insurance," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan, vol. 35(3), pages 484-497, July.

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