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Pay Per Mile Auto Insurance: The Future of Car Insurance?

Around 12 years ago, Aaron Edlin, a PhD on the President's Council of Economic Advisors, developed the idea for pay per mile auto insurance as a radical alternative to the current car insurance system used in the United States.

Here's a quote from an April 2008 New York Times article on pay as you go insurance (written by Stephen Dubner and Steven Levitt — the authors of Freakonomics): "since no one expects to pay the same price for, say, a 60 minute massage as they pay for a 15 minute massage, why should people pay the same for insurance no matter how many miles they drive?"

Together with colleagues Pascal Noel and Jason Bordoff, Edlin examined whether pay per mile auto insurance might be able to help lower pollution emissions, reduce congestion, and eliminate some accident risk. The pay per mile auto insurance pioneers concluded that the ultimate benefit of the adoption of a system would be a net societal savings of over $50 billion annually.

How and Why the Program Works
Basically, in the United States, auto insurance is a fixed cost. This means that you pay the same amount no matter how much or how little you drive. Yes, you can qualify for a "low mileage discount" to get a small reduction on your premium. But this discount program is nowhere near to optimal. In the simplest terms, pay per mile insurance allows you to pay based on how many miles you drive. You use a GPS like system to calculate the number (and quality!) of the miles you drive, and your premium gets calculated from these figures.

Pay Per Mile in Real Life
To-date, pay as you go insurance remains in the starting block. But a few companies, like GMAC and Progressive, have experimented with pilot programs to test the concept.

In a best case scenario, pay per mile auto insurance would yield a win-win situation. Insurers would win because they could price their products better and indirectly reduce the number of accidents on US roads (and thus the number of claims they would have to pay). And drivers would win because they could pay less for insurance, get into fewer accidents, and suffer fewer side effects from pollution and congestion. Low income drivers, most of all, could benefit because these drivers often bear a higher insurance burden than their mileage or real accident risk entail. Pay per mile insurance would make coverage more affordable for these drivers by giving them more control of the premiums they pay.

Challenges with Pay As You Go Insurance
Dubner and Levitt list three main challenges. First, to date, the tracking technology that allows insurers to accurately calculate the number of miles driven remains prohibitively expensive. Soon, with the advent of improved GPS technologies, this hurdle may be more clearable. Second, insurers and privacy advocates worry that the extensive monitoring of driver behavior may violate some privacy boundaries. Finally, in order for pay as you go insurance to really catch on, at least one major insurer has to dive into the market, whole-hog. Doing so carries more than a little risk.

Pilot Projects
Many groups, including the Conservation Law Federation, The Environmental Insurance Agency, Environmental Defense, and the Environmental Protection Agency, have explored the viability of pay per mile auto insurance programs. Pilot projects have been launched in Georgia, Massachusetts, Washington, Arizona, Indiana, Illinois, Pennsylvania, and Minnesota. These pilot programs are in various stages of completion. Initial data from them suggest that pay per mile auto insurance may indeed live up to its potential.

Obviously, as researchers glean more data from research efforts and pilot programs, we will have a clearer understanding of whether pay as you go insurance really does reduce congestion and pollution, improve insurance "fairness," help carriers optimize their revenues and reduce the number of accidents on the road.

In summary, the pay per mile insurance scheme is very interesting and very new. Initial data seem compelling, but more research is needed. But, if the pilot programs continue to perform well, we could very well see a revolution in insurance over the next decade.

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