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The Life Value of Financial Contracting: Evidence from the Insurance Market

We investigate whether financial contract terms alter individuals’ risk-taking behavior under a moral hazard framework. Exploiting (a) the contractual-level data of automobile insurance, and (b) a unique institutional reform that gives more pricing freedom to insurers, we discover a significant decline in the likelihood of accidents (and those involving injuries or deaths) after the premium becomes more sensitive to past performance. The effects are stronger for riskier drivers, and in regions with a more dangerous road condition. The evidence suggests that contracts with a more flexible premium scheme of rewards and penalties induce less risky behavior, mitigating moral hazard.