Fairness in Auto Insurance

What’s a fair way to price auto insurance?

My question begins from a personal financial setback.

My 16 year-old got her driver’s license in August, which I just learned will double our household automobile insurance premiums. We previously paid $678 every six months but will now pay $1,276 every six months. 

Yay. 

Hyundai_Elantra

Now I know where I’ll spend the automatic child tax credit that I was so happy about recently.

This new, egregious, pricing is typical for youthful drivers, who are guilty until proven innocent, from the perspective of insurance companies.

Another guilty until proven innocent factor used by auto insurance coverage is credit scores. The worse or thinner your credit, the more you pay for auto insurance. This feels unintuitive. Why should a person with a flawless driving record pay more for insurance if they were late on their credit card bill, or don’t have a credit record? Driving and using credit responsibly are clearly separate skills.

Using credit scoring in insurance products and pricing is an active debate at the federal and state level. New Jersey Senator Cory Booker has proposed banning credit scoring as a factor in auto insurance. Michigan Congresswoman Rashida Tlaib has done the same in the House.

The insurance industry maintains that the historic correlation between lower credit scores and a higher number of claims and a higher dollar value of damage claims justifies the use of credit scoring in pricing.

In June of this year entrepreneur Nestor Hugo Solari moved his startup auto-insurance company Sigo Seguros to Austin and launched a new program in the state, targeting the state’s Spanish-speaking population. 

One of Sigo Seguros’ selling points is that they do not consider personal credit scores when underwriting auto insurance. They consider credit-scoring discriminatory, especially against Spanish-speaking Texans. To further appeal to his target audience, the company will not require a traditional state driver’s license either. Customers can provide a foreign driver’s license and still receive coverage from Sigo Seguros, without any surcharge. 

The most typical customer for Sigo Seguros, according to Solari, seeks liability-only coverage, and may forgo collision coverage because they drive an older, less-valuable car. 

Sigo_Seguros

I’ve previously written about this, but from a personal-finance perspective, I favor this flavor of auto insurance. We need solid protection against catastrophic liability. But we don’t need protection against car damage because, for personal finance reasons, people shouldn’t drive valuable cars. Especially, I hasten to add, with a new 16 year-old driver behind the wheel. I decline to insure against damage to my 2009 Hyundai, which has a trade-in value of maybe 2 thousand dollars. At that kind of value, what’s the point of damage insurance? The thing is nearly worthless, on purpose, just the way I like it. So I save a little by declining collision coverage, as do many Sigo Seguros customers.

I asked Solari what his issue was with credit scores. Solari pointed out to me that the Spanish-speaking Texans his company seeks to serve may have thin or no credit files because of recent immigration status or because the community is relatively under-banked, compared to native English-speakers in the state. 

I confirmed with my own auto insurance company that they do consider personal credit as one of the factors determining my premiums. Texas insurance rules allow credit scoring as a factor for pricing, in a regulated way, and as long as it’s not the only factor considered. Some states, including California and Massachusetts, have banned personal credit as a factor because of their potentially discriminatory effects. 

Other factors also always matter, such as miles driven, car-density as measured by zip code, and of course past driving record.

Nestor_Solari
Nestor Solari

In theory, what is a fairer method for pricing auto insurance?

Critics of the use of credit scoring argue that observed driving behavior and driving record is what should count most. They have a point as well. 

In recent years auto insurance companies have experimented with telematics, which provide data directly to the companies on your particular driving style, based on a mobile phone app that tracks everything from acceleration and hard-braking to late-night driving and texting-while-driving. 

Sigo Seguros offers a discount for customers who sign up to its mobile-phone based telematic system, as a better way to measure driving risk. 

I was interested to learn this because I had previously enrolled about a year ago in an app that offers me a discount for letting my insurer track my driving experience. My insurance company’s app even reports to me about my sudden braking as well as my phone use while driving. It’s probably tracking overall miles driven as well.

This kind of driving data strikes me as quite fair, since it measures factors that could increase the likelihood of auto accidents which credit scores, for example, do not. This is the ultimate goal – fairness in auto insurance – based on observed risky behaviors. And fairness is good. 

