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Risk-Based Pricing and Risk-Reducing Effort: Does the Private Insurance Market Reduce Environmental Accidents?

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  • Haitao Yin
  • Howard Kunreuther
  • Matthew W. White

Abstract

This paper examines whether risk-based pricing promotes risk-reducing effort. Risk-based pricing is common in private insurance markets but rare in government assurance programs. We analyze accidental underground fuel tank leaks--a source of environmental damage to water supplies--over a 14-year period, using disaggregated (facility-level) data and policy variation in financing the cleanup of tank leaks over time. The data indicate that eliminating a state-level government assurance program and switching to private insurance markets to finance cleanups reduce the frequency of underground fuel tank leaks by more than 20 percent. This corresponds to more than 3,000 fuel tank release accidents forgone over 8 years in one state alone, a benefit in avoided cleanup costs exceeding $400 million. These benefits arise because private insurers mitigate moral hazard by providing financial incentives for tank owners to close or replace leak-prone tanks prior to costly accidents.

Suggested Citation

  • Haitao Yin & Howard Kunreuther & Matthew W. White, 2011. "Risk-Based Pricing and Risk-Reducing Effort: Does the Private Insurance Market Reduce Environmental Accidents?," Journal of Law and Economics, University of Chicago Press, vol. 54(2), pages 325-363.
    • Handle: RePEc:ucp:jlawec:doi:10.1086/655804
    DOI: 10.1086/655804
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    Cited by:

    1. Haitao Yin, 2013. "Insurance Approach for Financing Extreme Climate Event Losses in China: A Status Analysis," EEPSEA Research Report rr2013035, Economy and Environment Program for Southeast Asia (EEPSEA), revised Mar 2013.

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