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Reducing asymmetric information with usage-based automobile insurance

  • Arvidsson, Sara

    ()

    (VTI)

Registered author(s):

    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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    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
    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
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    1. Amy Finkelstein & Kathleen McGarry, 2006. "Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 96(4), pages 938-958, September.
    2. Fang, Hanming & Keane, Michael & Silverman, Dan, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," Working Papers 17, Yale University, Department of Economics.
    3. 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.
    4. Fridtjof Thomas & Gunnar Lindberg & Jan-Eric Nilsson & Lars Hultkrantz, 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.
    5. 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.
    6. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," NBER Working Papers 11461, National Bureau of Economic Research, Inc.
    7. 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.
    8. Hemenway, David, 1990. "Propitious Selection," The Quarterly Journal of Economics, MIT Press, vol. 105(4), pages 1063-69, November.
    9. de Meza, David & Webb, David C, 2001. "Advantageous Selection in Insurance Markets," RAND Journal of Economics, The RAND Corporation, vol. 32(2), pages 249-62, Summer.
    10. Tsvetanka Karagoyozova & Peter Siegelman, 2006. "Is There Propitious Selection in Insurance Markets?," Working papers 2006-20, University of Connecticut, Department of Economics.
    11. 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.
    12. 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.
    13. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
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