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Prevention Incentives in Long-Term Insurance Contracts

Author

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  • Renaud Bourlès

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)

Abstract

Long-term insurance contracts are widespread, particularly in public health and the labor market. Such contracts typically involve monthly or annual premia which are related to the insured's risk profile, where a given profile might change based on observed outcomes which depend on the insured's prevention efforts. The aim of this paper is to analyze the latter relationship. In a two-period optimal insurance contract in which the insured's risk profile is partly governed by the effort he puts on prevention, we find that both the insured's risk aversion and prudence play a crucial role. If absolute prudence is greater than twice absolute risk aversion, moral hazard justifies setting a higher premium in the first period but also greater premium discrimination in the second period. For specific utility functions, moreover, an increase in the gap between prudence and risk aversion increases the initial premium and the subsequent premium discrimination. These results provide insights on the tradeoffs between long-term insurance and the incentives for primary prevention arising from risk classification, as well as between inter- and intra-generational insurance.

Suggested Citation

  • Renaud Bourlès, 2015. "Prevention Incentives in Long-Term Insurance Contracts," Working Papers halshs-01214592, HAL.
  • Handle: RePEc:hal:wpaper:halshs-01214592
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-01214592
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    References listed on IDEAS

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    More about this item

    Keywords

    long-term insurance; prudence; moral hazard; classification risk;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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