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Optimal Insurance Under Random Auditing

  • Marie-Cécile Fagart


  • Pierre Picard


We provide a characterization of an optimal insurance contract (coverage schedule and audit policy) when the monitoring procedure is random. When the policyholder exhibits constant absolute risk aversion, the optimal contract involves a positive indemnity payment with a deductible when the magnitude of damages exceeds a threshold. In such a case, marginal damages are fully covered if the claim is verified. Otherwise, there is an additional deductible that disappears when the damages become infinitely large. Under decreasing absolute risk aversion, providing a positive indemnity payment for small claims with a nonmonotonic coverage schedule may be optimal. The Geneva Papers on Risk and Insurance Theory (1999) 24, 29–54. doi:10.1023/A:1008781131861

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Paper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 98-47.

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Date of creation: 1998
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Handle: RePEc:crs:wpaper:98-47
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  1. Border, Kim C & Sobel, Joel, 1987. "Samurai Accountant: A Theory of Auditing and Plunder," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 525-40, October.
  2. Picard, Pierre, 1996. "On the design of optimal insurance policies under manipulation of audit cost," CEPREMAP Working Papers (Couverture Orange) 9605, CEPREMAP.
  3. Robert M. Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  4. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  5. 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.
  6. David P. Baron & David Besanko, 1984. "Regulation, Asymmetric Information, and Auditing," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 447-470, Winter.
  7. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  8. Marie-Cécile Fagart & Pierre Picard, 1999. "Optimal Insurance Under Random Auditing," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 24(1), pages 29-54, June.
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