The state of California set up its own earthquake insurance program in 1997. Bec

Question

The state of California set up its own earthquake insurance program in 1997. Because the state agency in charge has few staff members, it will pay private insurance carriers to handle claims for earthquake damage. These insurance firms will receive 9% 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? OA. No because the fee is only paid on claims that are approved. O B. Yes, it creates a moral hazard. It would be better to pay a flat fee per claim plus a modest hourly rate to handle claims. ° C. 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. ( D. No because 9% is a high enough fee to discourage shirking

Explanation / Answer

B. yes, it creates a moral hazard problem...

Reason

Since private insurance companies get more profit out of approving more claims, thus it will give the company incentive to approve people with no earthquake damage creating the moral hazard problem.

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