Pay-As-You-Drive Vehicle Insurance
Converting Vehicle Insurance Premiums Into Use-Based Charges
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TDM
Encyclopedia
Victoria Transport Policy Institute
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Updated
September 4, 2007
This chapter describes
Pay-As-You-Drive (PAYD) vehicle insurance and its potential impacts on vehicle
travel and safety. PAYD means that a vehicle’s insurance premiums are
based directly on how much it is driven during the policy term, providing
additional savings when motorists reduce their annual mileage.
Description
Pay-As-You-Drive (PAYD) Vehicle Insurance (also
called Distance-Based Vehicle Insurance, Mileage-Based Insurance,
Per-Mile Premiums and Insurance Variabilization) means that a
vehicle’s insurance premiums are based directly on how much it is driven during
the policy term. The more you drive the more you pay and the less you drive the
more you save. This can be done by changing the unit of exposure (i.e., how
premiums are calculated) from the vehicle-year to the vehicle-mile,
vehicle-kilometer or vehicle-minute. Existing rating factors are incorporated
so higher-risk motorists pay more per unit than lower-risk drivers. For
example, a $375 annual premium becomes 3¢ per mile, and a $1,250 annual premium
becomes 10¢ per mile. An average
Pay-As-You-Drive can be optional, so motorists choose the unit of exposure they want, just as consumers now choose differ rate structures for telephone and Internet service.
Justifications for Pay-As-You-Drive Insurance
Vehicle insurance is a significant portion of total vehicle
costs, averaging about $800 per vehicle-year in the
Pay-As-You-Drive insurance reflects the Market Principle that prices (what consumers pay) should be based on costs (the costs of providing a good or service). Research indicates that within existing price categories, annual claims increase with annual vehicle mileage, as illustrated in Figure 1. Mileage is just one of several factors that affect crash rates. It would not improve actuarial accuracy (i.e., how well premiums reflect insurance costs for a particular vehicle) to use mileage instead of other rating factors, for example, to charge all motorists the same per-mile insurance fee, but accuracy improves significantly if annual mileage is incorporated in addition to existing rating factors. Any other price structure overcharges low-mileage motorists and undercharges high-mileage motorists within a rate class.
Figure 1 Crash
Rates by Annual Vehicle Mileage (Litman, 2001)
Crashes per vehicle tend to increase with annual mileage.
Pay-As-You-Drive pricing can help achieve several public policy goals including fairness, affordability, road safety, consumer savings and choice, and reduced traffic problems. PAYD gives consumers a new way to save money by returning to individual motorists the insurance cost savings that result when they drive less. Motorists who continue their current mileage would be no worse off on average then they are now, while those who reduce their mileage save money. As a result, consumers benefit overall.
It helps reduce traffic congestion, road and parking facility costs, and environmental impacts. It reduces the need for cross-subsidies currently required to provide “affordable” unlimited-mileage coverage to high-risk drivers. It can particularly benefit lower-income communities that currently pay excessive premiums (see discussion by NOW below).
How It Is Implemented
Pay-As-You-Drive pricing is implemented by individual insurance companies, although legal or administrative changes may be needed to remove regulatory barriers. Governments can implement incentives or regulations to encourage insurers to offer Pay-As-You-Drive pricing, and public-private projects can help pilot and promote this pricing option, as described in the case studies section below.
Several methods can be used to calculate and collect premiums. One is to have motorists prepay for the miles they expect to drive during the term of coverage (typically a year), either in a lump sum or in several payments. For example, some motorists might pay for 12,000 miles at the start of the term, while others might pay for just 5,000 miles at first and make additional payments as needed. The total premium is calculated at the end of the term based on recorded mileage. Vehicle owners are credited for unused miles or pay any outstanding balance. Other insurance companies charge for insurance as they do now, but provide a rebate if, at the end of the policy term, a vehicle’s mileage is below certain limits. Another approach is for insurance companies to bill motorists based on their monthly or bi-monthly vehicle mileage, similar to other utilities. This requires more frequent mileage data collection.
