Externalities in Automobile Insurance and the Underinsured Driver Problem

Keeton, William R.; Kwerel, Evan

doi:10.1086/467061

Cited by 46 publications

(28 citation statements)

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“…Moreover, under limited liability it can be shown that high-risk drivers are the most likely to forego liability insurance (Shavell, 1986). Keeton and Kwerel (1984) and Smith and Wright (1992) have shown that if a sufficiently large proportion of high-risk drivers is uninsured, and if high-risk drivers make up a sufficiently small percentage of drivers, premium cross-subsidies from low-risk to high-risk drivers can be Pareto improving. These gains come from the fact that subsidized high-risk drivers may purchase more insurance under communityrated premiums than they would under competitive (risk-based) premiums, reducing the external costs borne by insured drivers.…”

Section: Sharon Tennyson Incentive Effects Of Community Rating In Insmentioning

confidence: 99%

Incentive Effects of Community Rating in Insurance Markets: Evidence from Massachusetts Automobile Insurance

Tennyson

2010

Geneva Risk Insur Rev

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Rate regulations in insurance markets often impose cross-subsidies in insurance premiums from low-risk consumers to high-risk consumers. This paper develops the hypothesis that premium cross-subsidies affect risk taking by insurance consumers, and tests this hypothesis by examining the marginal impact of premium subsidies and overcharges on future insurance costs. The empirical analysis uses 1990-2003 rating cell-level data from the Massachusetts automobile insurance market, in which regulation produced large cross-subsidies across cells. Consistent with the hypothesized effects, premium subsidies are found to be significantly related to higher future insurance costs, and the opposite effects are found for premium overcharges.

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Section: Sharon Tennyson Incentive Effects Of Community Rating In Insmentioning

confidence: 99%

Incentive Effects of Community Rating in Insurance Markets: Evidence from Massachusetts Automobile Insurance

Tennyson

2010

Geneva Risk Insur Rev

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“…21 As a result, potential injurers generally will not seek full insurance coverage for liability (see Sinn, 1982;Huberman et ai., 1983;Keeton and Kwerel, 1984;Shavell, 1986). …”

Section: Limited Wealth and Limited Coveragementioning

confidence: 99%

“…Incentives to take precautions also may be diluted (Calabresi, 1970;Keeton and Kwerel, 1984;Shavell, 1986; also see Sykes, 1984Sykes, , 1994Beard, 1990, andPosey, 1993). Under a negligence rule, if the injurer's wealth is below a critical level that is less than the potential loss, incentives for care are suboptimal.…”

Section: The Judgement Proof Problem and Compulsory Liabilitymentioning

confidence: 99%

“…If insurers cannot observe care, above some (higher) critical level of wealth, injurers buy partial coverage but care is suboptimal. Many authors have considered whether making the purchase of liability insurance compulsory can restore efficient incentives for safety (e.g., Shavell, 1986; also see Keeton and Kwerel, 1984).25 Shavell (1986) shows that compulsory insurance can restore efficient incentives for care under both negligence and strict liability, provided that enforcement is complete and that insurers can observe defendants' care and rate premiums appropriately.26 However, if injurers' care is unobservable, compulsory coverage that fully protects injurers' assets will lead to an inefficiently 24 A large amount of anecdotal evidence on the demand for liability and workers' compensation insurance is consistent with the prediction that parties with low wealth will demand little or no coverage. 25 A related literature considers whether compulsory first-party insurance against catastrophic property losses can improve incentives for efficient investment and precautions (e.g., Kaplow, 1991).…”

Section: The Judgement Proof Problem and Compulsory Liabilitymentioning

confidence: 99%

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The Economics of Liability Insurance

Harrington

Danzon

2000

Handbook of Insurance

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Emphasizing general liability insurance, we describe basic relationships between legal liability law, liability insurance, and loss control, including the practical limitations of liability rules and insurance markets as mechanisms for promoting efficient deterrence and risk-spreading. After a brief introduction to the role of liability rules in providing incentives for loss control, we consider the implications of limited wealth and limited liability for the demand for liability insurance and accident deterrence. We then discuss the effects of correlated risk on liability insurance markets, the nature and causes of liability insurance contract disputes, causes of the U.S. tort liability / liability insurance crisis in the mid 1980s, and efficiency of the U.S. tort liability / liability insurance system.

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“…To see this we present here a simplified version of the models of Keeton and Kwerel [1984] and Smith and Wright [1992] in which a competitive market equilibrium with uninsured motorists is Pareto dominated by a regulated market with appropriate income transfers.…”

Section: B Uninsured Motoristsmentioning

confidence: 99%

The Causes and Consequences of Rate Regulation in the Auto Insurance Industry

Jaffee¹,

Russell²

1995

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rate suppression; see Harrington (1992) for a discussion of this term. We use the term rate regulation to refer to compression and suppression together. Rate compression is illustrated by California's Proposition 103, which stipulates that, without the additional approval of the insurance commissioner, passenger automobile insurance rates may apply only the following three factors: 1. The insured's driving record 2. The number of miles driven annually 3. The number of years of driving experience Such characteristics as the driver's place of residence, age, sex, and marital status could no longer be used without the approval of the insurance commissioner. These factors were frequently used by insurance companies prior to the passage of Proposition 103.3 Rate suppression is used in Massachusetts, where premiums in many categories are explicitly set below the actuarial cost-a system called tempering. Blackmon and Zeckhauser (1991) report that in Massachusetts, expected costs vary across drivers by a factor of 4.4, but premiums vary by only a factor of 3. Expected costs vary across territories by a factor of 2.7, but premiums vary by only a factor of 2. Insurance companies, of course, have an incentive to reject customers who must be charged suppressed rates. Since auto insurance is mandatory in all states, rejected customers still need insurance, which is generally provided through assigned risk pools. Drivers who are denied auto policies are placed in the assigned risk pool and charged premiums that may be below the actuarial costs. Each auto insurance company in the state is then required to take a share of the assigned risk pool equal to its share of the overall market.4 Standard welfare economics provides no simple explanation for regulatory pressures in this market. There are two factors that may work in the direction of welfare enhancement. First, in a world of imperfect information and costly sorting, rate compression could work to curtail a tendency to form (socially) too many risk categories. Second, by lowering premiums, rate suppression could induce previously uninsured drivers to purchase coverage, thus eliminating externalities associated with uninsured motorists. On the other hand, as with any cross-subsidization scheme, there are obvious welfare losses associated with rate regulation. Drivers who are charged premiums above their true costs will underconsume driving, auto insurance, or both, and vice versa. The net welfare effect of regulation is thus far from clear. Given this, we raise the question, Why has the auto insurance industry emerged as a primary target for increased regulation? The main goal of this paper is to try to answer this question by linking the possible sources and con

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Externalities in Automobile Insurance and the Underinsured Driver Problem

Cited by 46 publications

References 5 publications

Incentive Effects of Community Rating in Insurance Markets: Evidence from Massachusetts Automobile Insurance

Incentive Effects of Community Rating in Insurance Markets: Evidence from Massachusetts Automobile Insurance

The Economics of Liability Insurance

The Causes and Consequences of Rate Regulation in the Auto Insurance Industry

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