Optimal rules of negligent misrepresentation in insurance contract law
Rules of misrepresentation in insurance contract law differ widely between jurisdictions. When the insured has negligently misrepresented a fact prior to contracting, common law allows the insurer to rescind the contract if the misrepresentation was material, while civil law countries apply more lenient rules. The article compares the efficiency of the common and the civil law rules in an adverse selection model in which the insurer separates types of risk not only through a deductible but also by requiring the insured to represent their type. A strict rule of misrepresentation increases the incentive for policy holders to represent truthfully but also exposes them to risk when they may misrepresent by mistake. While the economic literature has tended to defend the strict common law rule, because it makes it easier for the insurer to separate types, the present article demonstrates that the more lenient civil law rules may be more efficient, especially when the cost for the insurer of auditing types is low.