Optimal insurance contracts under moral hazard

Abstract

This chapter surveys the theory of optimal insurance contracts under moral hazard. Moral hazard leads to insurance contracts that offer less than full coverage of losses. What form does the optimal insurance contract take in sharing risk between the insurer and the individual: A deductible or coinsurance of some kind? What are the factors that influence the design of the contract? Posed in the most general way, the problem is identical to the hidden-action principal-agent problem. The insurance context provides structure that allows more specific implications for contract design. This chapter reviews the static models of optimal insurance under ex ante and ex post moral hazard as well as the implications of repeated contracting.