Tuesday, December 04, 2007

The Economics of Auto Insurance and Discrimination

Car insurance companies base insurance premiums on factors such as your driving record, age, and gender. How do they get away with discriminating based on gender? Why should my premium be based on my gender and not just my driving record? And suppose that statistical studies show that black men have a much higher risk for car accidents than white men. If it is OK for insurance companies to make me pay more just because I am a man, then why shouldn’t they charge me even more for being a black man?

Some people support anti-discrimination legislation for the auto insurance industry to ensure that rates are based strictly upon an individual’s driving record and possibly some other factors that the individual has some control over, such as geographic location. Is there any reason why we should allow the auto insurance industry continue its sexist (and potentially racist) discrimination practices?

A knee-jerk economics argument in favor of refraining from instituting new regulations on the insurance industry might run as follows. It is a fact that men, on average, are more dangerous drivers than women. Observe that insurance companies who charge males higher premiums than they charge females are providing an incentive for fewer men to drive and more women to drive. In theory, this should result in fewer men (but more females) on the road, which means the roads would be populated by safer drivers, on average. Statistically speaking, then, we could expect accident rates to fall. This would be a obvious benefit to the economy.

It is unclear how relevant this argument is for the US economy, where the price elasticity of demand for car insurance could be very low. In other words, it is possible that substantial changes in the insurance premiums would not substantially influence the mix of male and female drivers on the road. (It should be possible to estimate this elasticity with existing data.)

Assuming for the moment that discriminatory insurance pricing does not lower accident rates by changing the mix of drivers on the road, it is very possible that anti-discrimination laws for insurance have a low cost, and that the societal benefits of equal treatment for all groups far outweigh the economic costs.

But even if we conclude that anti-discriminatory laws are desirable, it is unclear how well they can be meaningfully enforced. Often it is possible for an insurance company to discriminate against a protected group without explicitly naming the protected group. For example, if there is a rule that insurance companies must not include gender in their calculations, they might start including height. Since men tend to be taller, setting higher premiums for tall people would generally accomplish the goal of charging higher rates for men.

One surprising example of how institutions can get around anti-discrimination laws is provided by Central Michigan University. After the state of Michigan passed a ban on giving preferential treatment in scholarship funding to specific racial groups, the CMU came up with a creative way of getting around it:


“Undergraduate admissions has, in the past, focused mailings about certain scholarships on students who are members of ethnic and racial minority groups. The applications for these scholarships are available to all students at College Nights and are prominently displayed in the Admissions Office lobby area, but have been sent only to students who are members of ethnic or racial minority groups. In future, these mailings will go to all students who reside in a zip code area from which the university wants to enroll more students because students from this area are underrepresented in the student body.”


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