Why Do we Have Mandatory Auto Insurance?

Mike the Actuary (here and here) is musing about how to fix the mandatory auto insurance system.  Most states mandate coverage, penalize those without insurance, and then lean on insurers to keep the rates low.  This causes all sorts of pressure to refrain from rating based on risk and, in general, turns the automobile insurance system into a socialized risk program.

After musing along with Mike, I started to question why we even have this mandatory coverage. One could make the argument that the automobile insurance system should be socialized due to the negative externality caused by those #$%@ uninsured motorists.  I recall seeing an Insurance Research Council study of uninsured motorists and there was approximately 15 percent unisured motorists across the states.  I wonder (no data, just wondering) if the costs to the auto liability system would be lower if we had no mandatory coverage.  We could examine this, presumably, if we had the data on participation across states and across time.  This sounds like a job for a hungry Ph.D. student!

Update:  This thread has also continued off campus at http://www.actuarialoutpost.com/actuarial_discussion_forum/showthread.php?t=69297.

Comments

[tyleverty]

I was actually musing about this same thing. What I am curious about is the moral hazard aspect of compulsory auto insurance. Do states that have more uninsured drivers actually have lower fatality rates and/or lower accident rates since these uninsured drivers would presumably drive more cautious? Controlling for different regulatory regimes, liability systems, ect. that would be an interesting finding. But the key thing to remember is how would it impact uninsured motorists coverage. Would the net effect be lower cost auto liability insurance? Sounds like a job for a hungry assistant professor vying for tenure!

[Martin]

I almost put "this sounds like a job for Ty", but I know you are working on a good number of projects.
I, too, was wondering what the equilibrium unininsured motorist coverage would be like. I think I am going to get someone to see if they can track down this data!

[Kevin O'Reilly]

This much is clear: In most states it's pretty easy to avert the current mandates. Most of the people who do not comply with the law do so because they cannot afford the additional cost, and it doesn't seem that the public will exists to take away people's means of transportation -- and often their means to earning a living.

So instead of being fined or having their vehicle taken away, motorists are given a ticket and the fee is waived when they show up in court with proof of insurance. Naturally, they can then cancel the coverage or cease making payments once the court date has passed.

State efforts at enforcing mandatory insurance, then, have often focused on imposing paperwork burdens on insurers rather than targeting the motorists who don't comply with the law.

My point is that aside from looking at the total cost of UIM (which is still necessary as a coverage because people don't comply with the law)versus mandatory coverage, which ever hungry PhD student or prof examines this issue should also take into account the total costs of enforcing these laws. I suspect they're greater than the supposed benefit.

[Ted]

Not clear that uninsured drivers' incentives are really structured to drive more carefully. As Kevin notes, there's no political will to enforce mandatory insurance laws, and most people who don't buy insurance make that decision because they're outside the system as an illegal alien or too poor to worry about the prospect of civil liability.

[Martin]

Kevin and Ted... I agree there is hardly any will to enforce the mandatory coverage laws and that people will only voluntarily buy insurance when they have something to protect. It may be enough of a cost to lose a license for those who do not purchase insurance (the cost of driving without a license is probably high enough in terms of hassles) to provide enough discipline to keep the price of UMI at a reasonable level. However, this is an empirical question and it may differ in each states as the mixture of drivers is quite different.

[New Jersey Auto Insurance]

It is so important for everyone to carry auto insurance - a mjor accident liability would bankrupt 90% of families. And us legit payers also pay for those who break the law anyway. Car insurance would be so much less costly if people followed the law.

[snoteyed]

It's only obvious that UN-insured drivers are the safest ones on the road. The SCAM of mandatory insurance is only the tip of the fraud we are subsidizing. The insurers pay out about eighteen or maybe nineteen percent in claims, and lawyers get the bulk of THAT. Pay at the pump would only cost a couple of dimes per gallon and would help end the REEKING MESS government has made of every individual's RIGHT to travel UNHARRASSED AND UNIMPEDED....I personally have BACKED UP further than most folks will ever drive, and have NEVER had an accident. Why should I subsidize this clap-trap BS? A system of NO INSURANCE would erxponentially improve safety on the road, only if folks had to pay claims THEMSELVES would they quit crashing into one another.What a powerful incentive for safety.. .

