In the traditional auto insurance contract the premium depends on a number of variables basically describing the characteristics of the driver and the vehicle (such as the age, driving experience, type of the car, among others). Nevertheless, the use of the car, which can be easily measured by the number of annual kilometers, is ignored even though it is clearly associated with the exposure to the risk of accident. This article presents a review on the most relevant contributions about Pay as you drive Insurance (PAYD).
Drive insurance
The Pay as you drive Car Insurance is a concept of contract which takes into account the use of the car in order to calculate the premium. In this way, the premiums are more personalized, as those who use less the car are going to pay less than those who do more kilometers during the year. Other variables describing the use of the can be considered as well, such as the speed, type of road or part of the day when the car is most frequently used by the driver.
The insurance companies around the world offer this product, especially to young drivers with four types of claims:
The effect of the number of kilometers driven in the risk of these types of claims is analyzed by the relationship between the number of kilometers driven by the insured per year and the number of reported claims.
- Property damages and at-fault insured driver
- Property damages and not-at-fault insured driver
- Bodily injuries and at-fault insured driver
- Bodily injuries and not-at-fault insured driver
The effect of the number of kilometers driven in the risk of these types of claims is analyzed by the relationship between the number of kilometers driven by the insured per year and the number of reported claims.
Insurance pricing
Actually, the relationship between the distance run by a vehicle and its influence on the risk of accident has been discussed by many authors. Some of them consider that this relationship is proportional (Bordoff and Noel, 2008) while others argue that it is not proportional (Langford et al., 2008 and Litman, 2005). According to Litman (2005) those drivers who use more the car have fewer accidents per unit of distance (kilometer) than those who use less the car. The main reasons are:
- Those who use more the car have more driving skills than those who are less used to drive.
- Those with more annual kilometers normally use highways (and other safer roads) more than those who use less the car.
- Those who do more kilometers during the year have normally newer vehicles (therefore, safer vehicles) than those who use less the car.
Therefore, Litman (2005) supports the idea of considering the number of kilometers in order to fix the premium probably by using marginally declining per-kilometer premiums.
One of the proposals of distance-based pricing systems was the pay-at-the-pump (PATP) insurance, where the driver will pay for his coverage as he buys fuel for the vehicle (Vickrey, 1968). Another proposal was the socalled “insured tires” system, where an associated insurance company identified in some way with the tire itself, would cover the accident caused by the vehicle using these tires (Vickrey, 1968). These systems were criticized because they are measuring the use of the car in terms of fuel consumption or tire wear instead of real distance run by the vehicle. Additionally, these systems do not distinguish between good and bad drivers when charging the cost of the insurance (Khazzoom, 2000 and Guensler et al., 2003). The other possibility was to measure the distance driven by the car by odometer auditing. In that case, there are concerns that fraud could be a problem, but some authors consider that odometers are increasingly tamper-resistant (Litman, 2011) therefore it seems reasonable to propose PAYD pricing systems based on odometer audits.
Results of implementing PAYD systems
The advantages of commercializing PAYD contracts, both for the insurance company and the driver, have also been discussed in the literature (Peña, 2007). Regarding the insurance company, the actuarial accuracy of premiums will improve as a result of a better quantification of the exposure to the risk of accident of each driver. In this way, the insurer will also have a better segmentation of the market. Additionally, according to Hagerbaumer (2004) companies that offer PAYD will be viewed as customer-oriented, proactive and environmentally responsible (as PAYD incentives to reduce the use of the car). Therefore it can help the company to improve their corporate image and potentially increase its market share. The advantages for customers are clear, they will pay a lower premium if they do less kilometers or drive in a safer way. Additionally, it makes insurance more affordable, therefore it seems reasonable to think that the number of cars without insurance will be reduced (Peña, 2007).
We must say that PAYD insurance contracts contribute to reduce traffic congestion, road maintenance costs, energy consumption and air pollution (Peña, 2007). Additionally, Parry (2004 y 2005) concluded that under certain conditions, PAYD contracts are a better way to reduce gasoline consumption than gasoline taxes.
We can say that PAYD policies are a concept of insurance contract with potential advantages for customers, insurers and the society as a whole. In nowadays context, insurance companies which want to be customer-orientated should be able to offer personalized products, and PAYD insurance is an example.
On the study of PAYD motor policies, the number of kilometers driven by the insured is a key factor to determine the insurance premium. The exposure measurement of risk of an accident will be a function of the number of driven kilometers.
