Pricing railway safety

Yet another railway accident has happened. As someone on twitter pointed out,

Another train accident.23 dead. So what ? Ex-gratia will be announced, netas will go on accident tourism. Three days later all forget!

— Prashanth Bhat (@prashanthbhat) December 28, 2013

The problem with the Indian Railways is that there is no real measure of safety. How do we know how much safer the trains and tracks are compared to last year? Given the way the Railway finances are put out currently, there is no way to figure this out. Without the railways putting out more disclosures, is there a way to put a number on how safe the Indian Railways are? In other words, is there a way to “price” railway safety?

As you are well aware, and as the above tweet points out, it is standard practice in Indian Railway accidents for the Railway Minister to announce an ex-gratia payment to the families of the dead and the injured in case of any accident. I’m not sure if there is a formula to this but one cannot rule out the arbitrariness of this amount. As I had pointed out in an earlier post on RQ, accident compensation needs to be predictable and automatic. Can we use this to price railway safety?

First of all, we need to point out that the railways follows a cash accounting system, and thus doesn’t need to account for any contingent liabilities such as ex-gratia payment (last weekend I sat through an awesome lecture by Prof. Mukul Asher (councillor to Takshashila) on public finances, and he pointed this out). Hence, it would be prudent on behalf of the Indian Railways to hedge out this contingent liability.

How do you hedge a contingent liability? By buying insurance! What the Indian Railways needs to do is to buy group accident insurance – all the ex-gratia payments will then by paid out by the insurance company, and the railways will only pay a premium to these companies, thus hedging out the risk! And this process will help put a price on railway safety!

How is that? Let us say that given the railways’ bad record in safety, and its continued promises that safety will be improved each year, the railways decides to take up group accident insurance on an annual basis. Let us say that there is a competitive bidding process among general insurers in India (both public and private sector) to provide this insurance (railways is a large organization, and insuring them will be a matter of prestige, so companies will bid for it). The premium as determined by this competitive bidding process is the price of railway safety!

We can do better – instead of buying one overall policy, the Railways can think of insuring different routes separately, or perhaps zones. This will help put a price on the safety of each route or zone! There will be some transaction cost, of course, but price discovery will happen, and we will be able to put a price on risk!

But then, this is all wishful thinking. It is unlikely this will happen because:

1. Given the cash accounting system followed by the railways, there is no incentive to hedge contingent liabilities
2. Buying insurance means increasing scrutiny. The railways will not want to be scrutinized too hard. It is currently an opaque organization and it will want to be that way.
3. Given the railways are wholly government owned and there are government owned general insurers, there might be some collusion which might  result in underpricing the risk.
And so forth…

Nevertheless, the point of this post is that it is possible to put a price on safety!