The relationship between moral hazard and insurance fraud

Purpose The purpose of this paper is to investigate the insurance market in which moral hazard and insurance fraud coexist. In this situation, this research examines the relationship between moral hazard and insurance fraud. Also, this research shows how the amount of policyholder's effort to lower accident probability changes when insurance firm increases their investment in preventing insurance fraud. Design/methodology/approach Using a theoretical model containing five‐stages, the author sheds light on how the possibility of insurance fraud affects the amount of policyholder's effort. Findings The main results of this research are as follows. First, the amount of policyholder's effort is a weakly monotone decreasing function of the insurance firm's investment in preventing insurance fraud. Second, unlike in previous moral hazard models, the policyholder chooses a strictly positive amount of effort even in the full insurance case because the possibility of insurance fraud gives an incentive to realize policyholder's effort. Third, the amount of insurance firm's investment in preventing insurance fraud depends on whether it wants to give an additional incentive to policyholder's effort in exchange for realizing the possibility of insurance fraud. Originality/value This is the first paper to investigate the relationship between moral hazard and insurance fraud by using the microeconomic theory.