Usage-Based Insurance - Everything You Need To Know

Usage-Based Insurance (UBI) has emerged as a groundbreaking model that has the capability to reshape how insurers assess risk and price premiums. Here, we trace UBI's journey from conventional methods to the sophisticated, data-centric systems we see today.

The Traditional Insurance Paradigm

Historically, automotive insurance premiums have been calculated using broad actuarial categories such as age, gender, location, and driving history. While effective to an extent, this approach often results in generalised risk assessments that does not accurately reflect individual driving behaviors. Consequently, safer drivers tend to subsidise riskier drivers, leading to a less equitable pricing model.

Usage-Based Insurance offers a solution to this issue. The initial forays involved simple devices that recorded basic driving data, such as speed and mileage. Nonetheless, these early systems laid the groundwork for more sophisticated developments.

The Evolution of Usage-Based Insurance

In the late 1990s and early 2000s, insurers began experimenting with rudimentary telematics devices. These devices, often referred to (somewhat inaccurately) as "black boxes" were installed in vehicles to collect data on driving habits. The primary focus was on measuring mileage and other simple data sets, giving rise to the first form of usage-based insurance: Pay-As-You-Drive (PAYD) insurance. PAYD provided a more tailored approach, aligning premiums more closely with the actual use of the vehicle.

Since then, the evolution of telematics technology has been relatively rapid, ostensibly driven by advancements in GNSS, mobile communications, and data analytics. Modern telematics systems dedicated to the collection of usage-based insurance data go beyond mileage tracking, capturing a wealth of data, including acceleration, braking patterns, cornering, and time of day. This granularity of data allows for personalisation of premiums where they are adjusted based on "real" driving behaviour, something which was otherwise not possible using conventional actuarial risk assessment models.

A pioneering example of usage-based insurance is Progressive's Snapshot program, launched in the 1990s. By installing a small device connected to the OBD port of their vehicles, policyholders allowed Progressive to monitor their driving behaviour. The data collected was used to adjust premiums and create individual risk profiles.

The Rise of Smartphone Telematics

As smartphones became ubiquitous, some notable insurers and Telematics Service Providers (like Cambridge Mobile Telematics) saw an opportunity to leverage smartphones' telematics capabilities for insurance purposes. Smartphone apps were designed that could track driving behaviour without the need for additional hardware, and as a result, this innovation lowered the cost barriers to entry (for Insurers) for usage-based insurance, suddenly making such programmes more accessible to a broader audience.

However, smartphone-based usage-based insurance has not been without its own difficulties. By being reliant on the data connectivity and hardware of the policyholder, rather than a predefined hardware solution, the performance of the smartphone (whether in terms of battery life, accuracy of data reported, or the correct activation of the requisite app) has on occasion been brought into question vis-a-vis the performance of a dedicated hardware solution.

Challenges and Barriers

Despite its advantages, the adoption of usage-based insurance faces several specific challenges:

Privacy Concerns: The collection of detailed driving data raises significant privacy issues. In the European Union, the General Data Protection Regulation (GDPR) mandates strict requirements for data protection and privacy. Under GDPR, insurers must obtain explicit consent from drivers before collecting their data and must ensure that this data is securely stored and processed. In the United States, the California Consumer Privacy Act (CCPA) grants California residents specific rights regarding their personal information, including the right to know what data is being collected and the right to request deletion of their data.

Cost and Complexity: The initial setup costs for insurance telematics devices can be high, particularly for smaller insurers. Whilst the cost itself is not strictly prohibitive, the issue is that insurers already have a stable business model that operates at established margins and revenues. Usage-based insurance functions very differently; lower premiums = lower revenues, irrespective of improved claims ratios, but ask any business to reduce their revenue stream deliberately, and the response will obviously be rather muted.

Consumer Acceptance: There is often resistance from consumers who are concerned about surveillance and the potential misuse of their data. Insurers need to build trust by being transparent about how data is used and by demonstrating the benefits of telematics insurance through clear, tangible examples. This does vary from country to country, however, with two notable nations very "pro" usage-based insurance being the USA and South Africa, albeit both of them engaging with the product for quite different reasons.

Future Trends to Look Out For

The elephant in the room is that usage-based insurance remains a relatively niche product on a global scale. It is only when looking at the major activity areas across the globe, that you see the USA and Italy demonstrating robust market penetration (in the context of the percentage of active policies identified as being usage-based insurance). The United Kingdom and Germany are also demonstrating solid policy volumes too, albeit - in the UK - usage-based insurance is still seen very much as a way of lowering costs for young and high-risk drivers, rather than a mainstream alternative in places like Italy and the USA.

It remains to be seen what the impact of emerging technologies such as artificial intelligence will have, as whilst it's possible for AI to analyze vast amounts of driving data to identify patterns and predict risk, the technology is still in its infancy and has already been found to be fallible. The advent of autonomous vehicles could present new opportunities for telematics insurance, but this will be unlikely in the short- or medium-term future.

The biggest area of development that can complement usage-based insurance is connected vehicles. Equipped with line-fitted telematics systems, connected vehicles are becoming increasingly common. Increasing in volume on-the-road, these vehicles can communicate with each other and infrastructure, and are capable of providing real-time data. For insurers, connected vehicles have the potential to offer a rich source of data that can be used to refine risk assessments and develop new insurance products, provided OEMs make this data affordable.

Final Thoughts

The evolution of telematics insurance represents a paradigm shift in the automotive insurance industry. From its early beginnings with simple mileage tracking to the data-driven systems of today, usage-based insurance has the ability to transform how insurers assess risk and price premiums. The biggest issue for insurers is working out how to integrate such datasets when they choose to embrace such programs. By leveraging driving data, telematics insurance can offer a more personalized model for both insurers and policyholders. The future of telematics insurance looks promising, and coupled with other industry developments in software and autonomy, the need for alternative road usage charging systems (i.e., non-emissions-based taxation) plus the steady growth in personal mobility, and it's easy to see how the future of usage-based insurance is assured as a cornerstone product for any major insurer.