Pay As You Drive (PAYD). Business Model For Insurers That Is Low Data Intensive

What is Pay As You Drive (PAYD)?

Pay-As-You-Drive (also called Distance-Based, Mileage-Based, Per-Mile, Usage-Based, and Cent-Per-Mile) pricing means that a vehicle’s insurance premiums are based directly on how much it is driven during the policy term. This is done by changing the unit of exposure from the vehicle-year to the vehicle-mile, or vehicle minute. Other rating factors are incorporated so lower-risk motorists pay less, and higher-risk motorists pay more per unit of travel. PAYD can be proposed as a consumer option, so motorists could choose between current insurance pricing or PAYD.

By virtually any definition, PAYD increases equity. It makes premiums
more accurately reflect the claim costs of an individual motorist. It
provides significant affordability benefits and financial savings to lower income motorists. And most importantly it reduces the weight placed on rating factors considered inequitable, such as gender, age, and territory, and increases the weight applied to a factor that motorists can control.

PAYD is a significant change from current practices. Many insurers use annual vehicle mileage or a surrogate such as commute distance as a rating factor, but most have a small number of categories and place relatively little weight on this factor. As a result, premium payers perceive little financial savings from marginal reductions in mileage and does not get much traction from consumers.

Mileage as a Risk Factor

Insurance actuaries have long recognised that mileage is a significant risk factor. Annual crash rates can be considered the product of two factors: per-mile crash risk multiplied by annual mileage. Changing either factor changes annual crash rates. Research by Edlin (1999) finds empirically that changes in total vehicle mileage do produce proportionately greater changes in total crash costs. He analysed U.S. state-level mileage and insurance cost data, which indicates that the elasticity of insurance costs with respect to mileage is between 1.42 and 1.85, meaning that a 10% reduction in total vehicle mileage reduces total crash costs, insurance claims, and casualties by 14% to 18%.

Of course, a high-risk driver may crash every 50,000 miles, while a lower risk driver may crash every 500,000 miles, but in either case reducing annual mileage reduces annual crash rates. Even drivers who never violate traffic rules face risks beyond their control — an animal running into the roadway, catastrophic mechanical failure, a sudden medical problem and most drivers take minor risks that have small but real chances of contributing to a crash.

The relationship between mileage and crashes is not linear.

According to other research, drivers that drop in the range of the 25–30 thousand annual mile range drive 6 times as much as those in the <5 thousand mile range, but only have about 2.4 times as many crashes. There are various reasons for this:

• Urban drivers tend to have higher crash rates and lower annual mileage.
• Drivers who are higher-risk due to age or disability tend to drive lower annual mileage, while high-mileage drivers are likely to be relatively capable drivers.
• Newer, mechanically safer vehicles tend to be driven more annual miles than older vehicles.
• High drivers motorists do a greater share of driving on safer, grade separated highways.

Affordability

PAYD redefines insurance affordability to mean that drivers must limit their crash exposure to what they can afford. This is how affordability is defined for most consumer goods. For example, households limit their electrical use, long-distance telephone calls and clothing purchases to what their budget allows. PAYD achieves affordability by reducing accidents and total crash costs, rather than simply shifting costs. It results in true resource cost savings, not economic transfers. This is inherently better for society.
PAYD pricing tends to be progressive with respect to income. It benefits lower-income motorists directly as a group, since they tend to drive their vehicles less than average. In addition, lowerincome drivers tend to place a high value on opportunities to save money, so would probably reduce their per-vehicle mileage significantly if offered PAYD pricing.

Fairness

Drivers who are similar in claims and individual characteristics pay nearly the same premiums if they drive five thousand or fifty thousand miles a year. Research indicates that annual crash rates and claim costs tend to increase with annual vehicle mileage. This pricing system is inequitable because low-mileage drivers subsidize insurance costs for high-mileage drivers, and low-income people drive fewer miles on average.

Serious consequences during COVID-19

When majority of drivers had to stop commuting due to covid-19 restrictions all over the place that affected drivers income. Insurers not being able to collect their customers information about their driving activities, still charged drivers as if they were driving on the streets though the vehicles were safely parked. This came with a huge wave of unhappy drivers and this got reflected in the media. 2020 showed that auto insurance pricing models are outdated and not really fits current society trends.

Pricing modeling

Although PAYD insurance has long been advocated by transportation planners, little attention has been given to the precise design of a distance-based pricing system.

There are several possible ways for insurers to collect PAYD premiums:
• Premiums can be paid as they are now, with discounts offered at the end of the policy term for mileage below a reference value, such as a 15,000 annual mileage.
• Drivers can be required to prepay for insured miles, either in a lump sum or in several payments. For example, some drivers might pay for 12,000 miles at the start of the term, while others might first purchase 5,000 miles 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.
• Insurers can bill drivers based on their monthly vehicle mileage, as with other utilities.

Pay-As-You-Drive pricing requires credible mileage data. The simplest method is for vehicle owners or brokers to report odometer readings with a verified technology i.e. smartphone based solution that prevents fraud and ensures smooth user experience.

Who in the US is providing PAYD insurance?

Many major auto insurers in the USA are pushing new PAYD products to the market like on the list below.

Allstate — Milewise®
Liberty Mutual — ByMile™
Nationwide — SmartMiles®
Esurance — Pay Per Mile™
Metromile
Mile Auto

Yet, this still is the dawn of the driving data informed insurance pricing.

Use case

Here we are giving an imagined modelling how insurance carrier could inject PAYD without much technological and business effort.

Adjusting miles driven to premiums. Per-mile premiums are calculated by dividing current premiums by the current policy’s maximum annual miles, which is typically 20,000, so a motorist who currently pays $500 for up to 20,000 miles would pay $0.025.

Participants pay an “advance premium,” which is 90% of their current premiums, so those who currently pay $500s under this system pay an advance premium of $450. At the end of the policy term the motorist receives a rebate of up to 50% of their premium for lower mileage (in this case, a rebate up to $250 if they drive less than 10,000 miles), or their premiums can increase up to 50% if they drive more than the current maximum (in this case, they could pay up to $750 if they drive 30,000 miles during the policy year). If this motorist drives 20,000 miles they pay an extra €50 at the end of the term, so their total premium is the same as with a standard policy.

In the following years the advance premium is calculated based on the number of miles actually driven the previous year. Mileage is calculated using odometer readings.

Technology

At Stemic Drive we are developing computer vision based technology that allows through user smartphone camera capture odometer showings in any time interval needed. The image data is being transformed to miles and loaded to insurer CRM system where a consistent driver file is being developed. Stemic Drive risk and pricing engine recalculates the pricing after every premium contract closure moment and gives accurate information to insurer on how the pricing plan to be adjusted.

Conclusion

PAYD implemented using odometer audits to collect credible mileage data, PAYD has minimal incremental costs. Although there are some legitimate concerns about PAYD, virtually all can be addressed with a sufficient program design. When first implemented, PAYD may introduce uncertainty that could expose insurance companies to financial risks, but these can be managed by first implementing small pilot projects. After a few years there should be no greater financial risk than with vehicle-year pricing.

About Stemic Drive

Stemic Drive is a next-generation usage-based insurance (UBI) technology platform. We manage the full life cycle of data. From acquisition to transformation to analytics to insights for predictive insurance dynamic pricing. We are providing a risk score for the driver and fleet that can convert to a dynamic pricing strategy for the insurance carriers. We work with insurance companies that want to leap in UBI for their clients. We provide all the toolset and platform to run UBI business smoothly. Visit www.stemicdrive.com