Insurance companies charge annual premiums to collect revenue, which they then use to pay customers who file claims for damages they incur. As a result of the moral hazard problem (1) what is the effect on the percentage of policy holders making claims, and (2) what is the effect on the average premium charged when compared to a world with no moral hazard problem?

Question

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The moral hazard problem leads to an increase in the percentage of policyholders making claims. This is because policyholders who know they are insured may behave in ways that increase the likelihood of filing a claim. For example, if a person has car insurance, they may drive more recklessly than if they did not have insurance. This increased frequency of claims leads insurance companies to charge higher premiums to cover their costs. Therefore, the average annual premiums are higher in a world with moral hazard compared to one without it.

Insurance Companies Charge Annual Premiums to Collect Revenue, Which They