ANY driver knows that the freedom of the open road can come at a hefty cost. It is not the wheels—car prices have been crawling for years—but the insurance. In Britain, prices have rocketed in recent years. Britons’ weak-necks (there are 480,000 whiplash claims a year, many suspected to be fake) might explain about a quarter of the rise in costs. But other ways that insurers pay out have fallen drastically: vehicle theft fell by more than half in the G7 countries at the end of the 1990s, for instance. The acceleration in the cost of insurance therefore looks suspicious. Britain’s trust-busting watchdog, the Competition Commission, has been investigating, and will report next month. What's going on?

The first thing antitrust economists tend to examine when looking for shortfalls in competition is the structure of the market. That means things like the number of firms competing, and how easy it is for new ones to enter and for customers to switch provider. (Britain’s energy markets and banking score pretty badly here). The odd thing is that on all these measures car insurance competition should be in rude health. The largest ten insurers account for just 64% of the market, the Competition Commission reckons. Barriers to entry are low: new entrants and foreign firms have gained a foothold in recent years. And technology, in the form of price-comparison websites that make price checking and switching easier, help too. The structure looks good. Something else must be going wrong.



The next thing to check is incentives. Lifting the bonnet here reveals a mess. After an accident an “at-fault” driver’s insurer becomes liable—that is, it must pay for car repairs. The problem seems to be that, once liability is agreed, the firms take care of their own customers’ vehicles. The blameless motorist’s insurer is able to organise expensive repair work, knowing that the bill can be sent to the at-fault driver's insurer. This means the firm responsible for paying the bill does not control the costs. The result is predictable: when insurers retain cost control (for example, when a crash involves two drivers insured by the same company) bills tend to run to around £1,200 ($1,940). But when costs are to be passed on to competitors the tab jumps to £1,600. Overall, “overcosting” might add 30% to repair costs. Similar incentive problems, all seemingly stemming from a separation of liability and cost-control, plague hire cars (too many are provided) and vehicle write-offs (values are set too low) as well.



So prices are high because insurers’ costs are steep, meaning that both firms and customers are losing out under the current set-up. That explains why Britain’s insurers are keen for the Competition Commission to order remedial action (normally firms tend to fear antitrust regulators). It looks as if the watchdog is unlikely to recommend “structural” remedies, such as splitting up big firms to raise the number of rivals. Instead it will look for options that improve incentives to keep costs down. One idea is a shift to what insurers call a “first option” model, in which liability and cost-control stay together. Another would be to allow insurers to club together to agree the right prices to pay garages, and the appropriate number of days' car hire to provide (normally competitors agreeing these kinds of things would attract antitrust authorities' suspicion). Whatever the Commission proposes, drivers have room for optimism. The market has a lot of good attributes, including plenty of firms to chose from, price comparisons and switching. It means any sensible remedy has a decent chance of rewinding some of the huge run-up in insurance prices of the past few years.