Drive-by rates: can pay-as-you-drive insurance attract good risks and gain insurers an environmentally responsible image?

Auto insurance companies are constantly looking for ways to build customer loyalty and cut down on customer churn. They also want to attract low-risk drivers. A new insurance concept--"pay-as-you-drive" insurance--is being touted by a variety of public interest groups and policy makers for its potential environmental and social benefits. Perhaps surprisingly, PAYD insurance also might help insurance companies meet some of their own goals.

The concept is relatively simple: under PAYD insurance, the liability and collision portion of an insurance premium is converted from dollars-per-year to cents-per-mile. The only difference is the unit of exposure (one mile instead of one year). The per-mile premium incorporates all of the risk factors embedded in the standard premium, such as driving record, age, gender and location. If advanced tracking technologies such as global positioning satellite technology are used, the premium could be calculated on a cents-per-minute of cents-per-hour basis.

Under traditional auto insurance pricing, drivers pay a fixed rate each year. This rate may include a small discount for low-mileage drivers, but once the premium is paid, the driver cannot accrue any additional savings by driving less. In contrast, PAYD insurance provides an opportunity to save year round, every time one chooses not to get behind the wheel.

Why is the environmental community interested in insurance? Based on drivers' historic responses to increases in transportation costs, economists predict that the price incentive inherent in PAYD insurance would result in a 10% to 20% reduction in annual mileage. From an environmental perspective, this means improved air quality and lower emissions of carbon dioxide, the gas that causes global warming. Likewise, rewarding people for driving less curbs traffic congestion and reduces the need to expand highway capacity.

Insurance companies could benefit by offering PAYD insurance. Early adopters will attract lower-risk drivers and others who like the simplicity and flexibility of the PAYD pricing option. As validated mileage data is correlated with claims, the actuarial accuracy of rates will improve. Companies that offer PAYD will be viewed as customer-oriented, proactive and environmentally responsible. Perhaps most importantly, less driving means fewer crashes and fewer crashes mean lower claims costs.

Roadblocks

But insurance companies face two major hurdles: determining the correct per-mile rate and securing accurate mileage data in a cost-effective way.

According to the Casualty Actuarial Society, increased annual vehicle mileage increases annual cash risk, all else being equal. This common-sense conclusion is confirmed in several studies, including a 1999 analysis by the Victoria Transport Policy Institute. The institute analyzed claims data from the Insurance Corporation of British Columbia and mileage data from emissions checks and found a strong positive relationship between annual vehicle travel and crashes in virtually all categories of driving.

But not all miles are equal, of course. As one example, a person who drives 24,000 miles per year (twice the national average) is not necessarily twice as likely to be in an accident. This is because most of the additional miles logged are probably driven on divided highways where the risk of accident is lower than on congested arterials. Insurance companies rightly seek better data to provide the actuarial underpinnings for setting variable per-mile charges. To accurately reflect the risk per mile, the first several thousand miles driven might cost more on a per-mile basis than the last several thousand miles driven. At this point, insurance companies say setting the right rate is guesswork.

It's a classic example of the chicken and the egg. Insurers need better actuarial data, but can't get it unless they collect verified mileage data and correlate it with claims. This brings us to the second hurdle: collecting mileage data.

One option for collecting mileage data is the low-tech approach. Per-mile premiums could be based on audited odometer readings. By partnering with major national chains such as Jiffy Lube and local governments that perform emissions testing, odometer readings could be electronically transmitted directly to the insurance firm. So far, this concept has not gained traction. Insurance companies see the high-tech version of PAYD insurance as offering greater possibilities for increasing actuarial accuracy.

Been There, Done That

Progressive Corp. was the first to test PAYD insurance with advanced technology. Using its patented global positioning satellite system--Autograph--the company piloted cents-per-minute insurance in Texas in 1998 to 1999. Progressive sought to capture more than miles driven. It recognized that rush-hour and late-night driving are the times that drivers are most likely to crash and Autograph-based premiums reflected these costs. According to press reports, customer satisfaction was high and customer savings averaged 25%. However, Progressive chose to discontinue the pilot, citing the cost of the technology as a major barrier.

Now Norwich Union, the largest insurance company in the United Kingdom, is piloting the concept in London using the technology developed by Progressive. The company had twice as many drivers volunteer to participate in this pilot as needed. Robert Ledger, program director for Norwich Union, attributes this interest to several factors. "Motorists see it [Norwich Union's pay-as-you-drive insurance product] as a fairer way to pay for their insurance," Ledger said. He added, "Consumers are also very interested in the safety and security aspects of this technology, particularly the ability, to trace stolen vehicles and to immediately and accurately locate vehicles at the time of an accident," he said.

Norwich Union is undertaking the pilot to improve the accuracy of its insurance rates. "We want to better understand the risk associated with the usage of a vehicle and therefore be able to price more accurately," said Ledger. He noted that the product will help differentiate the company from its competitors. "Through monthly billing of the customer, we expect to build a stronger, more lasting relationship," he added.

Norwich Union soon may face stiff competition. Carlton Business Systems, another ILK, firm, has announced that it has developed an inexpensive alternative to the Autograph technology and that it has entered into partnership with a U.K. insurance company to offer a trademarked "Insure Per Mile" insurance in 2004.

The Downside

The high-tech method is not without its detractors. Privacy advocates are concerned that the data might be misused. In its defense, GPS technology is not necessarily more intrusive than many technologies that are standard in today's world. Consider bank cards and cell phones: every time you use one, both your location and the time of day are captured. And privacy concerns depend primarily on the technology's configuration. Progressive's Autograph did not bother noting which road the car was on, or in which neighborhood it traveled, but only whether the travel was urban, suburban, or rural, and the time of day.

However it is collected, validated mileage data would benefit more than insurers. Federal and state governments recognize that the gas tax will someday be an obsolete way to collect revenues for building and maintaining the road system. The fairest way to charge for road use is to base the cost on how much the driver uses the system, the simplest metric being miles driven. States such as Oregon and Minnesota are researching ways to implement mileage-based fees. In a decade or two, such fees are likely to replace the gas tax, and synergy between such road-user fees and insurance premiums seems quite possible.

There are now several incentives in place for insurers to offer PAYD insurance. In 2003, Oregon enacted legislation providing a corporate tax credit to companies that offer PAYD insurance. This legislation will reward insurers who voluntarily test the concept. It allows them to establish their own system to collect and verify mileage, and their own rate structure and administrative procedures. The law (Chapter 545 Oregon Laws 2003) provides a tax credit of $100 per eligible vehicle, up to $300 per eligible polio); and is limited to the 2005-2010 tax years.

The U.S. Environmental Protection Agency is developing a recognition program for companies that offer PAYD insurance. This public stamp of approval will be similar to its Energy Star program, where customers can easily discern which consumer products are most energy-efficient. And two not-for-profit environmental advocacy groups, Environmental Defense and the Oregon Environmental Council, have built databases of drivers who want to purchase per-mile auto insurance, together totaling more than 11,000 potential customers.

It's only a matter of time before some enterprising insurance company figures out how to base the unit of exposure on miles or minutes, not calendar years, and benefits financially as a result of reduced claims. That will be good news for the company, for consumers and for the environment.

Christine Hagerbaumer is program director of the Oregon Environmental Council. The Oregon Environmental Council was a major proponent of the Oregon legislation offering auto insurance companies a corporate tax credit for offering pay-as-you-drive premiums.