At a fundamental level, every auto insurer calculates premiumexactly the same way: rate times exposure. But beyond that simpleformula are differences as numerous as there are auto insurers,with each carrier trying to come up with the right actuarialwrinkle to give it an advantage in an increasingly commoditizedmarketplace.

One of those wrinkles is usage-based insurance (UBI), touted asa way to drive greater accuracy into pricing using an objective andequitable exposure base: miles driven. Since vehicles are much moreprone to loss when they are on the road rather than in the garage,the idea is to charge higher premiums to policyholders who drivemore miles.

Proponents of UBI assert benefits of "pay as you go" extend farbeyond accurate premium calculation. In a 2008 report titled"Pay-As-You-Drive Auto Insurance: A Simple Way to ReduceDriving-Related Harms and Increase Equity," The Brookings Instituteclaimed if drivers paid per mile rather than in a lump sum, almosttwo thirds of households would pay less for auto insurance.Furthermore, it maintained, because drivers would have an extraincentive to drive less, driving would decline by eight percentnationwide, saving society up to $60 billion a year by reducingdriving-related claims and costs.

Whether or not insurers agree with the extent of thatassessment, they should be aware consumers have become interestedin UBI. Kimberly Harris-Ferrante, vice president and distinguishedanalyst at Gartner, reports consumer awareness of these programs isgrowing, with 43 percent of those surveyed by Gartner in a recentstudy "strongly" interested in "pay-as-you-drive" autoinsurance.

However, there has been little insurer activity around usingtelematics to support mileage-based rating. Despite Progressive'swell-publicized initiatives that date back 10 years, only a handfulof carriers since then have piloted UBI programs. (Progressive hasa trademark pending on "Pay As You Drive" in the U.S.; RealInsurance claims a trademark on the term in Australia.)

Why the disparity between supposed demand and actual supply?"Telematics has been slow to take off among P&C carriers formany reasons, including the cost of the hardware and internaltechnology requirements needed to support this product type, suchas modification to policy administration and billing systems tosupport usage-based products," says Harris-Ferrante.

In order to support UBI technologically, insurers need to beable to digest information from telematics devices and perform moregranular, tiered-based rating than many currently can, states MarkPurowitz, a partner the insurance industry practice at Diamondmanagement and technology consultants. "There are very fewcompanies that do 'micro rating' right now. If they're going tocapture driving characteristics–how many times someone pressed thebrakes, how they accelerate–those are new types of algorithms thatare going to have to be built," he says.

Companies also need to decide what type of telematics devices touse to obtain driving data–or even whether to use an in-vehicledevice at all. As a result, within the industry today, there aretwo approaches to UBI that directly influence technology decisions:track or trust.

GPS TRACKING

Progressive was the first insurer to explore tracking-basedsystems, patenting the idea of using in-vehicle sensors and devicesto record how a vehicle is operated and transmit that data throughwireless technology for use in rating. It piloted a program, calledAutograph, in Texas in 1999, using a retrofitted "black box" devicethat included GPS and cellular technology. According to BillEverett, Progressive's product development manager of usage-basedinsurance, the program was "successful with customers but wasdiscontinued in 2001 because of the cost and logistics ofretrofitting devices into vehicles."

Progressive later licensed the idea to Norwich Union in the UK.Norwich deployed a UBI product in 2004, tracking customers'vehicles and adjusting premiums depending on when a vehicle wasbeing driven by using a device from UK-based TrafficmasterTelematics, which relayed information via satellite. However,Norwich discontinued its program in 2008, two years after it wasintroduced, reportedly due to lack of consumer interest and lack ofsupport from auto manufacturers. (The company did not respond torequests for comment.)

Likewise, other companies' GPS-based tracking programs have beenslow to get off the ground. Published reports of a federal grantreceived in 2007 by the Washington State Department ofTransportation detailed that a pilot program in King County withUnigard Insurance would use a GPS-based device to monitor where,when, how much, and how fast a vehicle is driven, with data beingused to develop the insurance premiums. However, today the toolstill is in the developmental stage, awaiting approval from KingCounty, according to Unigard spokesperson Anne Smith, who adds,"another method to gather only odometer readings" will be part ofthe project, as well.

"What's awaiting approval with King County is the study togather data–that's the first step," Smith explains. "An actualmileage-based auto insurance product is farther out in terms ofdevelopment."

NON-GPS TRACKING

Privacy is an issue that is inseparable from any discussion ofGPS-enabled telematics and UBI. "People fall back to [the argumentof] 'I don't want anybody tracking where I've been and where I'mgoing,'" says Purowitz.

Unless and until those concerns do disappear, insurers in theU.S. evaluating UBI, including Progressive, are focusing today onnon-location-based telematics.

After discontinuing Autograph, Progressive went back to thedrawing board and, in 2004, piloted the "TripSense" program.TripSense used a non-GPS device plugged into a car's onboarddiagnostics (OBD-II) port. Initially, the TripSense programrequired policyholders to install their device in the vehicle, thenperiodically remove it, connect it to their PC via a USBconnection, and upload data to Progressive.

