Deterrence by Insurance

Against the theory of third-party moral hazard—focusing on third parties who decline their risk-reducing effort in light of insurance—I analyze the mirror-image phenomenon of third-party deterrence: cases in which third parties engage in activities designed to counterbalance the insured’s moral hazard. I characterize the settings in which third-party deterrence replaces third-party moral hazard; address the economic foundations of this problem; and study its effects on risk transferring within the triangle of insurer, insured, and third parties. I also point to additional frameworks that may give rise to third-party deterrence, discuss possible implications for the incentives of insurers, and identify countervailing forces that may alleviate the ascribed distortion.