The Economics and Politics of Automobile Insurance Rate Classification

By Harrington, Scott E.; Doerpinghaus, Helen I. | Journal of Risk and Insurance, March 1993 | Go to article overview
Save to active project

The Economics and Politics of Automobile Insurance Rate Classification


Harrington, Scott E., Doerpinghaus, Helen I., Journal of Risk and Insurance


Press).

Austin, Regina, 1983, The Insurance Classification Controversy, University of Pennsylvania Law Review, 131: 517-583.

Baumol, William J., 1991, Technological Imperatives, Productivity and Insurance Costs, Geneva Papers on Risk and Insurance, 16: 154-165.

Becker, Gary, 1983, A Theory of Competition Among Pressure Groups for Political Influence, Quarterly Journal of Economics, 98: 371-400. The Risk Classification Debate

The pooling of losses in private insurance markets allows risk averse individuals and businesses to achieve valuable reductions in risk. Market-determined risk classification schemes and associated insurance prices affect the societal allocation of the cost of risk. Market classification also affects the magnitude of the cost of risk by influencing the types and amounts of risky activities that are undertaken and the level of precautions taken to reduce losses for any given level of risky activity. The cost of risk also depends on insurer claim settlement practices, including the incentives for insurers to pay contractually specified claims and to detect and control fraud, and on numerous laws and institutions that affect the frequency and severity of accidents and insured claims.

The efficacy of risk classification in private passenger automobile insurance markets has been debated for at least two decades. A number of states have significantly restricted certain types of information that can be used by insurers, such as age, sex, marital status, and territory; and they have set limits on discretionary underwriting, established requirements that involuntary market insureds without accidents and convictions be charged rates similar or identical to voluntary market insureds, and adopted other constraints (see Mintel, 1983) that cause involuntary market rates to fall below the expected cost of providing coverage. Advocates of these limitations characterize certain types of market classification as unfair, arbitrary, or both (see Shayer, 1978, and Abraham, 1985, 1986; also see Federal Insurance Administration, 1974; Koston, 1979; Underwood, 1979; Austin, 1983; Wortham, 1986; and Butler, Butler, and Williams, 1988). For example, market classification in the automobile insurance industry is said to produce rates that are unaffordable to many buyers and to reflect characteristics that are not causally related to losses, that are not within the buyer's control, that provide little or no incentive for increased safety, or that are socially inadmissible.

In contrast, the actuarial community generally argues that pricing and classification should be cost-based; that is, the price charged to a buyer should reflect the estimated expected value of claim costs under the contract plus a loading to cover administrative costs and to provide compensation for bearing the risk. Much of this literature deals with technical aspects of pricing and classification to achieve predictive accuracy. The actuarial literature responds to criticisms of insurers' risk classification methods by stressing the importance of achieving the most homogeneous rate classes possible given imperfect and costly information on expected losses (e.g., Walters, 1981; also see Casualty Actuarial Society, 1988; Stanford Research Institute, 1976; and National Association of Insurance Commissioners Advisory Committee, 1979). Thus, each rating class should contain no clearly identifiable subsets of buyers with different expected losses. This literature also emphasizes that risk classification must consider the accuracy of information used and the cost of obtaining information. It is argued that affordability problems should not be addressed by regulatory restrictions on pricing and classification and that, given the costs of information, competitive pricing and risk selection produce the greatest possible degree of homogeneity.

Economic analysis of insurance classification generally focuses on the efficiency of market classification.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

The Economics and Politics of Automobile Insurance Rate Classification
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?