Third Party Moral Hazard and the Problem of Insurance Externalities

Journal of Legal Studies, Forthcoming 2022

U of Penn, Inst for Law & Econ Research Paper No. 22-12

37 Pages Posted: 16 Mar 2020 Last revised: 25 Feb 2022

See all articles by Gideon Parchomovsky

Gideon Parchomovsky

Hebrew University of Jerusalem - Faculty of Law; University of Pennsylvania Carey Law School

Peter Siegelman

University of Connecticut - School of Law

Date Written: November 4, 2021

Abstract

Insurance can lead to loss or claim-creation not just by insureds themselves, but also by uninsured third parties. These externalities—which we term “third party moral hazard”—arise because insurance creates opportunities both to extract rents and to recover for otherwise unrecoverable losses. Using examples from health, automobile, kidnap, and liability insurance, we demonstrate that the phenomenon is widespread and important, and that the downsides of insurance are greater than previously believed. We explain the economic, social and psychological reasons for this phenomenon, and propose policy responses. Contract-based methods that are traditionally used to control first-party moral hazard can be welfare-reducing in the context of its third-party analog, so new approaches are required.

Keywords: Law & behavioral economics, insurance, third party moral hazard, risk, qui tam litigation

JEL Classification: D91, G22, K23

Suggested Citation

Parchomovsky, Gideon and Siegelman, Peter, Third Party Moral Hazard and the Problem of Insurance Externalities (November 4, 2021). Journal of Legal Studies, Forthcoming 2022, U of Penn, Inst for Law & Econ Research Paper No. 22-12, Available at SSRN: https://ssrn.com/abstract=3554010

Gideon Parchomovsky

Hebrew University of Jerusalem - Faculty of Law ( email )

Mount Scopus
Mount Scopus, IL 91905
Israel

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-898-1603 (Phone)

Peter Siegelman (Contact Author)

University of Connecticut - School of Law ( email )

65 Elizabeth Street
Hartford, CT 06105
United States
860-570-5238 (Phone)
860-570-5242 (Fax)

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