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Why is auto insurance required?
Of all personal lines of insurance, only your auto insurance is mandatory coverage. In other words, it is required if you drive an automobile on public roads.
Why does the government require you to have auto insurance?
In answering this question, it is helpful to understand the concept of externalities.
An externality is a result of a certain economic activity, either conducted by a person, a business, or the government. Shortened, it is a side effect.
Externalities can be both negative and positive. However, the ones you hear about in the news cane often be negative.
As an example, a nuclear power plant, that is dumping it's reactor cooling water into a nearby stream. The water's warm temperature alters the river’s ecosystem, thus causing all of the fish to die off.
Meanwhile, down the river, Richard, who operates a fly-fishing business, suddenly faces a river without fish. He is now the victim of a negative externality. Richard had no economic investment in the nuclear plant’s activities, nonetheless, he will pay a price.
Now, with a clear understanding of externalities, back to car insurance.
It has to do with the ability of cars to cause damage, either in the form of bodily injury or property damage.
“We force people to buy auto insurance." for the purpose of protecting others says writer and economist Megan McArdle. Drivers can often cause more damage than they can pay for.
In a world without car insurance, driving would carry too much financial risk. Someone could smash into your automobile, send you to the emergency room with a broken spine, and be completely unable to pay for the damage they have caused.
In such a world you would be stuck with the medical bill.
In short, McArdle says that mandatory auto insurance can be defined as “a social arrangement to minimize externalities.”
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