Pay-As-You-Drive Insurance as a Tool For Conservation?

Over the weekend, the New York Times Magazine carried a Freakonomics article which looked at mileage-based auto insurance rating as a tool to promote energy conservation:

While economists may argue that gas is poorly priced, that imbalance can’t compare with how poorly insurance is priced. Imagine that Arthur and Zelda live in the same city and occupy the same insurance risk pool but that Arthur drives 30,000 miles a year while Zelda drives just 3,000. Under the current system, Zelda probably pays the same amount for insurance as Arthur.

While some insurance companies do offer a small discount for driving less — usually based on self-reporting, which has an obvious shortcoming — U.S. auto insurance is generally an all-you-can-eat affair. Which means that the 27,000 more miles than Zelda that Arthur drives don’t cost him a penny, even as each mile produces externalities for everyone. It also means that low-mileage drivers like Zelda subsidize high-mileage drivers like Arthur.[...]

Edlin and a few others, including Jason Bordoff and Pascal Noel at the Brookings Institution, have since done such research. It makes a compelling case that PAYD insurance would work well, reducing the carbon emissions, congestion and accident risk created by too much driving while leading drivers to pay the true cost of their mileage. Bordoff and Noel put the total social benefit at $52 billion a year.

PAYD insurance is no longer just an academic exercise. G.M.A.C. has begun using OnStar technology to offer mileage discounts, and next month Progressive will roll out a comprehensive PAYD plan called MyRate. Progressive, the huge Ohio-based insurer that has long prided itself as an innovator, will first offer the plan in six states, having run a similar pilot in three other states. Drivers who sign up for MyRate will install a small wireless device in their cars that transmits to Progressive not just how many miles they drive but also when those miles are driven and, to some extent, how they are driven: the device measures the car’s speed every second, from which Progressive can derive acceleration and braking behavior. Which means that Progressive will not only be able to charge drivers for the actual miles they consume but will also better assess the true risk of each driver.

It is an excellent article, not only catching the reason for the delays in implementation, but also catching one of the hidden consequences of Progressive’s program—that participation is voluntary, which will tend to mean that low-mileage drivers will participate, which, if the program reaches critical mass, means that the non-participating group should see rate inflation due to the group’s higher risk…or which will encourage adverse selection on competing insurers, by “encouraging” these higher risk customers to go elsewhere.

I love the idea of rating based on GPS data…especially when the measuring device (like Progressive’s) includes other meters measuring acceleration and g-force, providing additional data about how well the insured drives. With data like that, personal auto insurers could move away from…or at least deemphasize… more controversial rating variables, like credit, age, and (to a lesser extent) geography.

However, there are a few gotchas that I don’t think the article’s authors have fully contemplated:

• I am lead to believe that the technology and rating algorithms are currently patented. While some creativity can find ways around that, the threat of a big, ugly patent suit…or the need to pay a licensing fee to a tough competitor…is likely to discourage rapid adoption of the technology throughout the market.
   
• Progressive is phenomenal when it comes to slicing and dicing data. While there are a few other carriers with the talent, technology, and corporate philosophy to fully capitalize on such new information, small, mid-sized and even a few large carriers may not be nimble enough to use such data on their own…if they can even collect enough data to model off of (a potential problem for small insurers).
   
• I have to question whether some state regulatory agencies are ready to cope with such newfangled developments. While there are many great folks working at state DOIs, certain departments can be challenging, either due to the local political climate, or due to concerns inherent with new things. Heck, Massachusetts has only recently moved into the late 1980’s when it comes to auto insurance rating!
   
• Some consumer advocates tend to be extremely vocal about the nature of auto insurance costs. Specifically, the unfortunate tendency for the folks with the least disposable income being over-represented in the more expensive ends of different rating/underwriting variables. In most states, after all, auto insurance is mandatory, and folks generally believe that driving a car is a requirement for routine existence in much of the country.
   
  I could be mistaken, but my gut tells me that PAYD rating probably wouldn’t help, and might actually aggravate that phenomenon. Think about fewer cars per family leading to increased utilization; the increased likelihood of a disadvantaged insured working more than one job, or working at odd hours. And so forth.
   
• Whenever someone starts talking about insurance rating as a social tool, I start to get uncomfortable, as such interpretations invariably suggest infringing on the efficiency of the free market. There are plenty of free-market reasons to get excited about pay-as-you-drive. However, if society starts imposing inefficient requirements or constraints…you end up with a mess that privately-owned businesses really shouldn’t be underwriting.
   
• Having said that, the idea of using insurance rates rather than higher gas prices to incent average Americans to conserve is still very intriguing to me. However, I wonder if insurance rates are a less psychologically-effective tool than gas prices.
   
  After all, under a pay-as-you-drive system, you’re likely to see a bill once a month, reflecting your past driving behavior. Otherwise, you’re unlikely to be reminded that driving less, and driving efficiently saves you money.
   
  Gas prices, on the other hand, can be rather effective at jarring drivers into awareness. At least, it’s effective for me. Every time I drive past a gas price sign showing prices creeping closer to $4/gallon, I’m reminded that I really want to conserve to the greatest extent possible.