Pay-As-You-Drive pricing requires verified mileage data. This can be collected in various ways. The simplest approach is to have brokers or vehicle owners report odometer readings, by email or mail, with random verification spot checks. More sophisticated systems use electronic devices which automatically send mileage data, or even track when and where a vehicle is driven. The cost of automated data collection is declining since most newer cars have odometer data recorded in the engine computer, and many have wireless communication systems or GPS transponders. Two insurance companies use mileage data that is automatically transferred each time a vehicle is refueled. Another approach is to require odometer audits as described below. This could provide data as accurate as other metered goods (such as electricity) at little extra cost.
|
Odometer
Audits Odometer
audits
involve the collection of odometer data by a certified business. An odometer
audit requires five steps: 1.
Check speedometer and instrument cluster for indications of
tampering. 2.
Record tire size and check that it is within the specified range. 3.
Attach a small seal to the ends of mechanical odometer cables to
indicate if it has been removed. This is unnecessary on most newer vehicles
with electronic speedometers. 4.
Check odometer accuracy and calibrate with a dynamometer (this step
is optional, or could be performed on a spot-check basis). 5.
Record odometer reading and forward results to the vehicle licensing
agency. Odometer
audits would be performed when a vehicle’s insurance is renewed, in most
cases once a year. Odometer audits typically require 5 to 10 minutes, and
less if performed with other vehicle servicing (tune ups, emission
inspections, etc.), with an incremental cost of $5 to $10 (assuming chargeout
rates of $60 per hour). Existing vehicle service businesses and emission
inspection stations could be certified as auditors, and some insurance
agencies might offer free audits as a marketing strategy. Auditors could be
certified by a government agency, as with other types of public services, or
by individual insurance companies or insurance professional organizations. There
are concerns that odometer fraud could be a problem, but odometer audits
should provide data as accurate as that used in other common commercial
transactions and more accurate than self-reported information now used for
insurance pricing. Most tampering can be detected during audits and crash
investigations, and fraud would void insurance coverage. Vehicle manufactures
produce increasingly tamper-resistant odometers since leases, warranties and
used-vehicle sales all rely on odometer readings. Audits would provide
additional benefits, including accurate mileage information for used-vehicle
buyers, and more accurate information for transportation planning. Other
systems could be used to measure vehicle use, including special on-board
electronic meters and GPS-Based Pricing, but these add significant costs and
raise privacy issues (Distance-Based Pricing). Several
new technologies being proposed or implemented which could automate some or
all of the data collection processes, including: |
Travel Impacts
Pay-As-You-Drive insurance averages about 6¢ per mile. The table below shows the vehicle travel reductions predicted from mileage-based fees. The Transport Elasticities chapter provides additional information on the travel impacts of various price changes.
Table 1 Travel Reductions Estimates (2001 dollars)
|
Mileage Fee |
Travel Reduction |
|
1¢ |
-1.8% |
|
2¢ |
-3.5% |
|
3¢ |
-5.1% |
|
4¢ |
-6.7% |
|
5¢ |
-8.2% |
|
6¢ |
-9.7% |
|
7¢ |
-11.2% |
|
8¢ |
-12.5% |
|
9¢ |
-13.8% |
|
10¢ |
-15.2% |
(Deakin
and Harvey, 1997, Table B-21, updated to account for 30% inflation from 1991 to
2001)
This indicates that vehicle insurance fees of 6¢ per mile would reduce vehicle travel by 10% or more. Higher-risk motorists would pay larger per-mile premiums and so would have a greater incentive to reduce mileage. Optional Pay-As-You-Drive Insurance is likely to attract 10-30% of policies during it first few years (depending on how it is structured and marketed), with penetration increasing over time as it become more competitive compared with vehicle-year pricing.
Table 2 Travel Impact Summary
|
Travel
Impact |
Rating |
Comments |
|
Reduces total traffic. |
3 |
Provides an incentive to
reduce vehicle use. |
|
Reduces peak period
traffic. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Shifts peak to off-peak
periods. |
0 |
|
|
Shifts automobile travel to
alternative modes. |
3 |
Provides an incentive to
reduce vehicle use. |
|
Improves access, reduces
the need for travel. |
0 |
|
|
Increased ridesharing. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Increased public transit. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Increased cycling. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Increased walking. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Increased Telework. |
2 |
Provides an incentive to
reduce vehicle use. |
|
Reduced freight traffic. |
0 |
Would not generally apply
to freight vehicles. |
Rating from 3 (very beneficial) to –3 (very harmful). A 0 indicates no impact or mixed impacts.
