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Costly risk verification without commitment in competitive insurance markets

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  • P. Picard

Abstract

This paper analyzes the equilibrium of an insurance market where applicants for insurance have a duty of good faith when they reveal private information about their risk type. Insurers can, at some cost, verify the type of insureds who file a claim and they are allowed to retroactively void the insurance contract if it is established that the policyholder has misrepresented his risk when the contract was taken out. However, insurers cannot precommit to their risk verification strategy. The paper analyzes the relationship between second-best Pareto-optimality and the insurance market equilibrium in a game theoretic framework. It characterizes the contracts offered at equilibrium, the individuals' contract choice as well as the conditions under which an equilibrium exists.
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Suggested Citation

  • P. Picard, 2002. "Costly risk verification without commitment in competitive insurance markets," THEMA Working Papers 2002-30, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    • Handle: RePEc:ema:worpap:2002-30
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    References listed on IDEAS

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    1. Dionne, G. & St-Michel, P. & Gibbens, A., 1993. "An Economic Analysis of Insurance Fraud," Cahiers de recherche 93010, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    2. Fahad Khalil, 1997. "Auditing Without Commitment," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 629-640, Winter.
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    9. 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.
    10. Spence, Michael, 1978. "Product differentiation and performance in insurance markets," Journal of Public Economics, Elsevier, vol. 10(3), pages 427-447, December.
    11. A. Dixit, 1999. "Adverse Selection and Insurance with Uberrima Fides," Princeton Economic Theory Papers 99f5, Economics Department, Princeton University.
    12. Arnott, Richard J. & Greenwald, Bruce & Kanbur, Ravi & Nalebuff, Barry, 2003. "Joseph Stiglitz and Economics for an Imperfect World," Working Papers 127202, Cornell University, Department of Applied Economics and Management.
    13. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    14. A. Dixit & P. Picard, 2002. "On the Role of Good Faith in Insurance Contracting," Princeton Economic Theory Working Papers 26c6897fd1cd46f8f39ffb6ca, David K. Levine.
    15. Crocker, Keith J. & Snow, Arthur, 1985. "The efficiency of competitive equilibria in insurance markets with asymmetric information," Journal of Public Economics, Elsevier, vol. 26(2), pages 207-219, March.
    16. Pierre Picard, 2012. "Economic Analysis of Insurance Fraud," Working Papers hal-00725561, HAL.
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    Cited by:

    1. Lando, Henrik, 2016. "Optimal rules of negligent misrepresentation in insurance contract law," International Review of Law and Economics, Elsevier, vol. 46(C), pages 70-77.
    2. Michal Krawczyk, 2009. "The Role of Repetition and Observability in Deterring Insurance Fraud," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 34(1), pages 74-87, June.
    3. Raduna, Daniela Viviana & Roman, Mihai Daniel, 2011. "Risk aversion influence on insurance market," MPRA Paper 37725, University Library of Munich, Germany, revised 01 Feb 2012.
    4. Pierre Picard, 2012. "Economic Analysis of Insurance Fraud," Working Papers hal-00725561, HAL.
    5. Jill M. Bisco & Kathleen A. McCullough & Charles M. Nyce, 2019. "Postclaim Underwriting And The Verification Of Insured Information: Evidence From The Life Insurance Industry," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 86(1), pages 7-38, March.

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