The automotive insurance market represents a market for lemons problem.1However, in the automotive insurance market the informational asymmetry is in favor ofthe consumer because it is the consumer who best knows his driving habits andlikelihood of accidents.2 This situation works to the disadvantage of both insurers andconsumers. It works against insurers because they are unable to sell policies thataccurately affect the true risk posed by a consumer. This in turn creates a disadvantageto a majority of consumers because the insurers discount for the risk by overcharging“low-mileage drivers.”3Can we make the automotive insurance market reflect the actual risk posed, andif there is way to do this what would that market look like? The new insurance marketwould be one where both sides have equal information about the consumer’s drivinghabits. However, in order to make such a system feasible the information would have tobe obtainable with low transaction costs.4 Such a system would increase theeffectiveness of insurance companies’ actuaries because they would have moreaccurate information about the consumers. The insurance companies would then usethis information to make an individual policy with premiums that reflected theindividualized consumer’s risk level, as evidenced by his driving habits.5 Because these
policies are based on the consumer’s individual driving habits, we will call this marketPay-As-You-Drive (PAYD) insurance. The recent development of wireless technology has made the PAYD insurancemarket a reality and a majority of state insurance regulations allow for PAYDinsurance.6 However, PAYD policies are only available in less than half of the states.7Why?
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