Telematics-Based Insurance: Evolution, Not Revolution

By Christopher Sirota

The prospects of usage-based auto insurance have been well documented. Insureds install small telematics devices under their dashboards and transmit vehicle-generated data such as speeds, locations, and risky maneuvers to their insurance companies. Insurers use the data to refine their pricing structures, reward safe driving, modify risky behavior, identify fraudulent applications or claims activity, and dispatch emergency assistance or adjusters to accident locations. The overall cost of insurance decreases — and in the ideal world, everybody wins.

Rumors of a Revolution
Based on that scenario, one might expect telematics to alter fundamentally how auto insurance is priced and underwritten. Unfortunately, the revolution hasn't happened. One global consulting firm estimates that insurers representing 60 percent of the U.S. auto market have launched usage-based insurance (UBI) initiatives.[1]1. Harbage and Laurie (Towers Watson), "Brink of a Revolution," Reactions (April 2011), page 89. This statistic is difficult to interpret because many such programs may be rudimentary (for example, mileage-only) or not commercially available. Few insurers' websites presently reveal any signs of telematics-based offerings. Conversely, previous breakthroughs in insurance have shown higher adoption rates at similar stages in evolution. For example, a 2001 survey revealed that 92 of the 100 largest auto insurers were actively using credit history in pricing or underwriting.[2]2. Conning Research and Consulting, Insurance Scoring in Personal Automobile Insurance — Breaking the Silence, Introduction.

It doesn't take an expert to ascertain why UBI hasn't taken off. Some cite privacy concerns or lack of industry expertise as hindering factors, but the biggest obstacle is best described in the words of a political scientist: "It's the economy, stupid." Telematics devices are similar in cost to consumer GPS (Global Positioning System) devices, which retail in the range of $100 to $200 per unit. And telematics data plans are analogous to cost-efficient cellular plans that bill at $5 to $10 per month. Additional investment may be necessary to ensure that terabytes of potentially sensitive information are stored securely and data is backed up regularly. All told, equipping 1,000 insured vehicles with telematics technology may easily cost an insurer a quarter of a million dollars in the first year, other fees notwithstanding. One can only imagine the cost of including a substantial portion of an insurer's book of business in a UBI initiative.

The property/casualty sector has at times been willing to invest heavily in the latest sources of information. Motor vehicle records (MVRs) cost $10 to $20 per vehicle depending on the jurisdiction.[3]3. Purdue University Risk Management Department, US MVR Pricing Breakdown (February 2010). Still, insurers routinely purchase them to identify the most accident-prone risks and price them accordingly. Similarly, credit histories may cost insurers up to $10 per risk just to classify insureds into a few broad pricing or underwriting tiers.[4]4. Federal Trade Commission, Need Credit or Insurance? Your Credit Score Helps Determine What You'll Pay. Either source costs insurers less than 10 percent per vehicle of what UBI might cost, enabling them to cast a wider net. Yet although telematics requires greater effort and technological cost per risk, its sharper focus may yield a higher-quality catch.

Figure 1
UBI: An Evolutionary Step in Auto Rating

evolutionary step in auto rating: UBI

Automobile premiums have become increasingly individualized as technology has increased the accessibility of information. Usage-based insurance is the latest step in this evolution.

A New Species: Insuratus Telematicus
UBI initiatives often take shape in the following manner: Insurers offer small initial discounts to encourage data sharing, with larger discounts available for safer driving as demonstrated through telematics. Responsible drivers are thought to gravitate toward such programs because they save money as a result of their ordinary driving habits. Those who do not opt into UBI may still receive discounts based on a clean driving record or attendance of a defensive driver course. Riskier drivers have less incentive to enroll unless they are determined to modify their behavior, which they can do given the strong tools that UBI provides through real-time feedback and online portals. Either way, the insurer has invested in creating a small but promising new segment within its overall book. Over a period of years, this business may produce the consistently improved loss ratios and retentions necessary to generate profits on the initial investment, not to mention claims databases large enough to support predictive modeling and analytics.

Unfortunately, in the short term, discount-only UBI programs are likely to have difficulty effecting loss ratio improvements or other cost reductions great enough for positive return on investment (ROI). Insurers looking for shorter payback must instead demand and innovate ways to improve margins. For example, newer technologies featuring Wi-Fi or Bluetooth capabilities enable vehicle-generated data to pass through insureds' own data plans. Cellular transmission may be bundled with fee-based services such as roadside assistance to make insureds coinvestors in UBI. Hardware costs may be amortized over product life cycles and devices shuttled between vehicles after obtaining credible samples of driving behavior. Such techniques help spread initial costs over a larger number of vehicles and a longer time horizon, allowing for better alignment with expected profits.

Natural Selection
Of all the unknowns surrounding user-based initiatives, the legal aspects may cause the greatest concern. Early innovators and patent trolls in the telematics space have obtained sweeping intellectual property (IP) protections and litigated against other insurers on multiple occasions. Those developments have ­osten­sibly been effective in stifling innovation but have yet to prove as effective in court: One decision recently resulted in cancellation of the plaintiff's own original patent claims, pending modification. To be safe, many organizations prudently license or apply for their own protections or, at a minimum, obtain legal opinions regarding the originality of their envisioned IP. Until the legal issues are resolved, many insurers will proceed cautiously.

Conversely, insurance companies are equally wary of missing the next wave of innovation, the opportunity cost of which is inestimable. Moody's Investors Service recently noted that usage-based products are "credit positive" for insurers,[5]5. Moody's Investors Service, "Usage-Based Auto Insurance Is Credit Positive for Insurers," Weekly Credit Outlook, December 19, 2011. giving pioneers an advantage over competitors that may become victims of adverse selection. Launching a small-scale UBI pilot allows an organization to limit its investment while establishing the infrastructure necessary to excel once costs become more sustainable — or at least definable. Insurers possess the expertise and entrepreneurial spirit to monetize new data sources, but few have the internal resources to produce credible results expediently using telematics. Industry organizations may play a role in providing technological assistance, decision support, and data aggregation services that help insurers leverage economies of scale.

While every revolution begins with a single act of defiance, every evolutionary process begins with a single step forward. In the case of UBI, such a step may be a single-device test. Executives interested in telematics should consider plugging devices into their own dashboards for a month. Seeing the value of the information and resulting costs firsthand can provide invaluable insights that serve as a starting point for discussion and action. The UBI programs that evolve may ultimately be revolutionary.

Christopher Sirota, CPCU, is principal at Applied Informatix, a unit of Verisk Analytics. Applied Informatix provides analytical tools to help collect and use driving behavior data for personal and commercial auto insurance.

1. Harbage and Laurie (Towers Watson), "Brink of a Revolution," Reactions (April 2011), page 89.

2. Conning Research and Consulting, Insurance Scoring in Personal Automobile Insurance — Breaking the Silence, Introduction.

3. Purdue University Risk Management Department, US MVR Pricing Breakdown (February 2010).

4. Federal Trade Commission, Need Credit or Insurance? Your Credit Score Helps Determine What You'll Pay.

5. Moody's Investors Service, "Usage-Based Auto Insurance Is Credit Positive for Insurers," Weekly Credit Outlook, December 19, 2011.