Insurance Law and Incomplete Contracts

Under moral hazard, most insurance contracts are incomplete, to the extent that they condition the coverage neither on the contingencies under which policyholders choose their behavior, nor on the circumstances of the loss. This incompleteness can be explained by underwriting and auditing costs borne by insurers, by policyholders cognitive costs, and by the limits of market regulation. It opens the door to controversies and disputes between insured and insurer. In this context, we analyze how insurance law can mitigate moral hazard, by allowing insurers to cut indemnities in some circumstances, while preventing them from excessive nitpicking. We also highlight conditions under which the burden of proof should be on the policyholders, provided that insurers are threatened by bad faith penalties.