Resistance (to Fraud) Is Futile

This article studies a static principal–agent model of insurance fraud using a costly state verification approach. In an economy where there are two types of agents, the Truths, who always report the true state of the world, and the Dares, who dare misreport the true state of the world, I show that no separating contract exists. Furthermore, if the proportion of Dares is large enough, then the pooling contract, the amount of fraud and the number of agents found to have committed fraud are independent of the Dares' exact proportion in the economy. Finally, I show that investment in prevention can be useless if the proportion of Dares is large enough, which means that investing in prevention becomes a waste of resources. This last result holds when the proportion of Dares is large. When their proportion is small, investing in prevention reduces fraud.