Usage Based Insurance – Big Brother Just Might Be Your Friend

A 2011 Towers Watson white paper, “The brink of a revolution – Usage based insurance promises profound change”, laid out a vision for auto insurance that the authors reported is fast becoming reality http://www.towerswatson.com/assets/pdf/4583/1104_Towers_Watson.pdf. Usage based insurance (UBI), sometimes called pay-as-you-drive (PAYD), is simple in concept but somewhat more complex to deliver. The basic idea is that drivers’ insurance premiums should be calculated based on their actual driving behaviour, rather than by relying exclusively on proxies such as age, gender or number of years licensed, or self-reported data such as annual distance driven. The trick is being able to reliably gather sufficient, meaningful data on each insured driver to allow usage based pricing.

After something like a decade of experimentation by insurers and technology companies around the globe, the means to gather the data is both robust and inexpensive enough to support large-scale deployment of UBI. According to Towers Watson, insurance companies representing more than 60% of the U.S. market now have, or are in the process of developing, UBI programs. The telematics technology employed to deliver PAYD uses sophisticated electronics to measure speed, time of travel and length of journey, rate of acceleration/deceleration, cornering force and, in some instances, vehicle location. These data are acquired in real time as the vehicle is driven, and then transferred wirelessly at journey’s end to the insurers for storage and subsequent analysis.

Many telematics devices are designed for easy installation, often by the vehicle’s owner, into the onboard diagnostics port that became standard on virtually every vehicle manufactured and sold in North America about fifteen years ago, and in Europe about a decade ago. Some more complex systems require installation by qualified technicians, but this is less and less the case as ongoing development has succeeded in squeezing more and more functionality into the cheaper plug-in devices. Perhaps more importantly, vehicle manufacturers and original equipment suppliers have been hard at work on telematics hardware and software to support a variety of needs, and the day is probably not far off when the capability to support UBI will be either built into or available as an option on all new vehicles.

Insurers have long known that the more you drive the higher the probability that you will one day be involved in an accident. Similarly, they know that driving at certain times of the day, or days of the week, carries greater risk of accident than driving at other times. Consider, for example, how different the experience of driving early on Sunday morning is when compared with driving in rush hour on any weekday. With UBI, insurers can clearly identify those drivers who rarely drive in weekday rush hours or late at night on weekends (another high-risk time) and who also drive just a few thousand kilometers annually. With conventional insurance products, the premiums paid by these drivers differ little from those paid by their neighbours who commute daily in rush hour and then pile on the kilometers driving to the cottage every summer weekend. Using UBI, insurers can offer substantial discounts to demonstrated lower risk drivers. The flip side is that higher risk drivers will have to shoulder heavier premiums; ultimately, a fairer model than what we have today.

So why hasn’t this happened already? The principal factors have been cost and a lack of real-world data to convince insurers they should add UBI to their range of products. Momentum is gathering, however, as costs decline and other factors come into play. One of the ancillary benefits of UBI is that it makes people more aware of their vehicle usage, and in an age where emissions and resource use are of increasing concern this is seen as a positive. UBI is also thought to have the potential to positively influence people’s driving behaviour. For example, if a driver understands that excessive speeding will impact their insurance premium they may be inclined to ease up – a safer practice but also good for the environment and fuel consumption.

The main opposition to UBI has focused on its potential impact on personal privacy, its ‘Big Brother’ aspect. For this reason, many insurers have consciously decided not to incorporate GPS functionality into the telematics devices they use. Although where you drive may be an important risk factor, gathering location data is regarded by many as too invasive. Most responsible drivers who don’t drive a lot will likely be quite happy to share their other driving data in exchange for a double-digit percentage reduction in their insurance premium. That’s what the pioneering UBI providers have been discovering. Most regulatory bodies too, are comfortable with, or even openly supportive of the UBI model and see it as a means for providing much needed premium relief to responsible drivers.

In the U.S., the telecom companies have begun to recognize UBI as a potential new revenue source. Sprint’s Emerging Solutions group recently announced that it is capable of providing end-to-end solutions for insurers wanting to get into the game. http://www.youtube.com/watch?v=JSNJkeKwS08&feature=player_embedded Sprint can look after shipping, installing and connecting devices to its network and can then deliver the collected data either directly to an insurance company or via a cloud-based platform. Sprint further claims that it can implement a pilot program of up to fifty vehicles in thirty days or less. Insurers can also buy off-the-shelf analytics to facilitate building a UBI pricing model or utilize their own in-house actuarial expertise. Allstate, which has a UBI product, believes that PAYD will have about 20% of the U.S. market in five years’ time. http://online.wsj.com/article/SB10001424052702303901504577462382411135766.html

Ready to buy? Well, you’ll likely have to wait a bit if you live in Canada. To date, only one insurer, Aviva Canada, has offered UBI to its customers and only on a trial basis, having pulled the plug on its program in 2011. Chances are, other companies may be looking at offering a PAYD product but Canada’s insurance industry is probably better known for stifling over-regulation rather than for being a hotbed of customer-centric innovation. As in other arenas, we won’t be pulling the bandwagon but we’ll probably hop on when the parade is well under way.

