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Moral hazard is the proclivity of insureds to decrease their level of care once they have insurance. Unchecked moral hazard can hinder insurance markets and, on occasion, cause loss to third parties affected by and uncompensated for losses. Two traditional methods for control of moral hazard are incomplete insurance and conditioning indemnity on observations about the level of care taken by the insured. This Demonstration simulates the situation of an insured who has an initial wealth of 20 but faces the possibility of a loss of 15. The idea is to assume various levels of σ (the accuracy with which the insurer can measure the care taken by the insured) and try to find the levels of indemnity, premium and care condition that result in the highest level of insured wealth that doesn't result in the insurer's profit becoming negative. (Insurers avoid contracts that will result in their losing money.) See what level of care proves optimal and the associated level of insured wealth for each "optimal" insurance contract you create. How does the "optimal contract" vary with the accuracy with which the insurer can determine the level of care taken by the insured?
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