Reducing asymmetric information with usage-based automobile insurance
AbstractAutomobile 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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Bibliographic InfoPaper provided by Swedish National Road & Transport Research Institute (VTI) in its series Working Papers with number 2010:2.
Length: 28 pages
Date of creation: 28 Aug 2010
Date of revision: 03 Feb 2011
Contact details of provider:
Postal: VTI, Transport Economics, P.O. Box 6056, SE-171 06 Solna, Sweden
Phone: +46-13-20 40 00
Fax: +46-13-14 14 36
Web page: http://www.vti.se/tek
More information through EDIRC
Usage based insurance; UBI; Pay as you drive; PAYD; Pay as you speed; PAYS; Insurance;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-01-30 (All new papers)
- NEP-CTA-2010-01-30 (Contract Theory & Applications)
- NEP-IAS-2010-01-30 (Insurance Economics)
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