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Moral Hazard in insurance claims

In Moline, Il, a man busted his windshield when a one pound piece of hail smashed into his car windshield. He had his car repaired by Safe Auto Glass, which advertised that it provided a free box of AB steaks with every windshield repair. The value of the AB steaks was $60. Safe Auto Glass charged the man's car insurance company, All Straight, $350 for the repair. 123 Auto Glass didn't offer customers any bonus for having their windshield replaced and was charging $250 to insurance companies for windshield replacement.

a. Explain what happened in Moline.

b. Do the actions of Safe Auto Glass generate a so-called "residual loss"? If so compute the residual loss. If not explain why there is no residual loss.

c. The Governor signed a law prohibiting auto glass repair companies from paying customers premiums like frozen steaks. How would such a law affect what happened in Moline? Does such a law harm or hurt the people of Illinois?

Solution Preview

a. The man took an incentive from the windshield repair company that led to a higher price for the work than than that of the competition. The company's policy is design to exploit the principal-agent problem, where the ...

Solution Summary

In Moline, Il, a man busted his windshield when a one pound piece of hail smashed into his car windshield. He had his car repaired by Safe Auto Glass, which advertised that it provided a free box of AB steaks with every windshield repair. The value of the AB steaks was $60. Safe Auto Glass charged the man's car insurance company, All Straight, $350 for the repair. 123 Auto Glass didn't offer customers any bonus for having their windshield replaced and was charging $250 to insurance companies for windshield replacement.

a. Explain what happened in Moline.

b. Do the actions of Safe Auto Glass generate a so-called "residual loss"? If so compute the residual loss. If not explain why there is no residual loss.

c. The Governor signed a law prohibiting auto glass repair companies from paying customers premiums like frozen steaks. How would such a law affect what happened in Moline? Does such a law harm or hurt the people of Illinois?

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