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.