We examine the optimal claims settlement strategy for a liability insurer when claimants can permanently misrepresent their loss by engaging in costly claims falsification. In this environment claims auditing is not a possible deterrent to fraud, and the settlement strategy consists of an...

If people take due care, they will not be found negligent under the Rule of Simple Negligence. Moreover, under this rule, investment in due care is privately and socially optimal. These results jointly imply that liability insurance should not exist. But it does. One explanation relies on errors...