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Liability, Insurance and the Incentive to Obtain Information about Risk

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Abstract

We examine the incentives to obtain information about risk under strict liability and negligence rules when insurance is available. Information helps reduce the expected cost of accidents, but also exposes the potential injurer to classification risk. As a result, the social value of information may be negative. Under both strict liability and negligence, the private value of information may also be negative when insurance is available.

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Notes

  1. See Aalberts et al. (2008) and Aalberts et al. (2010) for discussions of this issue and potential risk mitigation strategies.

  2. Shavell (1992).

  3. Kaplow and Shavell (1992).

  4. Kaplow and Shavell analyse decisions to seek advice about properly determined liability and to seek advice about mistakes that might be made in determining liability. This paper is concerned with the first type of legal advice.

  5. Hyman et al. (2007).

  6. Zeiler et al. (2008).

  7. Silver et al. (2008).

  8. Black et al. (2006).

  9. Black et al. (2005).

  10. Liability insurance policies are commonly renewed annually which makes it possible for insurers to experience rate the policyholders. Therefore, insureds with poor loss histories may face significant increases in renewal premiums. This implies that the availability of insurance does not completely unwind the financial incentives created by the tort system.

  11. Crocker and Doherty (2000).

  12. Bajtelsmit and Thistle (2007, 2009).

  13. Although the analysis and discussion here are in terms of liability risk, a broader interpretation is possible. For example, the analysis of strict liability can be reinterpreted as an analysis of the effect of property insurance on the incentives to learn about the risk of damage to the individual’s own property. Similarly, the negligence rules can be reinterpreted as regulatory standards where violations lead to financial sanctions. However, the analysis in this paper does not apply to regulatory situations in which sanctions are non-monetary and therefore uninsurable.

  14. Hoy (1982); Crocker and Snow (1992); Doherty and Thistle (1996); Ligon and Thistle (1996a, 1996b).

  15. Crocker and Snow (2013).

  16. For example, Cremer and Khalil (1994); Nosal (2006).

  17. For example, Viscusi (1978); Matthews and Postlewaite (1985); Polinski and Shavell (2012).

  18. For example, Hua (2011).

  19. For example, Shavell (1982, 1987).

  20. We can extend the models analysed here to allow a portion of the potential injurers to be exogenously informed. This does not change any of the results in the paper.

  21. This is an assumption about timing, namely, that care is observed ex ante so that the premium can depend on care. However, under the alternative assumption that care is only observed ex post in the event of an accident, the indemnity can depend on the level of care.

  22. Kaplow (1994).

  23. Kaplow and Shavell (1996, p. 192).

  24. We would like to thank Mike Hoy for pointing out the importance of accounting for the cost of classification risk.

  25. The Kaldor–Hicks criterion involves interpersonal utility comparisons. It assumes that a dollar gain to person A has the same social value as a dollar gain to person B. This is true whether the parties are risk neutral or risk averse. We use the certainty equivalent income of potential injurers (include the classification risk premium) to account for potential injurers’ risk aversion.

  26. Of course, after the fact, potential injurers who learn that their activity is dangerous are worse off.

  27. Jullien et al. (1999).

  28. We would like to thank the referee for pointing this out.

  29. Shavell (1992, p. 260).

  30. This is the negligence rule considered in Kaplow and Shavell (1992) and Crocker and Doherty (2000).

  31. Bajtelsmit and Thistle (2007).

  32. The optimal level of care is convex as a function of damages if, and only if, tx*(d1)+(1−t)x*(d2)>x*(td1+(1−t)d2). In particular, if optimal care is convex in damages then The private value of information is positive if the inequality in (25) is reversed. This is equivalent to requiring that the optimal level of care be “sufficiently” concave as a function of damages.

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Acknowledgements

Earlier versions of this paper were presented at the American Risk and Insurance Association and Western Risk and Insurance Association meetings, and at the University of Georgia and Ludwig-Maximilians University. We thank session and seminar participants and, especially Richard Peter, for comments that have improved the paper, Thistle’s research was supported by the Nevada Insurance Education Foundation. We retain the responsibility for any remaining errors.

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Bajtelsmit, V., Thistle, P. Liability, Insurance and the Incentive to Obtain Information about Risk. Geneva Risk Insur Rev 40, 171–193 (2015). https://doi.org/10.1057/grir.2014.17

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