Auto insurance regulations in California are going to change. At first glance, the changes look completely reasonable: Insurers will have to base rates on the driving records of the people insured. From the Daily News:

Moving to end years of wrangling over the “redlining” issue, state Insurance Commissioner John Garamendi said the new regulations will require insurers to look first at a driver’s record – not the community of residence – when determining rates.

This seems like a regulation against burning money. Isn’t it in insurers’ best interest to base premiums on riskiness of the individuals insured? But the economics is far more complex, for at least two reasons.

  • The correlation between actual driving ability and driving record is far from perfect. There are a lot of bad drivers who get lucky and avoid accidents and tickets, and a lot of good drivers who get unlucky and have accidents and tickets. Using information about the riskiness of drivers in your zip code is a good way to compensate.

    Simple example: The typical 16-year-old male has a perfect driving record, but he’s still probably a bad driver. There just hasn’t been time to reveal it. Basing his premiums on his demographics rather than exclusively on his record makes perfect sense.

  • The expected cost of insuring a driver depends on a lot more than his driving ability. It also depends on the driving ability of the people who live near him, the value of their cars, the way the local courts work, and so on. A bad driver who lives in the middle of nowhere is unlikely to get into expensive accidents.

As usual, California regulators play the demagogue. They don’t even bother asking “If this regulation is such a good idea, why aren’t insurers already doing it?” Here’s Commissioner Garamendi: “A good driver, wherever they are in the state of California, ought to have a lower rate than a bad driver, wherever that person is in the state of California.”

If Garamendi were consistent, of course he’d decree that rates in California have to equal the national average. After all, shouldn’t a good driver, wherever he is in the nation, have a lower rate than a bad driver? The average rate in California for 2004 was $2243; why not force it down to $1222, the average premium in North Carolina? I’d like to hear Garamendi’s answer.

Well, actually, I wish I could read his answer on an exam, then give him the F he deserves.