Preprints of the Max Planck Institute for Research on Collective Goods 2010,24
Most insurance companies publish few data on the occurrence and detection of insurance fraud. This stands in contrast to the previous literature on costly state verification, which has shown that it is optimal to commit to an auditing strategy, as the credible announcement of thoroughly auditing claim reports might act as a powerful deterrent. We show that uncertainty about fraud detection can be an effective strategy to deter ambiguity-averse agents from reporting false insurance claims. If, in addition, the auditing costs of the insurers are heterogeneous, it can be optimal not to commit, because committing to a fraud detection strategy eliminates the ambiguity. Thus strategic ambiguity can be an equilibrium outcome in the market and competition does not force firms to provide the relevant information. This finding is also relevant in other auditing settings and complements the literature on games with ambiguity-averse players.
Fraud Commitment Ambiguity Strategic Uncertainty Costly State Verification