Pay as you drive – too sensible for America?

If you live in an average-sized household, and your household drives 20,000 miles or fewer per year, you are probably paying too much for automobile insurance.  If, on the other hand, your household is driving more than 22,000 miles per year, you are being subsidized by those who pay car insurance but drive less.

This is because, with very limited exceptions, insurance premiums are based on a set of risk factors that do not account for the fact that risk rises with greater-than average driving and falls with less-than-average driving.  (The average rate of per-household driving in the US was 21,252 miles per year, as of 2001.) 

This is where the highly sensible concept of “pay as you drive” auto insurance comes in.  Under PAYD, a large portion of your premium would be variable, depending on how much you drive, accurately measured by GPS devices or odometer readings.  If you reduce your driving, you would get rewarded with lower premiums, and your gas-guzzling neighbor would have to start paying his fair share.  My friend Allen Greenberg, one of the good guys at the US Department of Transportation, has been sending me emails about this for, literally, years.  He’s relentless on the subject.  And he’s right. 

The best accessible analysis I have read on the subject appeared in the Sunday magazine of The New York Times last week, and can be found online here.  It was written by the maverick authors of the best-selling book Freakonomics, Steven Levitt and Stephen Dubner.  Here’s some of what they have to say:

“Imagine that Arthur and Zelda live in the same city and occupy the same insurance risk pool but that Arthur drives 30,000 miles a year while Zelda drives just 3,000. Under the current system, Zelda probably pays the same amount for insurance as Arthur. 

“While some insurance companies do offer a small discount for driving less — usually based on self-reporting, which has an obvious shortcoming — U.S. auto insurance is generally an all-you-can-eat affair. Which means that the 27,000 more miles than Zelda that Arthur drives don’t cost him a penny, even as each mile produces externalities for everyone. It also means that low-mileage drivers like Zelda subsidize high-mileage drivers like Arthur.” 

Rectifying this unfairness would, say the two, produce a societal benefit of $52 billion per year, because the properly aligned incentives would reduce driving and associated carbon emissions, congestion, and accident-related property and medical costs.  Next month Progressive insurance will roll out a PAYD plan in six states and, if it goes well, eventually expand it.  The authors allow that Progressive will be taking a risk because, if other companies do not follow suit, high-mileage drivers may go subsidy-seeking and sign with other companies.  But, if low-mileage drivers flock to Progressive, maybe that’s OK.  Then the laggard companies would have to adjust their rates upward anyway, because their client base would be a higher-risk portion of the market.  Interesting, no? 

Check out the article.  Personally, I think it’s a swell idea, though if it catches on I’m not sure if my email volume from Allen will go up or down.  :)