February 23, 2005

The 'but for' and the 'what if'...

As I read through a little more research information and theory surrounding PAYD each day, I cannot help but feel a need for discussion. So far, most of what I found reflects a broad consensus on two things; one: you cannot argue with the rationality of implementing PAYD when viewed from the angle of societal benefits, two: The only things keeping PAYD from being the most common form of vehicle insurance are: implementation cost, either because of the necessary technology or because of odometer reading schemes, and added uncertainty over annual premium income for insurance companies.

It would be nice to read something from people who take a different view. In the past week, I came across two thoughts that may begin to constitute an argument.

I encountered the first when I read Aaron S. Edlin's article: Per Mile Premiums for Auto Insurance (published in: Economics for an imperfect world. Essays in Honor of Joseph E. Stiglitz, Arnold, Greenwald, Kanbur and Nalebuff, The MIT Press, Cambridge, Massachusetts/London, England, 2003). It runs: (...)"If insurance company C is able to reduce the driving of its insureds, although it will save on accident payouts, substantial 'external' savings will be realized by other insurance carriers and their insureds, who will get into fewer accidents with C's insureds. These externalities follow from Vickrey's observation that if two drivers get into an accident, even the safer driver is typically a 'but for' cause of the accident in the sense that had the driver opted for the metro, the accident would not have occurred"(...)

This would mean that insurance companies implementing PAYD would not only face implementation cost and transfer of benefits to society instead of to their own bottom-line, but also a transfer of benefits into the pockets of the competition.

Incidentally, this view of accident externalities is also taken in the article Distance-Based Vehicle Insurance As a TDM Strategy,(Litman, version 1 december 2004, as published on www.vtpi.org, p. 5), where the same line of thought is used to show that "Since about 70% of crashes involve multiple vehicles, each 1.0% mileage reduction should reduce total crash costs by 1.7%.(...)" So the externality effect seems to increase expected societal benefits while worsening the business case for offering payd for an individual insurance company... what a pity!

The second thought was suggested to me by a workshop participant whom I met in The Hague last week. He said: What if PAYD reduces insurance cost for those who drive little, and what if those who drive little don't drive more because of budgetary constraints (which is often assumed)? Why wouldn't those who drive little spend their new-found savings by driving more, not less? Wouldn't these extra kilometres at least partly offset the reductions of those who drive a lot?

It set me thinking. If so, that might reduce the societal benefits of payd considerably...

Well, the proof of the pudding is in the eating. It would be nice to test some of the predictions made by payd advocates in practice. And since several projects are in progress already (by, amongst others: Progressive Insurance in Texas, Norwich Union in the UK, and Polis Direct in the Netherlands), time will tell.

In the meantime, suggestions for sources on alternative views on payd are more than welcome! I also want to thank those that mailed me already!

Christof

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