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Monitoring and Privacy in Automobile Insurance Markets with Moral Hazard

This paper considers moral hazard insurance markets when voluntary monitoring technologies are available and insureds may choose the precision of monitoring. Also privacy costs incurred thereby are taken into account. Two alternative contract schemes are compared in terms of welfare: (i) monitoring conditional on the loss with only the insurance indemnities based on the monitoring data, and (ii) unrestricted monitoring with both the premiums and the indemnities depending on the data. With any contract scheme some monitoring will be optimal unless the privacy costs increase too fast in relation to the precision of the monitoring signal. In the benchmark situation (without privacy costs) relying completely on both signals (monitoring and the outcome) informative of effort (ii) maximizes welfare. In the presence of privacy costs, the contract with conditional monitoring (i) might dominate the contract which fully includes the outcome and the monitoring signal into the sharing rule (ii). Apart from the direct effect of restricting privacy costs only to the state of loss, there are also an additional indirect incentive and a risk-sharing effect with this contract. Letting the individuals choose the precision of the monitoring technology at the time they reveal the data (ex post) is inefficient with either contract scheme.

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Paper provided by Universitaet Augsburg, Institute for Economics in its series Discussion Paper Series with number 293.

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Length: pages
Date of creation: Jul 2007
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Handle: RePEc:aug:augsbe:0293
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  1. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
  2. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
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  4. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
  5. Ronald A. Dye, 1986. "Optimal Monitoring Policies in Agencies," RAND Journal of Economics, The RAND Corporation, vol. 17(3), pages 339-350, Autumn.
  6. Demougin, Dominique & Fluet, Claude, 2001. "Monitoring versus incentives," European Economic Review, Elsevier, vol. 45(9), pages 1741-1764, October.
  7. Shavell, Steven, 1979. "On Moral Hazard and Insurance," The Quarterly Journal of Economics, MIT Press, vol. 93(4), pages 541-62, November.
  8. G. Dionne & M. Maurice & J. Pinquet & C. Vanasse, 2001. "The Role of Memory in Long-Term Contracting with Moral Hazard : Empirical Evidence in Automobile Insurance," THEMA Working Papers 2001-11, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  9. Kim, Son Ku, 1995. "Efficiency of an Information System in an Agency Model," Econometrica, Econometric Society, vol. 63(1), pages 89-102, January.
  10. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-67, November.
  11. Harris, Milton & Raviv, Artur, 1979. "Optimal incentive contracts with imperfect information," Journal of Economic Theory, Elsevier, vol. 20(2), pages 231-259, April.
  12. Son Ku Kim & Yoon S. Suh, 1992. "Conditional Monitoring Policy Under Moral Hazard," Management Science, INFORMS, vol. 38(8), pages 1106-1120, August.
  13. Singh, Nirvikar, 1985. "Monitoring and Hierarchies: The Marginal Value of Information in a Principal-Agent Model," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 599-609, June.
  14. Gjesdal, Froystein, 1982. "Information and Incentives: The Agency Information Problem," Review of Economic Studies, Wiley Blackwell, vol. 49(3), pages 373-90, July.
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