Premium
Insurance law and incomplete contracts
Author(s) -
Bourgeon JeanMarc,
Picard Pierre
Publication year - 2020
Publication title -
the rand journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.687
H-Index - 108
eISSN - 1756-2171
pISSN - 0741-6261
DOI - 10.1111/1756-2171.12356
Subject(s) - insurance policy , actuarial science , balance (ability) , moral hazard , insurance law , business , sanctions , good faith , audit , bad faith , indemnity , casualty insurance , economics , law and economics , law , incentive , general insurance , microeconomics , political science , accounting , medicine , physical medicine and rehabilitation
We analyze how insurance law can mitigate moral hazard by allowing insurers to reduce or cancel coverage in some circumstances. We consider an incomplete contract setting in which the insurer may obtain information related to the policyholder's behavior through a costly audit of the circumstances of the loss. Court decisions are based on a standard of proof such as the balance of probabilities. We show that an optimal insurance law brings efficiency gains compared to the no‐audit case. We also highlight the conditions under which the burden of proof should be on the insured, provided that insurers are threatened with sanctions for bad faith.