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Reducing asymmetric information with usage-based automobile insurance

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  • Arvidsson, Sara

    ()
    (VTI)

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    Abstract

    Automobile insurers currently use available information about the vehicle, the owner and residential area when determining the probability of a claim (insurance risk). A drawback is that several risk classification variables are based on the policyholder’s self-reported risk. This study highlights the fact that the information asymmetry associated with classifying risk may cause unfair premiums, since it is possible for high risk drivers to mimic low risk drivers. The aim of this paper is to explore the possibility of reducing information asymmetries by introducing a Usage Based Insurance (UBI) option where the driving behavior is monitored. While most models focus on identifying the high risk type, this approach provides an opportunity for the low risk individuals to reveal their type. The results suggest that voluntary UBI is an efficient instrument to separate risks and that the low risk drivers do not suffer the utility loss generally associated with asymmetric information. Introducing UBI as an additional contract enables full coverage at an actuarially fair premium for both types of policyholders. Besides, by reducing information asymmetries UBI can, in a wider perspective, provide incentives for the high risk driver to become a low risk driver by reducing risk-taking behavior.

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    File URL: http://www.transportportal.se/SWoPEc/Essay_4_Arvidsson_Reducing_asymmetric.pdf
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    Bibliographic Info

    Paper provided by Swedish National Road & Transport Research Institute (VTI) in its series Working Papers with number 2010:2.

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    Length: 28 pages
    Date of creation: 28 Aug 2010
    Date of revision: 03 Feb 2011
    Handle: RePEc:hhs:vtiwps:2010_002

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    Postal: VTI, Transport Economics, P.O. Box 6056, SE-171 06 Solna, Sweden
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    Web page: http://www.vti.se/tek
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    Related research

    Keywords: Usage based insurance; UBI; Pay as you drive; PAYD; Pay as you speed; PAYS; Insurance;

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    1. Pierre-André Chiappori & Bernard Salanié, 2002. "Testing Contract Theory : A Survey of Some Recent Work," Working Papers 2002-11, Centre de Recherche en Economie et Statistique.
    2. John Cawley & Tomas Philipson, 1997. "An Empirical Examination of Information Barriers to Trade inInsurance," University of Chicago - George G. Stigler Center for Study of Economy and State 132, Chicago - Center for Study of Economy and State.
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    7. Hanming Fang & Michael P. Keane & Dan Silverman, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," NBER Working Papers 12289, National Bureau of Economic Research, Inc.
    8. Alma Cohen, 2012. "Asymmetric Learning in Repeated Contracting: An Empirical Study," The Review of Economics and Statistics, MIT Press, vol. 94(2), pages 419-432, May.
    9. Philippe Donder & Jean Hindriks, 2009. "Adverse selection, moral hazard and propitious selection," Journal of Risk and Uncertainty, Springer, vol. 38(1), pages 73-86, February.
    10. Hemenway, David, 1990. "Propitious Selection," The Quarterly Journal of Economics, MIT Press, vol. 105(4), pages 1063-69, November.
    11. Gunnar Lindberg & Lars Hultkrantz & Jan-Eric Nilsson & Fridtjof Thomas, 2005. "Pay-as-you-speed: Two field experiments on controlling adverse selection and moral hazard in traffic insurance," Framed Field Experiments 00170, The Field Experiments Website.
    12. Chiappori, Pierre-Andre & Salanie, Bernard, 1997. "Empirical contract theory: The case of insurance data," European Economic Review, Elsevier, vol. 41(3-5), pages 943-950, April.
    13. Tsvetanka Karagoyozova & Peter Siegelman, 2006. "Is There Propitious Selection in Insurance Markets?," Working papers 2006-20, University of Connecticut, Department of Economics.
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