###### Distance-Based Vehicle Insurance

**A Practical Strategy for More Optimal Pricing**

By Todd Litman

*Victoria Transport Policy Institute*

12 November, 2023

**Abstract**. A significant portion of vehicle expenses are fixed, and
therefore not marginal. This is economically inefficient and results in
excessive automobile travel. Insurance premiums are particularly
appropriate for converting to distance-based charges. Newly available
data indicate that distance-based insurance pricing is more actuarially
accurate, and therefore more equitable and economically efficient than
current pricing. Distance-based insurance provides specific benefits
including reduced accidents, traffic congestion, and pollution, facility
cost savings, insurance affordability, and increased consumer welfare.
Vehicle travel foregone consists of low-value trips that consumers
willingly give up in exchange for financial savings. This paper
evaluates different distance-based insurance pricing options. Per-Mile
Premiums is found to provide the greatest net benefits. It would use
"odometer audits" to provide accurate mileage data, which is estimated
to have incremental costs averaging \$7.50 per vehicle year. Total
benefits are predicted to be many times greater than costs.

# 

**Note:** A more comprehensive and technically detailed version of this
paper is available from the author.

**What would be the consequences if gasoline were sold like vehicle
insurance?**

With gasoline sold by the car-year, vehicle owners would make one annual
advance payment allowing them to draw gasoline unrestricted at their
company's fuel stations. Prices would be based on the average cost of
supplying gasoline to vehicles with similar user profiles.

Unmetered fuel would cause a spiral of increased fuel consumption,
mileage, and total vehicle costs, including externalities such as
accident risk, congestion, pollution and infrastructure costs. Low
mileage (particularly lower income) drivers would simply drop out of the
system because their costs per mile would be excessive, leaving them
with fewer travel options. Of course, above average fuel users would
defend this system because they enjoy benefits.

Such a system would be irrational. It is comparable to current insurance
pricing.

# Introduction

There is growing interest in pricing instruments to address various
transport problems. Although most proposals focus on internalizing
externalities,[^1] converting fixed costs into variable costs provides
benefits of equal magnitude.[^2] Nearly a third of automobile costs are
external, and another quarter are internal but fixed, as illustrated in
Figure 1.

**Figure 1 Distribution of Automobile Costs**[^3]

![](media/image1.wmf)

This figure shows that a majority of automobile costs are either fixed
or external.

Figure 2 shows the distribution of motor vehicle expenses (financial
costs). Most are considered fixed with respect to vehicle travel. This
price structure encourages excessive driving since vehicle owners
perceive minimal savings when they reduce their mileage.

***Figure 2* Typical Financial Costs of an Intermediate Size Car**[^4]

![](media/image2.wmf)

*This figure illustrates the distribution of financial costs for an
intermediate size car.*

Although fixed vehicle expenses have increased during the last three
decades, variable costs have decreased in real terms. As a result,
variable costs as a portion of total costs have declined significantly
over the last several decades, as indicated in Figure 3.

***Figure 3* Variable Automobile Costs as a Portion of Total Costs**[^5]

![](media/image3.wmf)

Variable costs have declined as a portion of total vehicle expenses,
from almost 40% in 1950 to just over 20% in 1995.

Current insurance pricing fails to effectively represent marginal crash
costs.[^6] This creates a number of problems:

-   It is economically inefficient. It does not convey to drivers the
    true costs they impose, and deprives drivers of a chance to save
    money by avoiding costs. This reduces consumer choice.

-   It is unfair. It significantly overcharges low mileage vehicles and
    undercharges high mileage vehicles relative to their true crash risk
    costs.

-   Since lower income households tend to drive their vehicles less than
    average, it is regressive.

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-   In order to provide "affordable" but unlimited (in terms of mileage)
    insurance coverage, low-risk drivers are overcharged while
    higher-risk drivers are undercharged their true costs. This fails to
    provide efficient rationing of travel risk.

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-   The excessive driving that results from fixed insurance pricing
    (about 10% of vehicle travel) increases crashes, congestion, road
    and parking facility costs and pollution. Thus, the total economic
    inefficiency is several times greater than just the direct harm to
    insurance buyers.

