Risk-Based Pricing and Risk-Reducing Effort: Does the Private Insurance Market Reduce Environmental Accidents?

Haitao Yin, Howard Kunreuther, Matthew White

NBER Working Paper No. 15100
Issued in June 2009
NBER Program(s):   EEE   IO   LE   PE

This paper examines whether risk-based pricing promotes risk-reducing effort. Such mechanisms are common in private insurance markets, but are rarely incorporated in government assurance programs. We analyze accidental underground fuel tank leaks--a source of environmental damage to water supplies--over a fourteen-year period, using disaggregate (facility-level) data and policy variation in financing the cleanup of tank leaks over time. The data suggest that eliminating a state-level government assurance program and switching to private insurance markets to finance cleanups reduced the frequency of costly underground fuel tank leaks by more than 20 percent. This corresponds to more than 3,000 avoided fuel-tank release accidents over eight years in one state alone, a benefit in avoided cleanup costs and environmental harm exceeding $400 million. These benefits arise because private insurers mitigate moral hazard by providing financial incentives for tank owners to close or replace leak-prone tanks prior to costly accidents.

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Document Object Identifier (DOI): 10.3386/w15100

Published: “Risk-Based Pricing and Risk-Reducing Effort: Does the Private Insurance Market Reduce Environmental Accidents?” (with Haitao Yin and Matthew White), Journal of Law & Economics, Vol. 54, No. 2 (May 2011), pp. 325-363

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