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On the Design of Optimal Insurance Policies Under Manipulation of Audit Cost
Author(s) -
Picard Pierre
Publication year - 2000
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/1468-2354.00095
Subject(s) - deductible , audit , actuarial science , damages , business , inherent risk (accounting) , insurance policy , economics , accounting , external auditor , internal audit , law , political science
This article characterizes optimal insurance policies under deterministic auditing in a situation where the policyholders can misrepresent their losses. Under exogenous audit cost, a straight deductible is optimal when the policyholders can inflate their claims by intentionally increasing the damages. If policyholders can manipulate the audit cost and the insurer is unable to observe the cost incurred by his or her auditor, then the auditor should receive contingent fees. When the auditor is risk‐averse, the optimal insurance policy involves some degree of coinsurance. An upper limit on coverage is optimal when the auditor is infinitely risk‐averse.