Distance-based pricing converts insurance from a fixed cost into a
variable cost with respect to vehicle travel. This "marginalizes" crash
compensation costs, making premiums more actuarially accurate.
Distance-based insurance provides a positive financial incentive to
reduce mileage by returning to individual vehicle owners a greater share
of the insurance cost savings that result when they drive less. These
insurance savings are currently dispersed among all vehicles in a rate
class.

# Relationship Between Vehicle Travel and Crashes

Common sense indicates that a vehicle's crash risk is related to how
much it is driven. All else being equal, increased driving increases
crash risk. There is considerable empirical evidence indicating this
relationship.[^7] Insurance actuaries recognize it.[^8]

A given reduction in vehicle travel can cause proportionally *larger*
declines in crashes, since it reduces each vehicles' chances of both
*causing* a crash and *being hit by* another vehicle. About 70% of
crashes involve multiple vehicles. An average driver is culpable
(at-fault) in less than 50% of the crashes they are involved in. As a
result, a 10% reduction in a vehicle's mileage reduces that vehicle's
claim rate by 10%, and total claims, by as much as 17%, since it reduces
risks to other road users, including accidents caused by another
driver's error.

Available data on the relationship between mileage and crash rates is
almost entirely based on comparisons between different vehicles, which
underestimates the true crash reduction that results when individual
vehicles reduce their annual-mileage, since most factors that influence
crash rates are held constant. This further implies that crash
reductions and insurance claim cost savings should exceed travel
reductions, although how much is difficult to predict with available
data.

Low-mileage vehicles as a group tend to have higher crash rates per mile
than higher-mileage vehicles for the following reasons:[^9]

-   People with specific high-risk attributes related to age and
    physical disability tend to limit their annual mileage, while
    high-mileage drivers are likely to be relatively capable drivers.

-   Newer, mechanically safer vehicles tend to be driven more each year
    than older vehicles.

-   Urban drivers tend to have higher crash rates and lower annual
    vehicle-mileages.

-   High vehicle-mileage drivers tend to do a greater share of their
    travel on safer, grade-separated highways.

-   There may also be other types of offsetting behaviors, by which
    higher-mileage drivers take more precautions to limit their risk.

In the past, insurers and other road safety experts actually had little
information on the relationship between individual vehicles' annual
mileage and crash rates. The data were simply not available. Since 1993,
motor vehicles in the Greater Vancouver region have been required to
undergo emission tests prior to their annual registration. These
odometer readings have been matched to the insurance claim records of
specific vehicles, providing a unique database of the relationship
between crashes and claims.

***Figure 4* Distribution of Annual Vehicle Kilometres**[^10]

![](media/image4.wmf)

This figure shows the distribution of vehicle-kilometres.

Figure 5 illustrates the relationships between annual vehicle kilometres
and crash rates for all vehicles in aggregate. It shows that both
culpable and non-culpable crashes tend to increase with vehicle use in
the most common annual-kilometre ranges (0-40,000 km/yr).

***Figure 5* Crash Rates by Annual Vehicle-mileages**^10^

![](media/image5.wmf)*Crash rates tend to increase with annual
kilometres at the aggregate level.*

Figure 6 shows the crash rates for various major categories. Figure 7
illustrates crash rates for individual "RoadStar" rate classes (RoadStar
refers to vehicles with at least nine continuous years without a
culpable claim). Crash rates tend to increase with annual vehicle use in
all categories.

***Figure 6* Crashes Per Year By Major Category and Annual
Kilometres**^10^

![](media/image6.wmf)*All categories show a positive relationship
between crashes and vehicle travel.*

The evaluation by rate class is particularly important for this study
because it represents actuarial analysis. These graphs show clearly that
within specific pricing categories there is a strong positive
relationship between vehicle travel and crashes. This indicates that
distance-based pricing is essential for actuarial accurate pricing.

***Figure 7* Crashes Per Year By Individual Rate Classes**^10^

![](media/image7.wmf)*This figure shows that crash rates increase with
annual vehicle travel within rate classes.*

# Distance-Based Insurance Pricing Options

Three distance-based insurance pricing strategies are described in this
section.