Although it did not report vehicle location, the device didperform more than mileage tracking. According to Everett, itrecorded vehicle speed and time and when the device was connectedand disconnected from the vehicle. Other information, such as milesdriven and rates of acceleration and braking, was derived from thespeed and time information.

In 2008, the company announced an expanded rollout of theprogram and rebranded it "MyRate." Currently, MyRate is availablein eight states: Kentucky, Alabama, Louisiana, Maryland, Michigan,Minnesota, New Jersey, and Oregon. Progressive bears the cost ofthe device but charges policyholders a "technology fee" in certainstates.

The upload procedure for the device also changed to a wirelessnetwork connection that requires no device removal. According toRichard Hutchison, general manager of MyRate, the company sourcesthe device from its exclusive vendor, Xirgo Technologies LLC ofCamarillo, Calif.

Progressive calls MyRate a "behavior-based" insurance programbecause it tracks not only miles driven but also how and when thosemiles are driven. Drivers who exhibit safer habits or drive duringsafer times–per Progressive's proprietary algorithms–receive lowerpremiums as a reward. Progressive spokesperson Susan Gallik Rouserindicates rating for new variables required changes toProgressive's back-end administration systems but declined tospecify what changes were needed or how those algorithms arederived.

Progressive reports a full one third of customers who areoffered the MyRate program sign up, and Everett believes theprogram will overcome some of the cost and logistics problems thathamstrung the previous technology.

"Unlike Autograph and TripSense, the MyRate program features awireless device that can be self-installed. These features make theprogram easy to use and more convenient for the customer," hesays.

Like Progressive, GMAC Insurance takes a non-GPS trackingapproach to its "Low Mileage Discount" program, which uses GM'sfactory-installed OnStar diagnostics and information device.However, unlike Progressive, GMAC Insurance tracks only milesdriven, not how they are driven.

A miles-only approach is one Purowitz says goes even further toaddress consumer concerns with telematics. "People are very leeryof the fact that, while they might drive within the parameters of a[behavior-based] program the majority of the time, the outliersmight somehow impact the potential benefit," he explains.

OnStar is a GPS-enabled system, using cellular technology tolink vehicles and drivers–and their location–to the OnStar servicecenter. OnStar also collects maintenance and diagnosticsinformation from a vehicle's operating systems. In establishing theparameters of its UBI program, John O'Donnell, vice president ofbusiness development at GMAC Insurance, reports the insurerconsidered using some of this data in its rate making but electednot to in either the program's pilot or its July 2007 nationalrollout.

"So far, we've found customers are comfortable opting in andthey like the transparency of understanding how they're going to berated based only on mileage. They fit into a tier, and we publishthose tiers in a chart. I think there would be more concerns if wecollected other information and didn't share openly how [we] wereusing [the data]," O'Donnell says.

New customers in the program receive a discount based on theirOnStar history of miles driven, if known, or a 26 percent discountbased on an under-10,000-mile rating tier, if not. On a weeklybasis, OnStar provides GMAC Insurance with a file of mileage datafor subscribers who have opted into the program. Based on thatinformation, at policy renewal, GMAC Insurance will adjust itspremiums using discount tiers corresponding to miles driven.Customers who drive more than 15,000 miles per year are notpenalized but receive no discount.

As part of the partnership with GMAC Insurance, OnStar sendspersonalized e-mails to targeted subscribers who are eligible forthe discount based on actual historical miles-driven information inthe OnStar database. OnStar subscribers who respond to the e-mailand opt in to sharing mileage information are linked to the GMACInsurance online quote portal, which is prepopulated withinformation to streamline the application process.

O'Donnell reports 17 percent of the insurance policies GMACInsurance sold through direct marketing efforts in 2008 includedthe discount, up from 7 percent the previous year. "Currently, wehave more than 30,000 people enrolled in the program," he says. "Wehave seen 150 percent annual growth, year over year, in newcustomers."

He attributes growth in the program not only to the fact thatdrivers receive a discount but also that it requires no effort onthe part of consumers to use. "They get the e-mail and can respondto it, and it happens automatically. OnStar itself is user-friendlywith no user install required. There's no downloading [from theOnStar device] required by the customer," says O'Donnell.Additionally, he believes policyholders see the insurance discountprogram as an extension of the service package they buy as OnStarsubscribers.

TRUST

Both Progressive and GMAC Insurance take a retrospectiveapproach to UBI, setting premiums based on miles policyholders havedriven in previous terms. However, 2008 start-up insurer MileMetertakes a different approach that is truly "pay as you go":Policyholders buy insurance for a specific number of miles, andonce those miles have been driven or the term of the policy runsout, coverage expires.

For consumers accustomed to having insurance in-force for aspecific period of time as long as premiums are paid, this approachcould mean an adjustment. However, Chris Gay, CEO of MileMeter,claims the program works because, despite greater accountabilityrequired, MileMeter provides transparency to premium calculationsthat consumers appreciate.

"People understand exactly how their premiums are calculated,know exactly what they're going to pay based on how much theydrive, and can make informed decisions based on that information,"Gay relates.

