Moral Hazard in Dynamic Insurance,

This paper examines the effect of moral hazard on dynamic insurance contract. It models pri-mary prevention in a two period model with classification risk. Agents ’ preferences appear to play an important role in the determination of preventive effort and prepayment. If absolute prudence is larger than twice absolute risk aversion, moral hazard increases prepayment of premium and clas-sification risk. This highlights a tradeoff between prevention and prepayment that arises from the classification risk. An increase in the difference between prudence and twice risk aversion (that we define as the degree of "protectiveness") moreover makes dynamic insurance contracts more stable (when competing with spot insurance) if the cost of prevention is low enough when agents preferences exhibit CRRA. Under a formulated utility function with linear reciprocal derivative, we finally show that an increase in agents ’ degree of "protectiveness " enhances the stability of dynamic contract and the extent of prepayment