The downside of telematics is that Big Brother – in the form of my auto insurance company – is totally watching me drive around everywhere. 

This makes me paranoid about my ability to get away with doing crimes in the future, which is a real negative. On the plus side, I get 3 percent annual savings on my auto insurance premiums! 

We are now paying through the nose because of my teen driver. Eventually I will need to rob banks just to pay for the auto insurance, but the auto insurance telematics will increase my likelihood of getting caught for this behavior. A classic Catch-22.1

A version of this post ran in the San Antonio Express News.

Please see related stories:

Yup, My 16 Year-old Got a Credit Card (Need to link here)

Auto Insurance and My Personal Finance Theories

Buy the Least Amount of Car

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  1. Speaking of Big Brother watching, and as a total aside, I have really enjoyed the idea that Bill Gates can track my every move, ever since I got the Pfizer vaccine against COVID. You know what’s nuts about that worry in particular? We all carry smartphones everywhere! That is the actual tracking device recording all of our movements, people! It’s not the vaccine. Please, for the love of McKenzie Scott and all that is beautiful in this world, get vaccinated if you haven’t already.

Transparency Part III – Salaries! All We Have To Lose Is Our Chains!

Ready for another crazy, but great, money idea that could change your life for the better?

Transparency
I’ve got one word for you, kid: Transparency

Salary transparency. At your workplace. Meaning: everyone knows what everyone else gets paid, every year. No, wait, stick with me here. I know you suddenly felt a little ill. But salary transparency works to your advantage.

Salary transparency is an idea most commonly discussed as an ideal in recent years among Silicon Valley tech companies, but it shouldn’t begin or end there.

San Antonio-based software engineer Nancy Hawa of DevResults a data-organization and data-visualization company based in Washington DC, pushed for salary transparency in her 12-person company earlier this year. DevResults decided to take the plunge.

As a result, her CEO and COO released to employees a completely open set of data around not only what all employees make this year, but the entire history of everyone’s compensation.

The initial feeling among Hawa and her colleagues with that disclosure, she admits, was dismay. She described the higher-paid employees in the office holding their heads at their desks in a kind of awkward embarrassment. Lower-paid employees, like Hawa, held their breath to find out what would happen next.

To the credit of DevResults’ leadership, they announced that despite what appeared to be “unfair pay” then, nobody would be paid less as a result. Over time, Hawa reports, lower-paid employees received a bump up in pay to put them in line with their colleagues. Transparency for Hawa meant she will be paid a lot more, not only this year, but in the future.

I learned from my conversation with Hawa a bunch of the nuances around salary transparency, a topic about which she is passionate.

The first nuance is about the “Why?” of salary disclosure.

The two best reasons to want financial transparency are to fight corruption and to ensure fairness.

I wrote earlier about income tax transparency, which is mostly about fighting corruption, and somewhat less about fairness.

Salary transparency is an even more radical departure from current norms than tax transparency. I’m increasingly convinced good business leaders should institute it as a matter of setting company culture.

Now, before you all freak out, salary transparency actually is somewhat normal in certain circumstances. As Hawa notes, “The State of Texas is not a progressive or radical organization, but they decided they needed salary transparency.”

Texas believes strongly in salary transparency as a public policy value, presumably for both anti-corruption and fairness reasons.  I did an experiment, moments ago, to answer the question of how long it would take me to figure out Texas Governor Greg Abbott’s annual salary. The answer, in my case: 46 seconds. He makes $153,750 per year.

But immediately, I realized the next important nuance about transparency.

Partial Transparency

One of Hawa’s main warnings is that ‘partial’ salary transparency is actually destructive. With ‘partial’ disclosure she points out, you move quickly from no salary information to salary misinformation.

For example, an online search would tell you that Texas legislators earn $7,200 per year. But that number totally overlooks the generous pensions they can accrue over years of service, as I wrote about earlier in the year. So ‘salary transparency’ can be done well, but it can also be done badly.

It took me 41 seconds to find that my wife has part of her salary disclosed online as well, as she is paid part-time by a State of Texas entity. That partial disclosure, however, is misleading because it’s only part of the story. Again, partial disclosure can obscure rather than illuminate.

