Costly State Falsification or Verification? Theory and Evidence from Bodily Injury Liability Claims

Abstract

The impact of private information on insurance markets has long been appreciated by both economists and practitioners. Spurred by the initial presentation of the problem contained in Akerlof’s (1970) examination of the market for lemons, analyses of environments in which insureds possessed asymmetric information about their likelihood of suffering insurable losses have addressed the issues of adverse selection (Rothschild and Stiglitz, 1976) and moral hazard (Shavell, 1979). More recently, the burgeoning problems associated with fraud in insurance claiming have led economists to consider an alternative form of informational asymmetry in which the private information held by the insured individuals involved the actual magnitude of an economic loss. The resulting analyses may be dichotomized into two distinct lines of inquiry, which are known in the literature as the problems of costly state verification and falsification, respectively.