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How to Prevent Traffic Accidents: AI and the “First-Best” Insurance Contract

Risk mitigation is an essential aspect of risk management, but it has largely evaded attention by auto insurers and researchers that optimize selective risk-sharing and claim mitigation instead. We use novel sensor data to track drivers’ handheld phone use behavior (“HPU”), a generalization of text-and-drive in the smartphone age, and demonstrate how a behavior-based insurance contract can prevent accidents. Based on a prior experiment conducted in Jin (Forthcoming), we develop a structural model to distinguish inattention, risk aversion, and the price elasticity of HPU. This facilitates counterfactual simulations of the “first-best” auto insurance contract with full insurance and a direct price on HPU (Holmstrom 1979). The contract features a 40-cent average charge per mile of HPU. 


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