Hawa also cited companies that release “salary bands” rather than all salary data. All that does is potentially hide big differences in total compensation within wide ranges, like $40,000 differences, as she has observed elsewhere. Also, releasing general information about characteristics of employees, like “new hires receive $X in salary, but with some exceptions” can actually deceive.

Why the exceptions? And why the non-identifiable descriptions? Selective disclosure, Hawa argues, is often worse than no disclosure at all, because it misleads.

I wondered if only a relatively “flat” organization would want to radical transparency. Hawa doesn’t think so. Companies should be free to pay for star performance, as long as management can justify it.

“The company doesn’t have to aspire to flatness, but does have to aspire to fairness,” says Hawa. “Unequal is not the same as inequitable.” Those seem to me important points as well. Pay as much as you want or need to, as long as you wouldn’t be embarrassed by everyone knowing everyone’s pay.

If you’re a business owner who would be embarrassed by full salary transparency at your firm, what does that say about your method of paying folks? In an important sense, Hawa believes, the discomfort is the point. Hawa described her colleagues’ initial discomfort as a positive rather than a negative.

From Hawa’s perspective, transparency challenges leadership to be introspective. That’s where the hard conversations, and maybe some learning, can begin.

Says Hawa, “If you are leader, give yourself the opportunity to be challenged by your employees. If your salaries are fair, you’re good. If they are not, you [the manager/owner] have something to learn.”

Who Benefits from Opacity?

I’m pretty interested in the thought experiment. This all got me thinking about the fact that salary transparency is really not considered ‘normal’ in most workplaces. But why? Why are we unwilling to be transparent? What are we uncomfortable with? Who benefits from the secrecy?

For competitive reasons, we can all agree it makes sense not to publish your data to your competitors. But to ensure fairness within your own organization, wouldn’t full disclosure for current employees reduce mistrust?

I asked Hawa if she thought disclosure helped managers run her business better.

“I think there’s a business value in taking this off of people’s minds.”

And if you are a worker at an organization and the idea of salary transparency makes you uncomfortable, you should probably realize that secrecy isn’t your friend. You might have some initial shock and resentment upon disclosure, sure, but after that you would likely benefit. Secrecy is a tool in the hands of management.

As Siskel and Ebert once said: All You Have To Lose Are Your Chains

I think if you’re a worker worried about salary disclosure, you should remember the words written by a couple of German guys who became famous in 1848: All you have to lose are your chains!

A version of this post previously ran in the San Antonio Express News and Houston Chronicle.

Please see related posts:

Tax Transparency – I’m a fan

City Economic Development Transparency – SA and Houston failing grades

San Antonio and Houston need transparency taken to 11

TX Legislative Salary transparency and opaqueness

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Transparency Part II – TOTAL Tax Transparency

I’ve been reading up on “tax transparency” lately and have become a convert to the idea. The idea is that the IRS could and should publish online, in a searchable database, the annual income and income taxes paid by all taxpayers.

Transparency

I’ve got political, economic, and sociological reasons for my conversion.

You probably already anticipate the political. Most Democratic presidential candidates this month have rushed to release a decade’s worth of their personal tax returns. They do this in part to contrast with President Trump, who has broken with forty years of tradition by not releasing his own tax returns. His stated reason is that his returns are “under audit” with the IRS. An audit process, however, does not prevent voluntary disclosure, according to the IRS itself.

But there is a better way. You’re going to love this idea.

If you’ve ever read my columns before, you probably realize that when I say “You’re going to love this,” I actually mean that you’ll probably hate this.

Let’s not limit ourselves to begging for voluntary disclosure by a president, or presidential contenders. Let’s get it all out there. For everyone. That was the rule back in 1924.  The IRS made public the amount of taxes paid by every individual and corporation. I say we reinstitute that rule, which was unfortunately repealed in 1926.

What happens when you disclose everyone’s income and taxes paid publically?

A primary goal of income and tax transparency is to deter tax evasion, especially by powerful people. A secondary goal is to increase the amount of taxes paid. A tertiary goal is that we get to address important issues like wage inequality. 

