On the design of optimal insurance policies under manipulation of audit cost

This article characterizes optimal insurance policies under deterministic a uditing in a situation where the policyholders can misrepresent their losse s. Under exogenous audit cost, a straight deductible is optimal when the po licyholders can inflate their claims by intentionally increasing the damage s. If policyholders can manipulate the audit cost and the: insurer is unabl e to observe the cost incurred by his or her auditor, then the auditor shou ld receive contingent fees. When the auditor is risk-averse, the optimal in surance policy involves some degree of coinsurance. An upper limit on cover age is optimal when the auditor is infinitely risk-averse.