Nitpicky Insurers and the Law of Contracts

29 Pages Posted: 24 Oct 2017

See all articles by Jean-Marc Bourgeon

Jean-Marc Bourgeon

French National Institute for Agricultural Research (INRA) - UMR Economie Publique; Ecole Polytechnique - Economic Department

Pierre Picard

Ecole Polytechnique, Paris - Department of Economic Sciences

Date Written: September 25, 2017

Abstract

The standard economic analysis of the insured-insurer relationship under moral hazard postulates a simplistic setup that hardly explains the many features of an insurance contract. We extend this setup to include the situation that the insured was facing at the time of the accident and the circumstances of the loss. We show that if this information is costlessly observable, then it should be included in the contract to improve the risk sharing-incentive trade-off under moral hazard. However, in practice the insurer observes the circumstances of the loss only in particular cases - most of the time by performing a costly audit - and almost never the situation the insured was facing at the time of the accident. The resulting incompleteness of the contract opens the door to controversies and disputes that may lead to judicial procedures. We show how the law of insurance contracts should allow insurers to incentivize policyholders to exert an adequate level of effort, and, at the same time, to limit their propencity to nitpick.

Keywords: insurance, moral hazard, incomplete contracts

JEL Classification: D820, D860, G220

Suggested Citation

Bourgeon, Jean-Marc and Picard, Pierre, Nitpicky Insurers and the Law of Contracts (September 25, 2017). CESifo Working Paper Series No. 6669, Available at SSRN: https://ssrn.com/abstract=3057924 or http://dx.doi.org/10.2139/ssrn.3057924

Jean-Marc Bourgeon

French National Institute for Agricultural Research (INRA) - UMR Economie Publique ( email )

Centre de Grignon
BP01
Thiverval-Grignon, 78850
France

Ecole Polytechnique - Economic Department ( email )

Palaiseau, 91128
France

HOME PAGE: http://www.polytechnique.edu

Pierre Picard (Contact Author)

Ecole Polytechnique, Paris - Department of Economic Sciences ( email )

Ecole Polytechnique
Department of Economics
Paris, 75005
France

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