True innovation is rare in the insurance industry, but telematics may be a genuine example. The technology is still in its infancy with regard to its application in the field, but its adoption rate is dramatically increasing and it has the potential to revolutionize the auto insurance industry.
Telematics refers to the use of wireless devices to transmit data in real time back to an organization. For insurance it is often used in the context of automobile policies: event data recording devices collect and transmit data on the vehicle location and usage, such as information on air bag deployments, how fast and distance traveled, and locate stolen vehicles by using GPS technology. The data recorded in the vehicle can then be used to develop more accurate pricing, improve the granularity in risk management and reduce losses by better assessments of claims.
Studies have shown, unsurprisingly, that the number of crash related claims increases based on mileage driven. For example, research by the U.K. Government in 2008 demonstrated that accident risk per mile on a highway is 80 percent less than on other roads. This raises questions about the relative risk of different driving profiles. What is riskier, An urban driver logging only 5,000 miles per year, or a regional sales manager who travels over 20,000 miles per year, but mostly on interstate highways? The analysis required to answer such questions shows that telematics on its own will not revolutionize the industry -- insurance companies need to use analytics to mine the vast amount of data that will be produced by the wireless devices. Using data mining techniques, insurers will be able to answer such questions and ultimately provide individually priced auto insurance based on a driver's past and forecasted driving behavior.
Pay-as-you-drive (PAYD, also known as usage-based or per-mile pricing) is the best known example of telematics. This type of insurance is in the early stages of implementation at a number of insurers across the United States, with many other companies watching closely to see if this initiative is a success or not.
Pay as you drive types can be broken down into three categories:
1. Mileage rate factors (MRF): Insurers offer a discount based on drivers who drive less than a specific amount, e.g., 8,000 miles. Often this mileage is based on self-reported estimates or third party odometer readings.
2. Per-mile Premiums (PMP): Insurance is sold by the mile rather by term. For example, the insured may purchase 10,000 miles worth of coverage.
3. GPS-based pricing: GPS devices installed in vehicles are used to price insurance based on time, distance and location. For example, a driver might pay 8 cents per mile for urban-peak driving, 6 cents per mile for urban off-peak driving and 3 cents per mile in rural areas.
In 1999, Progressive was the first insurer to launch a PAYD product. Initially only available in one state, today Progressive's telematics offering, Snapshot, is available in 27 States. Since then the adoption rate of this technology has been slower than expected, due to a number of factors. However, many objections to telematics have been shown to be unfounded, such as privacy concerns (in 2009 California passed a law allowing PAYD in the States); the cost of technology ("black box" telematics devices installed in cars are often under $100); or lack of standardized data (by 2012 all US vehicles must comply with minimum data standard, and all European cars must be equipped with eCall emergency calling capabilities by 2015).
Currently, the telematics proposition for customers is based on pricing. In the U.S. insurers are targeting, low-distance and safe drivers with lower premium rates. In the U.K., insurers are marketing to inexperienced drivers who are often "uninsurable" under the traditional pricing mechanism.
From an insurer's perspective, protecting existing book of business from competitors and growing revenue through new markets are the primary reasons why carriers are implementing telematics. However other benefits of telematics include the ability to improve claims processing. Vehicles fitted with telematics devices can have a dramatic impact on claims cycle times -- shortening the time between an accident and a report date can save insurers money. Plus the location data can help to reduce organized fraud. According, to a Celent report, one European insurer observed over 10 percent lower claims frequency for customers using telematics than those not in the program. Finally, insurers can also benefit from the market perception of introducing a "green" product that reduces road usage and lowers car emissions.
Telematics has a long way to go, but carriers who move early can gain from capturing the safest drivers, taking advantage of competitive pricing while reducing claim losses.
About the Author: Stuart Rose is global insurance marketing manager at Cary, N.C.-based SAS. Rose, a 20-year veteran of the insurance industry, began his career as an actuary. He has worked for a global insurance carrier in both its life and property divisions and has worked for several software vendors, where he was responsible for marketing, product management and application development. He has driven successful development and implementation of enterprise systems with insurance companies in the U.S., the U.K., South Africa and Continental Europe.