The economics of dishonest insurance companies

This paper investigates the dynamics of an insurance market on which insurance companies may dishonestly deny eligible claims. Behaving dishonestly can increase the current profit but also entails the risk of losing profit in the future due to a worse reputation. Depending on the reputation cost imposed by policyholders, the analysis either predicts the emergence of reputation cycles or convergence to a stable equilibrium in which all eligible claims are accepted and the insurers’ reputations remain at a high level. I also show that policyholders may discipline insurers using a buying strategy based on an image-scoring rule. My results lead to important insights. For instance, reputation campaigns may have a pro-cyclic effect which leads to more severe reputation crises in the future.