[Kendra-UHLaw]

The reason we have “mandatory” insurance is because a substantial portion of the population would refuse to voluntarily provide a guarantee (either through insurance or some other form of financial guarantee) that should they negligently cause an accident, they will be able to compensate the victim. The primary purpose of Compulsory Insurance Laws is to protect innocent victims. If there is not a compulsory system in place, it is very likely many drivers, namely those that are judgment proof, would go bare.

Every state in the nation suffers from this problem and some states have actually walked down the path of “socializing” coverage with alternatives to Compulsory or Financial Responsibility Laws, such as No-Fault. However, none of these three methods does much more than band-aid the problem. The real solution is tougher enforcement of laws. But because no politician will stick his head out to suggest something so harsh, it is but pie in the sky. Advocates of the No-Fault approach to coverage argue that everyone should share in the overall risk on the road and rather then find blame, all should cover their own damages and injury. Supporters of this method often assert the following benefits: insurers’ costs are lower due to no investigation and less adjusting fees, this in-turn lowers premiums for the public, and the system eliminates inequities in claim payments. What they fail to point out is that while insurers do not need to perform investigations to determine fault, investigation cost for insurers remain high as other factors, such as fraud and cost containment, are not eliminated. As far as lower premiums, as a one time consumer of this product I can tell you my premium was no cheaper in Florida (a no-fault state) than what it is now in Texas. Plus under no-fault, a driver really needs liability coverage and first-party coverage (first-party coverage for himself and liability coverage for serious accidents that exceed the no-fault threshold.) Whereas, under a compulsory system, a driver can decline first-party coverage which lowers premiums. So does it alleviate inadequacies in claim payments? Hardly; victims under this system have no more assurance that they will be fully compensated or indemnified than those under other systems. Even worse, no-fault systems often eliminate pain and suffering damages. Furthermore, a no-fault system intrinsically creates a moral hazard problem. Because drivers no longer face a threat of tort liability, they can drive more carelessly (although, there is still self-preservation that a driver presumable feels, similar to life insurance policyholders.) Lastly, the real proof of the inadequacy of this system is that no state has a “Pure No-Fault system” and states have had to adopt Add-On, Modified or Choice Plans.

Most states have Compulsory or Financial Responsibility Laws, which many would rightly argue do no better in resolving the underlying problem of enforcing current laws. While I do not 100% endorse either system, I do feel that the compulsory system is the best alternative. In comparison to Financial Responsibility Laws which demand proof of insurance only after an accident or judgment, Compulsory Laws demand proof of insurance (or financial guarantee such as a bond) at the time the auto is registered, i.e., put on the road. One who demands that everyone assume full ownership and responsibility for their own actions could ask for nothing more, in theory. Surely a driver would not procure insurance to meet vehicle registration requirements and then turn around and cancel the policy. Furthermore, when showing proof of insurance, at least in Texas, there is no way to verify that the insurance is actually in force. Compare that to New York where insurance cards have a barcode so that police can verify coverage on the scene of an accident or traffic stop. It all goes back to the root of the problem—it is not the law but rather the lack of enforcement of the law that is challenging in a compulsory scheme. (Texas is moving towards the barcode system, by the way, as are many states.)

Compulsory laws do have other shortcomings from just enforcement. For instance, certain policy exclusions have essentially been invalidated by courts as against the public policy underlying compulsory laws. Telling an innocent victim that they will not be compensated because the other driver, although insured and at fault, acted intentionally contradicts the assurances drivers are supposed to have under a compulsory system. Furthermore, discrediting policy exclusions will cause the moral hazard to recur since presumably policy exclusions are in place to combat moral hazard. Then there are the states with mandatory uninsured motorist requirements and compulsory requirements—why would a state be so concerned about uninsured drivers if they had strong compulsory laws? Again, probably because of weak enforcement of their compulsory laws. I would argue that because compulsory limits are too low, it would be best to also have mandatory underinsured motorist coverage (to the extent it would not discriminate against the poor, or course.) But if anything, at least the guise of compulsory insurance keeps UM rates relatively low.