Suppose that, instead of paying for gas each time they filled up,
drivers paid a fixed sum every six months to cover their fuel costs.
This sum would vary based on the driver's age, type of vehicle, and
location, but wouldn't change with the number of miles driven. It
sounds absurd, of course, but it's exactly what happens in the auto-insurance market. Accident risk—like fuel use—increases in
roughly linear fashion with each mile a person drives, but insurance
costs the same (or almost the same, since some insurers offer small
discounts to drivers with self-reported low mileage) whether you drive
500 miles each year or 50,000.
It's a huge market failure, one that leads people to drive much
more than would be economically optimal. The way to fix it is to make
drivers pay for insurance on a per-mile basis. According to Brookings researchers Jason Bordoff and Pascal Noel (who describe their work in a Resources for the Future web commentary),
getting all drivers to switch to pay-as-you-drive insurance would cause
an 8 percent reduction in the total number of miles driven in the United States,
roughly the same reduction that would result from a $1-per-gallon increase
in the gas tax. Better yet, because a few high-mileage drivers account
for a disproportionate number of miles driven, some two-thirds of
drivers would actually see their insurance rates go down.
Bordoff and Noel have some common-sense proposals for encouraging
pay-as-you-go insurance—most notably a tax credit to cover the initial
cost to insurance companies of installing remote mileage-monitoring
devices in customer's cars or setting up a network of
odometer-inspection stations. But what they don't point out (at least,
not until you read pretty far into their longish discussion paper
on the subject) is that once a critical mass of drivers switched to
pay-as-you-go, it would create a cycle of snowballing economic
incentives that would pretty quickly lead most people to switch, even
if they had to cover the initial cost of installing a mileage monitor
in their cars.
Why? The first people to switch to pay-as-you-drive
insurance would be the ones who drove the least. Because this would
effectively remove the lowest-risk drivers from the pool of people
buying lump-sum insurance, the prices for lump-sum insurance policies
would have to go up. This would cause slightly higher-mileage drivers
to switch to pay-as-you-drive policies, which would cause the price of
lump-sum policies to rise even further, and so on. In the end, only the
highest-mileage drivers would stick with lump-sum policies, and they
would pay a price that reflected the true cost of providing them with
insurance.
This process, better known as adverse selection,
is what causes individually-purchased health insurance to cost a lot
more than a comparable employer-provided plan. But the auto insurance
market is one place where it could have a positive effect—and an
impressively large positive effect at that. After all, the
Lieberman-Warner cap and trade bill would have raised gas prices by only 25 cents per gallon,
causing a much smaller than 8 percent decrease in driving. This means
that in the short run, at least, changing the way that auto insurance
is priced could have a much bigger impact on people's driving habits
than getting a climate bill passed.
--Rob Inglis