Solutions to Questions and Problems
1. Underinsured motorist insurance covers losses that an individual personally suffers that
are not compensated by an at-fault driver because the at-fault driver has too little
insurance coverage. Many people would prefer not to purchase insurance for non-
economic losses suffered as a result of an accident and therefore they would not purchase
underinsured motorist coverage with high limits. In contrast, liability insurance covers
the losses that a driver incurs as a result of being at-fault. The injured party may very
well seek non-economic damages in such a case. Therefore, to protect his or her assets
from being paid to compensate injured parties, a rational person might purchase liability
insurance with limits in excess of the limits on uninsured motorist coverage. In sum,
uninsured motorist coverage limits reflect the amount of coverage that an individual
personally would like to purchase, whereas, liability insurance limits reflect the amount
of coverage that other parties will seek following accidents (and the amount of wealth
that the person has to protect).
2. Underinsured and uninsured motorist coverage might be improved by eliminating any
mandatory coverage for pain and suffering. Many people would prefer not to purchase
insurance against non-economic losses and thus the mandatory coverage forces some
people to purchase insurance they do not desire.
3. The main rating factors are driving record, location of residence (territory), and
characteristics of the driver, such as age and gender.
4. It might be better to have a lower deductible for other-than-collision coverage than for
collision coverage, because collision coverage is likely to be susceptible to more moral
hazard. That is, losses from collision coverage are likely to depend more on the driver’s
behavior than other-than-collision. As a result, the effect of a lower deductible on the
premium charged is likely to be greater for collision than for other-than-collision
5. Such a guaranteed renewable policy would likely have a very high price, because of the
adverse effect a constant premium would have on the insured’s behavior. Most people
would prefer a policy that provided greater incentives for safety and thus lower
6. Insurers will be willing to sell coverage provided they can cover their costs, including
their cost of capital. Consequently, the people that are insured in residual markets are
typically people who have higher expected costs than the premium that insurers are
allowed to charge. Not surprisingly, residual markets typically lose money.
7. People who violate compulsory insurance laws and drive without insurance may have
greater incentives to avoid accidents so as not to incur the penalties associated with
violating the compulsory insurance law.
8. Repeal of compulsory liability insurance and limits on tort liability would likely decrease
drivers’ incentives for safety. The government could counteract this effect by increasing
fines for traffic violations and accidents and by increasing enforcement efforts.
9(a) The argument for compulsory auto liability insurance is that it forces people who
otherwise would drive without insurance to internalize (consider) the expected accident
cost that they impose on others as a result of their decision to drive. Since some of the
expected costs of driving are paid by others, some people might drive even though the
total expected cost of driving exceeds their benefit from driving. Also, to the extent that
future premiums depend on a person’s driving record, compulsory liability insurance can
encourage greater safety from those who otherwise would drive without insurance.
9(b) The main argument against compulsory auto liability insurance is that it forces poor
people (who are the ones most likely to drive without insurance) to purchase insurance
that primarily benefits other people.
9(a) The argument for compulsory PIP coverage is that it forces people who otherwise would
drive without such insurance to internalize (consider) their expected medical costs as a
result of their decision to drive. Without PIP coverage or other medical expense
coverage, a person seriously injured in an accident (without a third party at fault) would
receive medical care that would be paid by others. Since some of the expected costs of
driving are paid by others, some people might drive even though the total expected cost
of driving exceeds their benefit from driving. Also, to the extent that future PIP
premiums depend on a person’s driving record, compulsory PIP coverage could
encourage greater safety from those who otherwise would drive without medical expense
9(b) The argument against mandatory PIP coverage is that it forces poor people to purchase
insurance that they do not desire.
10. This is a difficult question given the complexity of actual no-fault laws and their effects
on litigation costs and limits on compensation for pain and suffering, reductions in which
could benefit both high and low risk drivers. To illustrate the effects ignoring litigation
costs and pain and suffering compensation, restrictions on tort liability without
mandatory PIP coverage would likely benefit high risk drivers more than low risk drivers
because the limits on liability would reduce the extent to which high risk drivers have to
pay the costs that they impose on low-risk drivers. Low risk drivers would have to pay
more of the accidents cost caused by high-risk drivers. Mandatory PIP coverage would
mitigate these effects somewhat as high-risk drivers would be required to purchase and
have to pay higher prices for PIP coverage.
11. Personal injury lawyers benefit from lawsuits and therefore generally would be hurt by
the limitations on legal liability of no-fault laws. To the extent that legislators are still
practicing law or plan to practice law after their term in office, voting on no-fault
legislation could represent a conflict of interest.