Are usage-based pricing models inherently better?

Insurtech is transforming the industry. Once a buzzword on Teams Meetings bingo cards, Insurtech is now firmly entrenched as a concept. Broadly speaking, Insurtech is the use of AI (artificial intelligence) and technology to streamline and shorten the distribution chain of insurance products. This benefits insurers by reducing the administrative overhead and, in theory, should contribute towards lower premiums for policyholders.

Usage-Based insurance (UBI) is a branch of Insurtech. It’s the insurance world’s cousin of taxpayers’ PAYE (pay-as-you-earn) or mobile phone users’ PAYG (pay-as-you-go). UBI uses technological solutions to enable insurers to offer virtually personalised premiums. The main application of UBI is in vehicle-related policies – private car and fleet covers.

In relation to private cars, it’s often referred to as “black box insurance”, because it operates via a little black box fitted somewhere in the vehicle. Like their chunky aviation big brothers, these devices track a wide range of data about journeys made in the vehicle. More broadly, the term telematics is used – a portmanteau word from telecommunications and informatics.

Using accelerometers and connections to in-car electronics they track acceleration and speed to derive a “profile” of the user’s driving style. Connections to GPS (global positioning satellites) track location, which assists with geographical rating of the cover. Using wi-fi and mobile phone networks they communicate with the insurer for rating purposes and an app on the user’s phone for information purposes. The mobile data together with traditional rating features such as driver age and experience, garage postcode and vehicle make and model combine to produce an overall “score”.

In this game, low scores are undesirable and 10 is perfection. In October 2021, What Car magazine cited figures from Aviva that 44% of UBI users score between 7 and 10 and achieve average discounts of £150. On the other hand, the magazine warned that some insurers levy extra premiums of £250 for low scores, with the risk of policy cancellation if not paid.

Like so many of the new-fangled things that have cropped up in our blogs, this turns out not to be that new-fangled after all. The first patent for a “Motor vehicle monitoring system for determining a cost of insurance” was granted to the Progressive Casualty Insurance Co in the US in 1996. Its potential was quickly spotted and in the UK Norwich Union (now Aviva) was an early adopter. They remain one of the principal developers of the technology in Europe.

In November 2019 The Daily Mail’s This Is Money page reported that there were more than 1 million “black box policies in the UK. US firm ABI Research (not to be confused with the UK’s own Association of British Insurers) estimated that by 2020 there would be 100 million UBI policies worth over €50 billion in premiums globally. So, whether UBI is better or not, it looks like it’ll be with us for a while.

In the UK, early implementations of UBI were aimed at improving the driving risk presented by young drivers, mainly young males. Early research by Norwich Union indicated that drivers in the age range 18-23 who signed up for telematics policies had an accident rate 20% lower than average.

In an article in May 2021 the Canadian Automobile Association (CAA) summed up UBI as a win-win-win situation for insurers, policyholders and brokers; “When people save on their insurance, there’s less of a chance of them shopping on renewal. And, with this satisfaction comes loyalty, retention, possible referrals, the list goes on. The customer wins, and so does the broker.”

UK based IMS (Insurance & Mobility Solutions) highlighted the benefit of attracting low-risk drivers and thereby reducing claims costs. The system offers CRM (customer relationship management) opportunities for tailored, value-added services and more “potential touch-points”, which they perceive as enhancing customer loyalty.

In a recent blog, we discovered that a Fleet Manager has his hands full, but UBI in a fleet context offers access to additional data specifically about his own fleet. The data can help with accident reduction, investigation and identifying training needs, as well as usage data.

Whilst UBI offers clear benefits for fleet managers and many private car users, as well as insurers and brokers, it’s not all sunny uplands. As the internet-of-things (IoT) expands exponentially, so does the cyber risk.

There are legitimate concerns about the “hackability” of telematics devices. Similarly, data privacy is a trending topic, following the Supreme Court’s decision earlier this month in the Lloyd v Google data breach case. Although Google won the battle, the war is far from over, as the Court specifically did not rule out future class actions.

The more complex a system, the greater the reliability challenges. Whilst we are still predominantly dealing with human drivers, it seems likely there will be a convergence of technologies. Just as smartphones have embraced the technology of watches, fitbands, calculators, cameras and radios, so telematics are likely to merge with car computers and driving aids. What could be the consequences of a failure of in-vehicle technology or a network on which it relies?

The Financial Ombudsman receives “a growing number” of complaints about “black boxes”, mainly about the accuracy of the devices, and has upheld several. There have been complaints about phantom journeys, and cases where lost GPS signals have made it look as if the vehicle was speeding.

The automatic accident reporting system in the boxes is often fooled by pothole jolts, leading to irritating enquiries from insurers checking all is OK.

Some private car systems are smartphone-based and can be susceptible to being confused in public transport, leading to excess mileage being logged, or in trains, leading to an appearance of speeding.

As the usage-based model takes hold, some insurers are moving to charging for administrative changes, the costs of which could outweigh any premium savings arising from safer use. This could be a difficult calculation for fleet managers to balance, given the attraction of the enhanced data usually available.

The calculation is likely to be more clear-cut for private users, but What Car magazine warned that; “drivers with a blemish-free insurance history and several years of no-claims bonus behind them may find a telematics policy more expensive than a conventional insurance policy.”

In summary, UBI potentially offers real benefits to all links in the distribution chain. Insurers can use the increased data for risk improvement, leading to lower premiums and better retention. Brokers can offer reduced premiums and, for fleet users, access to big data, leading to added value and better retention. Policyholders can see reduced premiums and possibly bundled services.

Brokers should be able to advise clients on the potential effects of admin charges, whilst direct buyers should check what charges may be levied and in what circumstances.

ABI Research has pointed out that as technology advances us towards autonomous vehicles, the importance of driver behaviour reduces, and with it, some of the benefits of UBI.

So, is usage-based better?

Definitely maybe, depending on individual circumstances.