Evaluating an Insurance Contract
An auto insurance company wants to encourage its clients to drive more carefully. The company cannot observe a driver's daily level of caution, but it can observe if an accident occurs. To motivate safer driving, the company offers a policy that requires the driver to pay the first $1,000 of any claim (an 'excess' or 'deductible').
Critically evaluate this incentive structure. Explain why this requirement helps motivate safer driving, but also why it fails to create a perfect alignment of interests between the driver and the insurance company.
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