Working Papers, Swedish National Road & Transport Research Institute (VTI)
No 2010:2:
Reducing asymmetric information with usage-based automobile insurance
Sara Arvidsson ()
Abstract: 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.
Keywords: Usage based insurance; UBI; Pay as you drive; PAYD; Pay as you speed; PAYS; Insurance; (follow links to similar papers)
JEL-Codes: D82; D86; (follow links to similar papers)
28 pages, August 28, 2010, Revised February 3, 2011
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