Exaggerating to Break-Even: Reference-Dependent Moral Hazard in Automobile Insurance Claims

Abstract

The effects of asymmetric information are often difficult to detect empirically, such as in insurance settings. We show that allowing for reference-dependent preferences can assist with this empirical challenge. Using detailed auto insurance claims data, we show that policyholders exhibit ex-post moral hazard by exaggerating their damage claims in a manner consistent with reference-dependent preferences. Consistent with our model of reference-dependent claims, we find stronger reference-dependent behavior among policyholders with higher premium levels and low risk policyholders. Also consistent with the model, policyholders are more reference-dependent in their first claims than in subsequent claims, and in the second half of the coverage year compared to the first half. Specifically, the detected reference point is the amount of the original premium paid - in other words, in claiming their accident damages, policyholders seek to claim back the original price paid for their insurance. The pattern does not hold for other potentially salient levels of damages, nor is it consistent with an inclination to merely inflate claims more generally. Since damage claims can only be very precisely manipulated by the policy holder after an accident has occurred, the findings can be attributed primarily to ex-post moral hazard rather than adverse selection or ex-ante moral hazard. Furthermore, the pattern exists only for individually-held policies but not institutionally-held policies, which is most consistent with a reference point in individual utility. Our study illustrates the potential of behavioral economics frameworks in assisting with identification challenges for classical information economics problems.