Effects of Monitoring Technology on the Insurance Market

Abstract

The car-insurance market is plagued with problems of adverse selection and moral hazard. In-vehicle data recorders can collect massive amount of information about the drivers’ driving behaviors and risk factors. This monitoring technology allows the firm to charge a premium based on the customer’s recorded driving behaviors; this helps to reduce the driver’s moral hazard. It can also allow the firm to set its insurance premium based on better estimates of the driver’s risk factors, alleviating the adverse-selection problem. We provide an analytical framework to examine the impact of such monitoring technology on the insurance firms and the drivers. Our analysis shows that in a duopoly one firm’s adoption of the monitoring technology may benefit both firms, because the firms have incentives to target different segments of drivers, leading to less intense competition in the market and reducing the surplus of the drivers. We show that if one firm has adopted the monitoring technology, its competitor may have no incentive to adopt that technology even if the acquisition cost is zero.