Why environmentalists and policymakers should read auto mags

I’m not sure what environmentalists and policymakers read in their spare time but I’d like to suggest they could do worse than read the odd car magazine. I’ve been reading them for years and have found them to be a window into emerging social trends, technologies and how government and industry can work together to improve the lives of ordinary citizens. For example, I first heard about cell phone technology in Road & Track. Other auto publications have helped expand my knowledge of recycling, energy use and pollution control – and all while being entertained.

The auto industry is often vilified by people who are passionate about living in a more environmentally and socially responsible way. For some, the car is a symbol of everything that is wrong with our modern industrial culture. There is no denying that private vehicles, for all the economic, convenience, and other benefits they provide, also impose a significant burden on the planet’s finite resources. And car accidents claim lives or leave people permanently injured, serious social and economic costs. Still, though, the car genie is long out of the bottle and won’t be put back soon, or easily, so we really have to be clever about how we live with the genie now and in the future.

The car was born of ingenuity, coincident technological developments and entrepreneurial spirit. The industry’s early and rapid growth and its ascension to a place of prominence in our modern economy bear testimony to the power of capitalism and free markets. Automobiles directly or indirectly transformed everything, from the physical landscape to how we live, work and play. Over time, and as vehicle ownership and use became pervasive, some of the negative aspects, e.g., tailpipe emissions or safety concerns, became more and more apparent and less and less tolerable.

Even if you view the car as a problem and an impediment to realizing a safer, greener world, there are valuable lessons to be learned from our now century-plus relationship with it. Over the past 40-50 years, the industry and its products have been transformed. This was achieved by identifying specific targets and then enacting regulations that forced automakers to respond. For example, tailpipe emissions of various gases and particulates have been dramatically reduced in response to California-led legislation that over the years established ever more stringent standards.  The smog over Los Angeles and other major urban centres – a visible manifestation of auto use – was the catalyst for massive, positive change. The US Environmental Protection Agency reports “…emissions from a new car purchased today are well over 90 percent cleaner than a new vehicle purchased in 1970.” Even with more vehicles on the road, the total environmental burden for specific emissions is lower. http://www.epa.gov/airquality/peg_caa/carstrucks.html

Great strides have also been made in recycling vehicles that have reached the end of their useful life. In 2000, the European Union issued a vehicle end of life directive and there have been many other initiatives on the part of governments and automakers globally aimed at reducing the volume of material that goes to landfill. Today, attention is paid to this issue from the design stage forward.

Similarly, highway death tolls and other safety concerns prompted the introduction of regulated standards so that modern automobiles are far more crash-worthy than their predecessors (check out this crash between a ’59 Chevy Bel Air and an ’09 Chevy Malibu staged by the Insurance Institute for Highway Safety http://www.iihs.org/50th/default.html. In addition to all of the “passive” safety features, e.g., collapsible steering column, seat belts, deformable structures and air bags found in modern vehicles, there are also “active” safety systems such as anti-lock brakes and electronic stability control which improve drivers’ chances of avoiding collisions in the first place.

Currently, automakers are focusing considerable attention on fuel economy. The US (Canada is following) is ramping up its fuel economy standards dramatically as a means for reducing greenhouse gas (GHG) emissions. The objective is straightforward – reduced fuel use and, therefore, lower carbon emissions – even if the solution is not.  Automakers are working on combustion technology, aerodynamics, new weight-saving materials and construction techniques, and other technologies to meet the regulatory requirements. They’re even building electric vehicles. The market will also play its role in shaping the final solution(s).

This approach differs in a very important way from other approaches such as the hotly debated idea of a carbon tax. People may or may not respond as hoped depending on their willingness and ability to shift consumption away from other goods so as to maintain their same level of energy consumption. A carbon tax is a blunt instrument that will potentially impose hardship on those who can least afford it. The objective of a tax is to raise money; taxes have generally been ineffective instruments for achieving other policy objectives. Governments are notorious for collecting revenues for a specific purpose and then redirecting the funds toward unrelated objectives.

Governments also founder when they attempt to pick solutions rather than set targets and regulate industry participants. In a number of jurisdictions globally, in an effort to reduce GHG emissions associated with electricity generation, governments picked wind and solar power as the solution. They have then have imposed taxpayer-funded subsidies to try and make their solution work, distorting the market in the process while also harming their domestic economies. In many cases, they simply shift emissions to a neighbouring country from which they buy power to make up for generation shortfalls.

Cars continue to play an important role in our everyday lives and in the global economy. That is why environmentalists and policymakers should read car magazines. They might then understand how regulated targets and market responses can, and do, deliver meaningful, positive outcomes. They would get some reasonable insight into the massive progress automakers have made toward making their products more socially and environmentally responsible and how that could be effected in other industries. They might also understand how consumers are willing to play along or even advocate for change when they have access to information about the intent and results of the process.