3/31/2008

Insurance to the Rescue… Probably Not

Gas prices are up again, but no matter how high the price of gasoline rises, people will still buy. It is estimated that it would take an 81-cent-per-gallon increase in the price of gasoline for consumption to decrease 6.5 percent. One theory circulating to lower gasoline consumption is car insurance. Insurance companies charge flat rates to customers with similar risks. One risk that is not accounted for is miles driven. It makes sense that the more a car is on the road the more likely a car will be in an accident, so people who drive more should have to pay more for their insurance. This benefits the insurance company by earning more premiums from those riskier clients. At the same time gas prices and consumption are kept are kept at a lower level. It could all be made possible with insurance.

It seems like this idea would result in nothing but positives for example: less traffic accidents, less congestion, cleaner air, less global warming, and less dependency on foreign oil; however, in today’s economy oil companies with monopoly power would simply raise their prices despite lower consumption. Monopolies can control price and quantity. Therefore rather than cause a gasoline shortage, monopolies will increase prices to realize more profits. The real result of the car insurance change is higher gas prices and premiums for commuters and logistical companies.

6 comments:

John said...

It seems like the amount of time and effort to track the miles you've gone per year/quarter/month whatever the insurance company decides would have a negative impact on the insurance company. Yes there may be some excellent benefits from driving less like pollution, traffic congestion, dependence on oil, etc, but how do those benefits make the company money? Is the extra expense to monitor mileage to your stock holders justifiable? Like the title says-probably not.

Olivia said...

Arguing that fewer miles equal fewer accidents may have some sort of face value, but I believe that it may not be true. The insurance industry has large financial resources and powerful incentives to mitigate risk, which forces insurance companies do their homework. My guess is that after controlling for other factors, total miles driven are actually insignificant. Also, Lily’s post makes some sweeping assumptions, that oil companies have monopoly power and that driving cars has a substantial impact on global warming. We should be cautious of assumptions without substantial justification when reacting to the actions successful industries

Lily said...

I have heard of insurance companies in Europe that do offer discounts by checking the odometer in clients cars. It still seems like a hassle. I even read one example of man getting charged more for exceeding his miles limit.

Rearden said...

I’m concerned that by limiting the ability for consumers to travel -due to increased costs- will have other negative economic impacts. Less travel means less traffic in retail stores, consider tourism and business travel, and also the effect on prices of goods and services. The health of our economy seems so dependent on affordable transportation.

In response to Olivia’s comment, she infers that the oil companies don’t have monopoly power. While this is true in an absolute sense, doesn’t OPEC’s process of setting price and production quotas resemble a cartel? Fortunately, there have been some non-OPEC oil companies who have entered the market that have consequently limited OPEC price setting power, but in my opinion we are far from enjoying the benefits of perfect competition here.

Jordan said...

I actually worked at an insurance company doing quotes for Home and Auto Insurance. Part of the quote did require the driver to estimate how many miles he or she drove in a year. I'm not sure, though, that this had a big impact on the insurance premium. Obviously, the driving record had a more direct impact on the quote. I think that if it were true that more miles driven causes more accidents, this would come through on the driving record and would raise the premium anyway. I would have to agree with Olivia that the insurance companies probably have a pretty good handle on how to calculate risk and charge a corresponding premium.

Dr. Tufte said...

I actually get the low mileage discount from State Farm for both of our cars. The limit is around 7500 miles per year, and they do spot check my odometer every few years if I don't make a claim.

I have also heard from an independent agent that there are companies out there that will offer a bigger discount for even lower mileage thresholds.

I think the insurance companies are pretty good at evaluating risk based on the information that they have, but hamstrung by limitations on information.

For example, it wouldn't be hard at all for them to put an RFID in a car and monitor where you went with it. If they wanted to lower my rate to intrude on my privacy, I'd let them. The problem is that many people would find that offensive.