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Innovation Principle: Be Agile, and Be Willing to Accept Risk
A number of insurers already have pioneered new auto insurance pricing models that differ significantly from traditional models. Progressive Insurance's Autograph, Norwich Union's Pay-As-You-Drive (which licenses Progressive's patented technology), and Safeco's Teensurance are solid examples of novel pricing models. These approaches provide evidence of a principle of innovation: Be agile, and be willing to accept risk.
These pricing models rely heavily on the use of telematics to report accurate measures of vehicle usage. In some cases, it is incumbent on the policyholders to upload their usage information to the carrier. In other cases, onboard global positioning system (GPS) devices use cellular phone communications networks to report to insurers the vehicle' locations and distances driven. Accurate data is the key to accurate pricing. A major challenge to the creation of alternative pricing strategies has been the inability to reliably collect data. For some drivers, more accurate pricing results in higher insurance premiums. For others, the converse is true. The latter drivers often willingly trade detailed information about their driving habits for lower rates. Over time, the accumulation of this data will provide insurers with greater insight into drivers' behavior. The data will ultimately be transformed into a more accurate risk profile for any combination of vehicle, location, and driver.
The technology described also has the potential to reduce or eliminate rate evasion. It is not uncommon for vehicle owners who live in higher-cost, higher-risk urban areas to claim that their vehicles are garaged at less-risky weekend homes in lower-cost rural areas. This practice results in higher rates for consumers who actually reside in rural areas. The telematics used by GPS-based pay-as-you-drive (PAYD) systems will clearly show the location of the vehicle and will make it impossible for the insured to falsely claim a rural address.
Another example of the pricing accuracy that results from PAYD systems is the application of discounts. Many carriers offer discounts for driving less than a preset number of miles each year. Most of these carriers require some form of proof, which must be provided annually by the policyholder to renew the discount. The collection of this data results in additional cost for the insurer and customer contact that is less than ideal. In July 2007, GMAC Insurance introduced a discount for insureds who drive less than 15,000 miles annually and who report their mileage automatically using the OnStar system available in most 2004 and newer GM vehicles. This innovation leverages technology to create a more accurate pricing structure, reduce the cost of data acquisition, and encourage the use of the OnStar service provided by the insurer's parent
company. This automatic reporting of mileage results in a data feed to the insurer that will ultimately lead to an opportunity to further divide annual mileage rating. The annual mileage cutoff of 15,000 seems to be rather high and undoubtedly includes the majority of the GMAC's current customers. Many insurers use a cutoff of 7,500 miles as the basis of their discounts for limited annual mileage. As GMAC gathers more detailed annual mileage measures, the company will gain the ability to create additional pricing cells for different annual mileage ranges. This will enhance the company's competitive position and increase the likelihood of pricing accuracy.
Rate evasion for auto insurance takes many forms. Many carriers rate policies based on the number of miles driven to and from work each day. For such carriers, a common cutoff between rates is 10 miles one way or 100 miles per week. Consumers and agents who are familiar with this cutoff have been known to underreport the distance driven in order to receive a lower rate. This leads to higher rates for drivers who legitimately drive less than 10 miles to and from work. GPS technology, geocoding, and other mileage-recording technologies can eliminate this inaccurate reporting of mileage.
The digital chauffeur scenario above alluded to the use of some form of driver recognition in the car of the future. Driver recognition will eliminate the ability to conceal undisclosed drivers. The most common example of this form of rate evasion occurs when the son or daughter of an insured obtains a driver's license but is not added to the insured's policy. The presence of a youthful driver, even one who rarely drives, results in significant increases in insurance costs. The combination of driver-recognition technology with telematics should be used to identify each driver. Telematic detection of a previously undisclosed driver using the vehicle on multiple occasions should alert the insurer to possible rate evasion.
The PAYD approach applies the fifth and sixth principles of innovation: Be agile, and be willing to accept risk. Most legacy policy administration and actuarial systems are designed with one particular exposure unit, the insured vehicle year. PAYD has completely altered this exposure unit to mileage driven. To adopt this type of pricing model, insurers must have systems that are agile enough to adapt to novel approaches. The systems must be designed to capture data that has never been captured in the past. Agility is key to revolutionizing pricing models. More important, having more accurate pricing models is a crucial component in attracting and retaining profitable customers. Departing from tradition presents risks, and there is no guarantee that novel approaches will pay off. The innovative insurer must be willing to accept the risk of project failure in order to receive the benefits of successful innovation.
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