MileMeter uses no in-vehicle device to confirm miles driven. "Wetrust our customers; we don't track them," Gay says.

More accurately, MileMeter's approach is "trust but verify."Although the company doesn't monitor miles as they are driven, itdoes receive odometer readings from vehicle emission, maintenance,and registration databases nationwide. It then matches thatinformation against VINs of newly insured and renewing vehicles toconfirm policyholder assertions. It also sends reminder e-mails topolicyholders before purchased miles are expected to run out inorder to minimize unexpected policy expirations.

Based on its approach to UBI, MileMeter didn't have to contendwith any technology issues or privacy concerns around trackingdevices; instead, its challenges centered on back-office systemsand administration. "First, the rating system needed to accommodatea proprietary rating approach, and then we had to interface withthird-party system APIs and our own underwriting system. We alsoneeded to handle accounting for policy administration–how to earnpremium on a policy denominated in miles or a combination of milesand time," explains Gay.

The insurer elected to develop its own rating, policy, andclaims administration platforms. "Commercial off-the-shelf systemsby their nature are legacy systems. We felt the uniqueness ofdistance-based insurance could not be adequately accommodated bythem," Gay indicates. "We wrote the majority of our software inRuby, using some Java, and we heavily utilize open sourcetechnology."

MileMeter built its administration platforms to operate in the"cloud," using Amazon's Elastic Compute Cloud (EC2) infrastructureand affiliated Web services. "We needed something that could scalein extremely short time frames. That required software that wasdeveloped to expand across an elastic storage network and computingcloud, such as Amazon's, which allows us to go from the equivalentof one server to one thousand servers within minutes," he says.

Although its current customers are exclusively in Texas,beginning in 2009, the company plans to expand into other states.It also intends to license its policy and claims administrationsystems to other insurers.

Gay would not cite specific revenue figures but claims responseto its UBI product has been "fantastic" since its rollout on Oct.15. He also points to anecdotal evidence for other benefits.

"If you want people to reduce their miles driven and get all thesocietal benefits–lower driving, fewer greenhouse gases, and soon–pricing must be linear and transparent, and that's what weoffer. People do change their behavior as a result, and consumerswho already are low-mileage drivers are encouraged to continue thatbehavior," he notes.

WHICH WILL PREVAIL?

Only time will tell whether both the "trust" and "track" modelswill compete evenly or one will prevail over the other.

"We believe tracking people is doomed to failure because ofprivacy concerns, or it is destined to be only a small marketniche," says Gay. "It comes down to cost and convenience. Everytime you add another device, it adds costs, diminishes yourcompetitiveness, and decreases convenience."

Stephen Longden, specialist in telematics at the UK-based autoindustry consultant SBD, believes tracking will dominate. The trickfor insurers, he says, is bundling benefits with trackingdevices.

"For usage-based insurance to be a success, it will requireinstalling one kit in your vehicle–a GPS- and GSM- [cellular]-basedkit–and using it for a whole variety of applications of whichinsurance will be one. You'll also get stolen vehicle tracking,navigation, traffic information, or more leisurely things, such as[information on] restaurants and amenities. If you're sharing thesame vehicle kit, you're dividing the cost of the application," hesays.

Harris-Ferrante contends insurers that use telematics only formileage reporting in premium calculation are missing one of thetechnology's key benefits. Omitting GPS-type tracking technology"would eliminate many of the privacy fears among consumers, but italso would erase one of the benefits of telematics–the ability tolocate a vehicle if it were stolen, for example," she says.

The type of bundling Longden proposes could involve actualalliances with vehicle manufacturers, such as the relationshipbetween GMAC Insurance and OnStar. Or it could result from theemergence of a third-party device provider that can serve as a databroker to insurers.

"There is a possibility for some sort of trusted third party tocollect all the tracking data, process it, and send it somewhere.That could be to an insurance company, or it could be to anothercompany that offers location services such as stolen vehicletracking," Longden says.

"In that way, insurers don't get involved in doing deals withvehicle manufacturers and dealing with the complications of gettinghardware and software into vehicles. All insurers would have to dowould be to buy the data from a telematics provider," he adds.

Ultimately, it will take a combination of push from insurers andpull from consumers to drive UBI to the mainstream. However, that'ssomething Harris-Ferrante doesn't see happening in the near future."Gartner does not feel telematics will take off significantlyduring the next three years within the U.S.," she says, maintainingthat lack of market pressure from other carriers and discontinuedpilots at large companies will impede its adoption among P&Cinsurers, at least in the short term.

And there may be more pressing issues for insurers to contendwith than telematics. "I don't think insurance companies will bewilling to invest [in telematics], particularly in this market,"Purowitz claims. "At this point, insurers have a far greater hurdleof getting their houses in order by remediating older systems andtechnology architectures."

Yet despite aborted programs and limited availability of UBI inthe marketplace so far, Harris-Ferrante says insurers shouldn'tgive up on the idea of "pay as you go." "Insurers should beactively involved with these initiatives," she advises. "Insurersultimately will need to craft the strategy and build the businesscase around offering telematics-based products to their customers."TD