Most automobile collision insurance policies have a deductible amount which the

Question

Most automobile collision insurance policies have a deductible amount which the policy holder has to pay before the insurance company covers any collision loss. Forexample, if you have a policy with a $500 deductible provision and you have an accident with $4000 in damages, you have to pay the first $500 and then the insurance company will pay the remaining $3500. Insurance companies use deductibles

A.

as a sneaky way to extract more money from policy holders.

B.

to reduce the problem of adverse selection.

C.

to reduce the problem of shirking.

D.

to reduce the problem of moral hazard.

Explanation / Answer

Option (D).

Moral hazard exists when the insurance buyers take risky actions as a result of insurance coverage, so the insurance firms pay the cost of such risky behavior of insurance buyers. Here, the deductible amount has to be paid by insurance buyer in case of accident, so in order to avoid this damage payment, buyers are more cautious, thereby reducing moral hazard problem.

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