Benefits and Costs
Pay-As-You-Drive Insurance can provide the following benefits (Edlin, 1999; Litman, 2001; Parry, 2004; Greenberg, 2007):
· Consumer savings. The average motorist is predicted to save $50-100 per vehicle. These savings represent the reductions in insurance compensation costs that are returned to individual motorists who reduce their driving, and therefore reduce their chance of having a crash. These are true cost savings, not just economic transfers.
· Economic Efficiency. Pay-As-You-Drive Insurance conveys to drivers the true costs they impose and allows motorists a chance to save money by reducing these costs. It reflects the principle that prices should reflect costs.
· Increased fairness. Current insurance pricing overcharges motorists who drive less than average and undercharge those who drive more than average each year in a price category.
· Progressive With Respect To Income. Since lower-income motorists tend to drive less than average, current insurance pricing is regressive. It forces lower-income motorists on average to subsidize the insurance costs of higher-income motorists. Butler (2000) argues that current insurance pricing results in extremely high premiums in lower-income areas (since a greater portion of low-mileage motorists drive uninsured which reduces funds to cross-subsidize higher-mileage motorists), a problem that can be corrected by PAYD pricing.
· Increased affordability. Pay-As-You-Drive pricing vehicle insurance more affordable (Litman, 2004). It allows more lower-income households to insure a vehicle, and makes it more cost effective for households of any income class to insure an extra vehicle that is seldom driven, such as an old truck used for errands or a recreational vehicle.
· Reduced Uninsured Driving. In some jurisdictions, a significant portion of vehicles is uninsured because of high premium costs, and because owners do not consider it cost effective to insure a low annual mileage vehicle. PAYD pricing makes insurance more affordable, which can help reduce this problem.
· Reduced Need for Cross-Subsidies. Pay-As-You-Drive pricing reduces the need to overcharge low-risk drivers in order to provide “affordable” unlimited-mileage insurance coverage to higher-risk motorists.
· Reduced vehicle travel. Pay-As-You-Drive Insurance is predicted to reduce vehicle travel by more than 10%, making this one of the most effective TDM strategies currently proposed. As a result it reduces:
o Traffic crashes.
o Traffic congestion.
o Road and parking facility costs.
o Energy consumption and pollution emissions.
o Consumer costs.
o Urban sprawl.
·
Increased safety. Vehicle crashes should
decline even more than mileage (a 10% mileage reduction is predicted to reduce
crashes by 12-15%) because higher-risk motorists (who currently pay high
premiums per vehicle-year) would pay higher per-mile fees, and would therefore
have the greatest incentive to reduce their driving. If implemented at
throughout the
Pay-As-You-Drive Insurance can provide significant Congestion and Emission reduction
benefits. Table 3 summarizes the results of a comprehensive traffic modeling exercise
which indicates, for example, that a 2¢ per mile vehicle fee in the
Table 3 Impacts
of 2¢ Per Mile Fee, Year 2010 (Harvey and Deakin, 1997, Table B.9)
|
Region |
VMT |
Trips |
Delay |
Fuel |
ROG |
|
Bay Area |
-3.9% |
-3.7% |
-9.0% |
-4.1% |
-3.8% |
|
|
-4.4% |
-4.1% |
-7.5% |
-4.4% |
-4.3% |
|
|
-4.2% |
-4.0% |
-8.5% |
-4.2% |
-4.1% |
|
|
-4.3% |
-4.1% |
-10.5% |
-5.2% |
-4.2% |
VMT = change in total vehicle
mileage. Trips = change in total vehicle trips. Delay = change in congestion
delay. Fuel = change in fuel consumption. ROG = a criteria air pollutant.
Revenue = annual revenue in millions of 1991 U.S. dollars. See original report
for additional notes.
