Mitigating Moral Hazard With Usage-Based Insurance

Technological progress has improved insurers' ability to monitor policyholders and has led to usage-based insurance (UBI) contracts that incorporate behavioral risk factors in pricing. Economic theory predicts that any informative monitoring signal should be adopted in equilibrium (see Shavell, 1979). In practice, the demand for UBI is still low to date with market shares in the single digits. We modify the standard moral-hazard model in insurance economics by trading off a simpler effort model for a richer strategy space. In our modified model, an informative monitoring technology is in use if it is sufficiently accurate. Otherwise, the premium incentive from monitoring is not large enough to alleviate the incentive-compatibility constraint to an extent that would make policyholders better off. Our theoretical results help explain the slow adoption of UBI contracts in practice and provide an avenue to increase their appeal to policyholders