Re-examining Moral Hazard under Inattention: New Evidence from Behavioral Data in Auto Insurance
This paper uses novel sensor data to study drivers’ risky phone use behavior. The results challenge the conventional wisdom of moral hazard in insurance. We first identify handheld phone use behavior (“HPU”) and quantify its causal impact on accident likelihood (“riskiness”) using exhaustive fixed-effect models. We then find HPU to be risky but insensitive to both insurance coverage changes and weather shocks that increase its riskiness. This contradicts the prevailing theoretical prediction and empirical studies that have thus far relied on claims data alone. On the other hand, an experiment with a one-time text-message warning led to a persistent 15% HPU reduction. Drivers’ inattention to risk thus limits moral hazard. .
What is "Fallacies of Hope"?
In graduate school, I was first inspired to focus on insurance and the issue of moral hazard by this painting at the Boston MFA.
During the Atlantic slave trade era, many slaves would die or revolt in transit, prompting slavers to purchase insurance against the resulting financial loss. However, these insurance contracts provided perverse incentives that directly resulted in the loss of lives, culminating in the 1781 event portrayed in this painting by William Turner.
From Pearson and Richardson (2019):
On 29 November 1781, the master of the Zong, a Liverpool slaver becalmed in the doldrums and running out of provisions, threw 132 living slaves overboard on the assumption that insurance would cover the loss. When the underwriters refused the claim the owners successfully sued. The underwriters applied for a retrial. At the Kings Bench in May 1783, Lord Mansfield and his fellow judges ruled in favor of the applicants, finding that there was no evidence that the loss had been occasioned by “perils of the sea” covered by the standard marine insurance policy.
Two years later Mansfield adjudicated another case, where a Bristol ship had lost 55 slaves during a revolt off the coast of Africa. The dispute centred on which losses the underwriters were liable for under the slave insurrection clause in the policy. The court ruled that they were to compensate for slaves shot dead or who died from wounds incurred directly in the struggle, but that they were not liable for deaths by other means, such as drowning, jumping overboard, or “abstinence” from despair at the failure of the uprising...
Legal ambiguities persisted. In 1794, breaking from standard policy conditions, parliament prohibited the recovery of slave losses due to jettison or as a result of quarrels with rulers on the African coast that derived from aggressive procurement by British crews... The insurance of slaves was finally made illegal in 1807 by the same act that abolished the British slave trade, although some underwriters continued to insure slavers sailing under foreign flags.
Alongside the painting, is William Turner's unfinished poem “Fallacies of Hope:”
Aloft all hands, strike the top-masts and belay;
Yon angry setting sun and fierce-edged clouds
Declare the Typhon’s coming.
Before it sweep your decks, throw overboard
The dead and dying – ne’er heed their chains
Hope, Hope, fallacious Hope!
Where is thy market now?
Empirical studies of moral hazard in insurance often focus on utilization of services after the losses have occurred: e.g. how to contain the cost of health care, or how to limit spending on accident remedies. These studies address the aptly termed "ex-post" moral hazard. But it is often the losses themselves and the associated human cost that will become the lasting legacy of a business or a policy. My work is a small step in understanding the determinants of risky behaviors, the magnitude of "ex-ante" moral hazard, and how new data and AI technologies can help restore contracting and market efficiency.