Does Private Information Influence Automobile Insurance Purchase Decisions?
This study quantifies the importance of private information, separates the extent to which the positive correlation between the accident probability and insurance coverage reflects adverse selection and moral hazard, and analyzes market segmentation on objective accident risk. We use data we collected to examine the importance of potential sources of private information in individualsʼ third- and first-party insurance choices. Individuals with higher subjective accident probabilities have less liability exposure post insurance purchase and more often experience an accident, conditional on factors insurers use for risk classification. This evidence is consistent with the positive correlation between accident occurrence and liability insurance coverage. We find that the positive correlation almost completely reflects adverse selection. In analysis of insurer sorting, we find that accident-free drivers obtain coverage from insurers with higher independent agency quality ratings. High-quality insurers eschew low-quality drivers on measured dimensions because these drivers are more likely to possess private information about their driving ability and proclivities that affect expected loss. Drivers with a higher risk on factors observable to insurers tend to have private information about their accident risk. This sorting process reflects an institutional response to asymmetric information, and assures a continuous supply of private insurance to unsafe drivers.
This paper was funded in part by a grant from the National Institute on Alcohol Abuse and Alcoholism (NIAAA, #R01AA017913-01A1). The sponsor had no role in the design or conduct of this study. There are no conflicts of interest nor any financial disclosures for any of the authors. We also thank Hanming Fang, University of Pennsylvania, and Ahmed Khwaja, Yale University, for their collaboration in writing the proposal that led to the grant, and for assistance in developing the questionnaire used in this study. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.