Suppose the state of Louisiana sets up its own flood insurance program. Because

Question

Suppose the state of Louisiana sets up its own flood insurance program. Because the state agency in charge has few staff members, it will pay private insurance carriers to handle claims for flood damage. These insurance firms will receive 10% of each approved claim. Is this compensation scheme likely to lead to opportunistic behavior by insurance companies? What would be a better way to handle the compensation? No because 10% is a high enough fee to discourage shirking. No because the fee is only paid on claims that are approved. Yes, it creates an adverse selection problem. It would be better to pay a flat fee per claim plus a modest hourly rate to handle claims. Yes, it creates a moral hazard problem. It would be better to pay a flat fee per claim plus a modest hourly rate to handle claims.

Explanation / Answer

Solution-

Suppose the state of Louisiana sets up its own flood insurance program. Because the state agency in charge has few staff ? members, it will pay private insurance carriers to handle claims for flood damage. These insurance firms will receive? 10% of each approved claim. Is this compensation scheme likely to lead to opportunistic behavior by insurance? companies? What would be a better way to handle the? compensation?

The correct option is D. Yes, it creates a moral hazard problem. It would be better to pay a flat fee per claim plus a modest hourly rate to handle claims.

Reason-

Moral hazard is the situation in which one party is engaged in a dangerous event, which protects it against risk and other parties spend it. This occurs when both parties have unfinished information about each other.

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