Insurance for better driving

A recent study shows that even when roads are of good quality and traffic density moderate, 1 per cent increase in driving can raise accident costs by as much as 3 per cent. This effect is likely to be more intense under Indian conditions where roads are generally of poor quality and congestion high. That is, driving entails huge externalities. The social costs of driving are much more than the private costs to individual drivers. According to the Planning Commission’s estimates, accident costs for the nation are as high as 3 per cent of GDP. Needless to say, accident losses are not the only costs of congestion. The are, for instance, losses caused by prolonged delays and stress leading to road rage.

Mainstream proposals to remedy this situation argue for better, wider roads, strict enforcement of traffic rules, and improved public transport systems. The RSTM committee’s recommendations are also along these lines. No doubt such measures are vital, but they suffer from one critical shortcoming in that they neglect the supply side of the problem. For instance, it is not clear how the construction of more and better roads can keep pace with an ever-accelerating rate of traffic growth — ranging from 7 to 10 per cent per annum for different states.

True, a stricter enforcement of speed limits and other rules — Delhi, for instance, has just made traffic rules stricter — can make roads less risky. Nonetheless, it is unlikely to restrict traffic growth. Since most rules put stress on vigilance, they do not induce people to drive less. Again, the supply side is neglected. The result? Too many vehicles swarm our roads. This has implications for our trade account, as well, given that we import most of our fuel.

It is pertinent to note that an increase in the number of vehicle owners as well as the level of driving by them increases traffic density. However, less driving can be made incentive compatible, even when the number of vehicles goes up. The fuel tax (cess) is a commonly advocated instrument that can help. The RSTM committee too has recommended this tax, though with a somewhat different motivation. In theory, by taxing fuel it is possible to align the private and social costs of driving. One big advantage of this tax is its universal coverage. No (private) individual using a motor vehicle can evade it. Therefore, it can moderate the growth of on-road vehicles. A major drawback of this measure is its political inexpediency. Government is unlikely to take the full advantage of this option. Moreover, this tax is inflationary in nature. It is not surprising that after increasing the cess on petrol and diesel to Rs 2 per litre in 2005-06 budget, the government has been forced to reduce not only the price but also the excise duty on both in 2007-08 budget.

This is where the insurance tax is helpful. This tax will require insurance companies to quote premiums by the number of kilometres done. Current insurance policy takes no effective account of the magnitude of driving. The recent ruling by the IRDA in which it has increased the premium for third-party insurance is a case in point. An across-the-board increase in premiums does not give the right kind of incentives. Kilometre-based insurance premiums can stem individual driving. In addition to reducing traffic congestion, this policy has several advantages. For one, it can take adequate account of the heterogeneity among drivers/vehicles. For instance, it enables insurers to charge higher per-km rates from drivers who have a history of repeated offences; and lower rates from safer drivers. It means that this policy can reduce the driving level of risky drivers more than that of less risky drivers, clearly a desirable outcome. Similarly, by taxing commercial vehicles at a lower rate, this tax can avoid inflationary pressure. Fuel tax cannot make such distinction.

Indeed, an insurance tax can go a long way in reducing congestion and making Indian roads safer.

Singh is reader, Department of Economics, Delhi School of Economics