Costs include transition costs to insurance companies and vehicle registration agencies of implementing a new pricing system, and the costs of “odometer audits,” which are estimated to have incremental costs averaging $5-10 per vehicle year.
Table 4 Benefit Summary
|
Objective |
Rating |
Comments |
|
Congestion Reduction |
2 |
Reduces total automobile
travel. |
|
Road & Parking Savings |
3 |
Reduces total automobile
travel. |
|
Consumer Savings |
3 |
Provides consumer savings. |
|
Transport Choice |
3 |
Improves automobile
affordability. |
|
Road Safety |
3 |
Reduces automobile travel. |
|
Environmental Protection |
3 |
Reduces automobile travel. |
|
Efficient Land Use |
3 |
Reduces automobile travel,
particularly benefits urban residents. |
|
Community Livability |
2 |
Reduces automobile travel. |
Rating from 3 (very beneficial) to –3 (very harmful). A 0 indicates no impact or mixed impacts.
Equity Impacts
Current vehicle insurance pricing significantly overcharges motorists who drive their vehicles less than average each year, and undercharges those who drive more than average within each price class (Edlin, 1999; Litman, 2001). Since lower-income motorists drive their vehicles significantly less on average than higher-income motorists, this is regressive. Distance-based insurance is fairer than current pricing because prices more accurately reflect insurance costs.
Distance-based pricing benefits lower-income drivers who otherwise might be unable to afford vehicle insurance, and who place a high value on the opportunity to save money by reducing vehicle mileage. It benefits lower income communities that currently have unaffordably high insurance rates, as described below. Distance-based insurance would provide significant savings to workers during periods of unemployment, when they no longer need to commute.
Figure 2 Current and Per-Mile Premiums Annual Costs Compared
This figure compares the costs of Usage-Based Premiums for Low, Average and High mileage vehicles. “Current” refers to vehicles with fixed-price insurance. “Same Mileage” refers to vehicles with Usage-Based Premiums that do not reduce annual mileage. “Reduced Mileage” assumes a 10% reduction.
Figure 2 illustrates the financial impacts of Pay-As-You-Drive pricing on different types of motorists. A low-cost, low-mile vehicle such as might be owned by a low-income motorist saves $225, an 8.4% reduction in total vehicle expenses. An average motorist saves $64 annually in insurance costs if vehicle travel declines 10% as expected. A high-mileage motorist pays $331 more per year, a 4.7% increase in total vehicle expenses.
Some people raise concerns that particular groups (such as rural residents) will be disadvantaged by distance-based price structure. This is not true of Pay-As-You-Drive pricing that is based on the average mileage of each rate class, as described here. Under such a system, only rural residents who drive more than average among rural residents would pay more, and about half of all rural residents would pay less. For example, if rural vehicles are driven an average of 18,000 miles a year, a rural motorist who drives their car “only” 15,000 miles annually would save money.
Table 5 Equity Summary
|
Criteria |
Rating |
Comments |
|
Treats everybody equally. |
2 |
Most groups benefit,
although some more than others. |
|
Individuals bear the costs
they impose. |
3 |
Makes insurance pricing
more actuarially accurate. |
|
Progressive with respect to
income. |
3 |
Provides savings to
lower-income motorists. |
|
Benefits transportation
disadvantaged. |
3 |
Makes automobile ownership
more affordable. |
|
Improves basic mobility. |
3 |
Makes automobile ownership
more affordable. |
Rating from 3 (very
beneficial) to –3 (very harmful). A 0 indicates no impact or mixed impacts.
Applications
Pay-As-You-Drive Insurance is suitable for implementation in any geographic region, and is particularly appropriate where insurance affordability, uninsured driving, traffic congestion, crashes or pollution are considered significant problems. It is implemented by individual insurance companies. Federal, state or provincial governments can require it or provide incentives to encourage it.
Table 6 Application Summary
|
Geographic |
Rating |
Organization |
Rating |
|
Large urban region. |
3 |
Federal government. |
1 |
|
High-density, urban. |
3 |
State/provincial
government. |
3 |
|
Medium-density,
urban/suburban. |
3 |
Regional government. |
1 |
|
Town. |
3 |
Municipal/local government. |