Monday, April 21, 2008

Pay-as-you-drive insurance

The Freakanomics team — Stephen Dubner and Steven Levitt — explains one of my favorite topics — externalities — in a discussion of what will soon be one of my favorite topics: pay-as-you-drive insurance.

Because there are all sorts of costs associated with driving that the actual driver doesn’t pay. Such a condition is known to economists as a negative externality: the behavior of Person A (we’ll call him Arthur) damages the welfare of Person Z (Zelda), but Zelda has no control over Arthur’s actions. If Arthur feels like driving an extra 50 miles today, he doesn’t need to ask Zelda; he just hops in the car and goes. And because Arthur doesn’t pay the true costs of his driving, he drives too much.

What are the negative externalities of driving? To name just three: congestion, carbon emissions and traffic accidents. Every time Arthur gets in a car, it becomes more likely that Zelda — and millions of others — will suffer in each of those areas.

Pay-as-you-go insurance promises to reduce the problem of negative externalities of driving by eliminating the subsidy that low-mileage drivers pay to high-mileage drivers. With pay-as-you go insurance, drivers' premiums are tied to the amount they drive. Drive more, pay more. Drive less, pay less.

Reduce the insurance subsidy, people pay closer to the true cost of high-mileage driving, and we can expect substantially less driving, reducing carbon emissions, congestion, and accidents.

We still need more pay-as-you-go, in the form of rational road-pricing and pay-as-you-go gas tax. But, insurance is a good start.

Coming soon to six states, but not Massachusetts, soon.

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