Everyday Economics

Uninsured-Motorist Fun

The laugh’s on you if you’re paying a high premium for car insurance.


If you live in Philadelphia, your auto insurance probably costs about three times what it would in Milwaukee–and more than twice what it would in Seattle. Philadelphians have traditionally paid more for insurance than their counterparts in Baltimore, Chicago, and Cleveland, despite much higher theft rates in those other cities. This led Wright to ask a question that ultimately became the provocative title for an article in the prestigious American Economic Review: “Why is automobile insurance in Philadelphia so damn expensive?”

Areasonable first guess is that the answer has little to do with economics and much to do with the behavior of state regulatory agencies. But the facts don’t support that guess. Pittsburgh is in the same state as Philadelphia, and Wright could have insured his car in Pittsburgh for less than half the Philadelphia price, even though Pittsburgh’s theft rate was then more than double Philadelphia’s rate. Other states provide equally striking contrasts: San Jose, Calif., is much cheaper than neighboring San Francisco; Jacksonville, Fla., is much cheaper than Miami; Kansas City, Mo., is much cheaper than St. Louis, Mo.


In brief, the theory is that uninsured drivers cause high premiums, and high premiums cause uninsured drivers. In somewhat more detail, a plethora of uninsured drivers increases the chance that, like Smith, you’ll have to collect from your own insurer even when you’re not at fault. To compensate for that risk, insurers charge higher premiums. But when premiums are high, more people opt against buying insurance, thereby creating the plethora of uninsured drivers and completing the vicious circle. Once a city enters that vicious circle, it can’t escape.


So it’s possible that modern Philadelphians are paying an exorbitant price for a brief outbreak of pessimism among their grandparents. If, for just one brief moment–and contrary to all past evidence–Philadelphians could believe that insurance rates will fall and their neighbors will become insured, that belief alone could cause insurance rates to fall and the neighbors to become insured. And then forever after, Philadelphia’s insurance market might look like Milwaukee’s.

It’s not certain that a burst of optimism would be so richly rewarded; the Milwaukee-style outcome will be undermined if Philadelphia is home to enough of the “hard-core uninsured,” who are unwilling to insure themselves even at Milwaukee prices. The Smith-Wright theory predicts that some cities, but not all cities, have the potential to maintain low insurance premiums in the long run.



For ideological free-marketeers (like myself), theories like Smith and Wright’s can be intellectually jarring. We are accustomed to defending free markets as the guarantors of both liberty and prosperity, but here’s a case where liberty and prosperity are at odds: By forcing people to act against their own self-interest in the short run, governments can make everybody more prosperous in the long run. (Though some diehard libertarians will object that the prosperity is an illusion, because governments that have been empowered to make us more prosperous will inevitably abuse that power to our detriment.)
