ArticleIP_2046.txt

   
   
      
         
            Uninsured-Motorist Fun

            Ten years ago, an economics
professor named Randall Wright resigned from his job at Cornell and drove his
Dodge Daytona Turbo down to Philadelphia to begin teaching at the University of
Pennsylvania. When Professor Wright found out how much Philadelphians pay to
insure their cars, he gave up driving.

            If you
live in Philadelphia, your auto insurance probably costs about three times what
it would in Milwaukee--and more than twice what it would in Seattle.
Philadelphians have traditionally paid more for insurance than their
counterparts in Baltimore, Chicago, and Cleveland, despite much higher theft
rates in those other cities. This led Wright to ask a question that ultimately
became the provocative title for an article in the prestigious American
Economic Review : "Why is automobile insurance in Philadelphia so damn
expensive?"

            Areasonable first guess is that the answer has little to do
with economics and much to do with the behavior of state regulatory agencies.
But the facts don't support that guess. Pittsburgh is in the same state as
Philadelphia, and Wright could have insured his car in Pittsburgh for less than
half the Philadelphia price, even though Pittsburgh's theft rate was then more
than double Philadelphia's rate. Other states provide equally striking
contrasts: San Jose, Calif., is much cheaper than neighboring San Francisco;
Jacksonville, Fla., is much cheaper than Miami; Kansas City, Mo., is much
cheaper than St. Louis, Mo.

            While
Wright was puzzling over these discrepancies, a Penn graduate student named
Eric Smith was involved in an auto accident. The other driver was at fault, but
he had few assets and no insurance, so Smith had to collect from his own
insurer. That unpleasant experience gave Smith and Wright the insight that led
to a new theory of insurance pricing.

            
In brief, the theory is that uninsured drivers
cause high premiums, and high premiums cause uninsured drivers. In somewhat
more detail, a plethora of uninsured drivers increases the chance that, like
Smith, you'll have to collect from your own insurer even when you're not at
fault. To compensate for that risk, insurers charge higher premiums. But when
premiums are high, more people opt against buying insurance, thereby creating
the plethora of uninsured drivers and completing the vicious circle. Once a
city enters that vicious circle, it can't escape.

            In other
words, insurance rates are driven by self-fulfilling prophecies. If everyone
expects a lot of uninsured drivers, insurers charge high premiums and then many
drivers choose to be uninsured. Conversely, if everyone expects most drivers to
be insured, insurers charge low premiums and then most drivers choose to be
insured. Either outcome is self-reinforcing. A city that falls into either
category (for whatever random reasons) remains there indefinitely.

            So it's possible that modern Philadelphians are paying an
exorbitant price for a brief outbreak of pessimism among their grandparents.
If, for just one brief moment--and contrary to all past
evidence--Philadelphians could believe that insurance rates will fall and their
neighbors will become insured, that belief alone could cause insurance rates to
fall and the neighbors to become insured. And then forever after,
Philadelphia's insurance market might look like Milwaukee's.

            It's not certain that
a burst of optimism would be so richly rewarded; the Milwaukee-style outcome
will be undermined if Philadelphia is home to enough of the "hard-core
uninsured," who are unwilling to insure themselves even at Milwaukee prices.
The Smith-Wright theory predicts that some cities, but not all cities, have the
potential to maintain low insurance premiums in the long run.

            But in
cases where that potential exists, it would be nice to see it realized. One way
to accomplish that is by enforcing mandatory-insurance laws. (Smith and Wright
point out that enacting a mandatory-insurance law, which a majority of
the states have already done, is not the same as enforcing a
mandatory-insurance law, which is nearly unheard of. Moreover, even where the
laws are enforced, minimum liability limits are typically very low, and
probably too low to make much difference.)

            
In theory, mandatory insurance could make life
better for everyone , including those who currently prefer to be
uninsured. Philadelphians who are unwilling to buy insurance for $2,000 might
welcome the opportunity to buy insurance for $500. So if mandatory insurance
yields a dramatic drop in premiums, then both the previously insured and the
newly insured can benefit. (In practice, there will probably be a small segment
of the population-- presumably at the low end of the income distribution--who
will be unhappy about having to buy insurance even at $500. But income-based
insurance subsidies would allow even the poorest of the poor to share the
benefits of lower premiums.)

            For ideological
free-marketeers (like myself), theories like Smith and Wright's can be
intellectually jarring. We are accustomed to defending free markets as the
guarantors of both liberty and prosperity, but here's a case where liberty and
prosperity are at odds: By forcing people to act against their own
self-interest in the short run, governments can make everybody more
prosperous in the long run. (Though some diehard libertarians will object that
the prosperity is an illusion, because governments that have been empowered to
make us more prosperous will inevitably abuse that power to our detriment.)

            Is it worth sacrificing a
small amount of freedom for cheaper auto insurance? I am inclined to believe
that the answer is yes, but the question makes me squirm a bit.