We document and attempt to explain the observation that automobile insurance premiums vary dramatically across local markets. We argue high premiums can be attributed to the large numbers of uninsured motorists in some cities, while at the same time, the uninsured motorists can be attributed to high premiums. We construct a simple noncooperative equilibrium model, where limited liability can generate inefficient equilibria with uninsured drivers and high, yet actuarially fair, premiums. For certain parameterizations, an optimal full insurance equilibrium and inefficient high price equilibria with uninsured drivers exist simultaneously, consistent with the observed price variability across seemingly similar cities.
- Federal Reserve Bank of Minneapolis. Research Department
- Federal Reserve Bank of Minneapolis
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