Adverse Selection and Moral Hazard in the Dynamic Model of Auto Insurance

We use the data on multiple years of contract choices and claims by customers of a major Portuguese car insurance company to investigate a possibility that agent’s risk is modifiable through costly (unobserved) effort. Using a model of contract choice and endogenous risk production we demonstrate the economic importance of moral hazard, measure the relative importance of agents’ private information on cost of reducing risk and risk aversion, and evaluate the relative effectiveness of dynamic versus static contract features in incentivizing effort and inducing sorting on unobserved risk.