Reducing asymmetric information in insurance markets: Cars with black boxes

Abstract

Monitoring and recording driving behavior has become technologically feasible recently which allows inference of drivers' risk types. We examine the effects of such technologies in automobile insurance markets with adverse selection for both perfect competition and monopoly. Specifically, we assume that insurers can offer a contract with access to recorded information ex post, i.e., after an accident, in addition to the usual second-best contracts. We find that this leads to a Pareto-improvement of social welfare except when high risks initially received an information rent. Regulation can be used to establish Pareto-improvement also in these cases. Explicit consideration of privacy concerns of insurees does not alter our positive welfare results. © 2010 Elsevier Ltd. All rights reserved.