A paper published in February 2019 by the National Bureau of Economic Research describes Pakistan’s recent experience with tax disclosure.

In Pakistan, the government began in 2012 to publish how much both elected officials and citizens earned in income and paid in taxes.

This has direct relevance to the current United States situation, since the program began as a result of press reports that elected officials had not been paying their taxes. 

What better way to ensure compliance and trust in the system than 100% exposure of all citizens’ income and taxes paid? Sunlight, as they say, is a great disinfectant.

In Pakistan, two free searchable directories are published in PDF form online each year. The first is income earned and taxes paid by all members of Parliament. The second directory has the same tax information on all taxpayers, searchable by name.

One hoped-for effect with this program is to encourage whistleblowers to come forward if they suspect someone, like a political rival or a neighbor, of not paying their fair share of taxes.

As a result of this program, among members of parliament in Pakistan, tax compliance moved from 30% to 90% within the first year of the program – an extremely dramatic jump. I feel like this kind of effect on public officials of tax transparency should be a requirement in a democracy.

For an entire society, individuals would be less likely to attempt illegal tax avoidance, or even plausibly legal but overly aggressive attempts to reduce taxes, if they knew others would be watching. Other taxpayers may enjoy the “bragging rights” afforded by high reported income and high tax compliance, possibly helping bring in additional revenue.

Norway has a strong tradition of tax transparency, dating to the 19th Century. Beginning in 2001, the central government began to publish all taxpayer wages and taxes paid online, searchable by anyone

A Norwegian study from 2014 found that business owners’ reported income increased by 3% on average following the change to total transparency, with a 0.2% bump in taxes collected. Higher reported income leads to higher taxes paid. An equivalent jump in taxes in the US would raise $3.2 billion. The effect is larger on business incomes rather than salaried incomes because of the extra wiggle room that businesses enjoy to report and pay taxes, when compared to W2-type earnings that are independently reported.

Norway_earth_porn
Norway: Earth Porn and Tax Porn! Photo credit : TORE MEEK/AFP/Getty Images)

Pakistan and Norway are not the only countries to experiment with tax transparency. Italy tried it in 2008, posting all tax returns from 2005 online, before taking down the information, following protests.

Greece and New Zealand use public exposure of tax evaders to encourage compliance.

This tax transparency may all sound radical, but we already have a small version of this in the United States. And life goes on. I just mean the fact that I can look up property taxes owed and paid by almost anyone who lives near me through a simple internet search of county records. 

Academic studies do acknowledge some downsides to transparency. Some consider this an invasion of privacy. We could easily imagine some embarrassment or even harassment about one’s level of income. 

Apparently in Norway, the well-known practice of “tax porn” internet searches – looking up people’s income for voyeuristic purposes – actually makes people unhappier in some instances. 

Dilbert_Taxes

As a result, since 2013 in Norway, the subject of a tax search is informed of who is doing the searching. This has led to a drop from 16.5 million searches to 2.15 million searches in the year after implementation of the rule change, all on a population of 5 million.

When I am declared benevolent dictator of this fair land, I will look to institute tax transparency similar to what they have now in Norway and Pakistan – an easy internet search of anyone’s net worth, taxes owed, and taxes paid. A moderate charge for each search would make it a revenue generator for my government’s coffers. The moderate charge would also limit “tax porn” searches and encourage tax compliance.

One additional benefit of this proposed database would be to equalize pay. Efficient markets, including markets for work, depend on the free flow of information. Pay information, however, is often obscured and secret. A 2010 economics paper found that disclosure of income not only mattered to lower-income people, but prompted them to take action, such as look for higher paid work. Under my tax transparency regime, people would have the information to make their arguments for better pay and equality.

Finally, Joel Slemrod, the University of Michigan economist who co-authored both papers on tax transparency in Norway and Pakistan, also published a paper in 2015 with the intriguing title “Sexing Up Tax Administration.” 

Let me know if you need a synopsis of that one in an upcoming post.

Please see related post


Transparency Part I – Legislative Salaries

Transparency Part III – Salaries

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