Ulric B. and Evelyn L. Bray Social Sciences Seminar

Abstract: Risk mitigation is an essential aspect of risk management, but it has largely evaded attention by auto insurers that optimize selective risk-sharing and claim mitigation instead. We use novel sensor data to study drivers' risky phone use behavior and how behavior-based insurance contract can prevent accidents. We first measure moral hazard. We find handheld phone use ("HPU") to be risky but insensitive to both insurance changes and weather shocks that increase its riskiness. However, an experiment with a one-time text-message warning led to a persistent 15% HPU reduction. Drivers' inattention to risk thus limits moral hazard while inducing inefficiently high HPU. Based on this finding, we develop a structural model to distinguish nudging effect, risk aversion, and the price elasticity of HPU. This facilitates counterfactual simulations of optimal contracts with full insurance and a direct price on HPU (Holmström 1979). The "first-best" can be achieved with a 40-cent average charge per mile of HPU. A 62-cent charge can resolve additional externalities on traffic congestion and injuries.

Written Tomas Yu.

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