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

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.