Moral hazard, insurance, and some collusion

We consider a model of insurance and collusion. Efficient risk sharing requires the consumer to get a monetary compensation in case of a loss. But this in turn implies consumer-provider collusion incentives to submit false claims to the insurer. We assume, however, that only some providers are collusive while some are honest, and determine the optimal contract specifying the treatment, the insurance policy and the reimbursement policy to the provider. Two cases are analyzed: the first allows contract menus that induce self-selection among the providers; the second allows contracts consisting of a single policy. In both cases, deterrence of collusion is optimal only if the probability that the provider is collusive is large. When the contract deters collusion, it is as if the provider was collusive with probability one. The first best is achieved only when the provider is honest with certainty. Furthermore, over-consumption of treatment occurs in many cases, and is sometimes used as a substitute for monetary compensation to the consumer. (C) 2003 Elsevier Science B.V. All rights reserved.