The driving habits of Americans drew intense public scrutiny during 2008 as the price of gasoline skyrocketed to more than $4 a gallon in many parts of the country. As Americans drove fewer miles, interest in programs to base insurance rates on mileage increased. The media, environmental and consumer groups and think tanks all highlighted the potential societal benefits of this approach. However, from an insurance perspective, mileage-based auto insurance creates challenges, benefits and an opportunity not only to meet consumer demand, but to look at how auto insurance rates are regulated.
According to the U.S. Department of Transportation, Americans drove more than 100 billion fewer miles between November 2007 and October 2008 than during the same period a year earlier. October, the most recent data available, marked the 12th consecutive month where Americans drove fewer miles than the year before. Americans drove 3.5 percent less, or 8.9 billion fewer vehicle miles traveled in October 2008 than October 2007, the sharpest decline of any October since 1971.
Noting that this is the largest continuous decline in American driving in history, U.S. Transportation Secretary Mary E. Peters said the fact that the trend persists even as gas prices are dropping confirms that America's travel habits are fundamentally changing.
While the increased price of fuel played a role, these numbers confirm what many had suspected: The decrease was part of a declining trend in miles driven that dates back several years. A slowing economy, increasing frustration with congestion and the availability of mass transit are all potential contributing factors for the decrease.
Although there is increased interest in mileage-based or “pay-as-you-drive” programs, the concept is not new. Miles driven have long been used as one factor among many in underwriting automobile insurance, dating back to attempts to base premiums on tire tread wear in the 1930s. Although it seems a safe assumption that the more you drive, the higher your risk of getting into an accident, the reality is more complex. Where and how you drive play a much larger role in your chances of getting into an accident.
Various studies by the Brookings Institution and others have shown that accident rates peak between 10,000 and 15,000 miles per year. After that point, accident rates tend to decrease, primarily because people who drive the most have more experience and tend to be better drivers. For example, people who drive 30,000 miles per year are involved in fewer than three collisions per million miles driven, while people who drive less than 8,000 miles per year are involved in seven collisions per million miles driven.
Another study in California found that the risk of collision per mile is almost three times higher in non-freeway traffic, on congested city streets with two-way traffic and no restriction of access. The study also found that high mileage drivers tend to do most of their driving on freeways with limited access, while low-mileage drivers accumulate their miles on more congested streets.
Problems with collection and verification of miles driven have presented a major challenge mileage-based auto insurance products. Self-reporting programs pose the risk of underreporting miles driven, intentionally or not, and verification programs can be expensive and can be affected by fraudulent activities such as odometer tampering. Pricing such a product also is problematic, as it involves a major shift of rating criteria from a “car year” to “car mile” basis. Insurers are reluctant to incorporate any program whose benefits are not clear, and especially without a strong indication that their customers will want it.
That said, a convergence of conditions could have led many companies to conclude that the time may be right to invest in the development of such programs. With the trend toward driving less and a weak economy, drivers are looking for opportunities to save money. Consumers also are increasingly aware of the effect their habits have on the environment, with many more likely to make green choices, whether by participating in recycling programs or driving less.
Perhaps most importantly, technology seems to be catching up to the concept. The increasing computerization of vehicles and the use of cellular and GPS devices have made it possible to track mileage in real time, if not close to it. Of course, technology is not cheap and its application must be developed though pilot programs. There are also privacy concerns. Many auto insurers have established pay-as-you-drive programs or pilots and still more are researching the possibility of doing so.
Mileage-based insurance provides a perfect example of the industry responding to the conditions of the marketplace. With improving technology and increasing consumer interest, companies will move to meet the demand. But there is another formidable potential roadblock to such programs in state insurance laws and regulations. A 2003 Georgia Institute of Technology survey of insurance commissioners found that 16 out of 43 participants did not allow this option. The reasons cited ranged from requirements for 3 years of data to show a direct link between on-road travel and the loss risk, to requirements for an “upfront statement of premium charge,” which might preclude a pay-as-you-drive program.
States that want to encourage mileage-based auto insurance are presented with an opportunity to review their regulatory systems to remove these potential impediments. Better still, adopting a more modernized rate regulatory system like file-and-use, use-and-file or flex band rating would provide insurers more flexibility to develop a per-mile system and adjust their rates promptly to be consistent with the costs. Going beyond mileage-based insurance programs, competitive rating systems encourage insurers to develop innovative coverages and products to meet consumer needs. In this economy, legislators and regulators looking for ways to help their citizens would find regulatory modernization an opportunity to do just that.