## Mileage Rate Factor (MRF)[^11]

Vehicle insurance could become more distance-based by placing greater
weight on mileage in existing rate structures, based on drivers'
self-reported estimates of future travel. However, vehicle owners cannot
predict with certainty how many miles they will drive, and most vehicle
owners significantly underestimate their annual mileage if this reduces
their annual premiums. As a result, Mileage Rate Factor is inaccurate
and can only apply a small portion of the actuarially justified weight
on mileage.

## Pay-at-the-Pump (PATP)[^12]

Pay-at-the-pump uses a surcharge on fuel sales, vehicle registrations
and drivers licenses to fund basic insurance coverage. Proposed fuel
surcharge range from 15-50¢ per gallon, depending on coverage. Collision
and comprehensive coverages, non-gasoline vehicles, and driving in other
jurisdictions requires insurance purchased as it is now. Various
administrative systems have been proposed. Some establish government
insurance agencies, others have insurance companies bid on blocks of
vehicles, or funds distributed to private firms based on the number of
policies they sell.

A major disadvantage with PATP insurance is that it does not directly
incorporate drivers' risk factor. Low-risk drivers with fuel-intensive
vehicles would overpay their actuarially-justified insurance costs,
while high-risk drivers with fuel-efficient vehicles would underpay. To
address this, most proposals also include surcharges on higher-risk
drivers and vehicles to incorporate various risk factors.

A second disadvantage of PATP is that it would only cover about half of
total insurance premiums, only part of which would be distance-based. It
would encourage high mileage drivers to shift to non-gasoline vehicles,
resulting in mixed emission and energy consumption impacts.

Another disadvantage of PATP it that it could cause significant revenue
"leakage" from cross-borders and illegal fuel purchases. This would
introduce a new inequity, since drivers who have the opportunity and
inclination to purchase fuel across borders or illegally would have
their insurance costs subsidized by drivers who have less opportunity or
inclination.

PATP provides universal liability coverage (at least for gasoline
vehicles) which makes it attractive in jurisdictions with high rates of
uninsured driving. However, there are other ways to address this
problem. For example, uninsured driving is not a significant problem in
British Columbia due to the integration of vehicle insurance and
licensing transactions (vehicle owners must pay for insurance to obtain
license tabs). Distance-based insurance addresses a major cause of
uninsured motoring by making insurance more affordable. The added cost
recovery of uninsured motoring is expected to be more than offset by
losses through cross-border and illegal fuel purchases in many
jurisdictions.

## Per-Mile Premiums (PMP)[^13]

This strategy means that vehicle insurance is sold by the vehicle-mile
or -kilometer rather than the vehicle-year. Other rating factors are
incorporated into this price unit, so higher-risk vehicles would be
charged more per mile than would lower-risk vehicles. Table 1 shows an
example of this price structure.

***Table 1* Per-Mile Premiums for Selected Rate Classes**

+---------+---------+---------+--------+---------+---------+---------+
|         | **P     | **P     | **To   | **To    | **B     | **B     |
|         | leasure | leasure | Work,  | Work,   | usiness | usiness |
|         | Use,**  | Use,    | Urban  | Urban   | Use,    | Use,    |
|         |         | Urban   | Core** | F       | Urban   | Urban   |
|         | **Urban | F       |        | ringe** | Core**  | F       |
|         | Core**  | ringe** |        |         |         | ringe** |
+---------+---------+---------+--------+---------+---------+---------+
| Low     | \$0.020 | \$0.016 | \      | \$0.016 | \$0.026 | \$0.017 |
| er-risk |         |         | $0.027 |         |         |         |
+---------+---------+---------+--------+---------+---------+---------+
| Higher  | \$0.125 | \$0.094 | \      | \$0.087 | \$0.108 | \$0.088 |
| risk    |         |         | $0.111 |         |         |         |
+---------+---------+---------+--------+---------+---------+---------+

*Premiums vary depending on factors such as driver history, rate class
and territory.*

Per-Mile Premiums requires "odometer auditing" to collect accurate
vehicle-mileage data. Odometer audits would be performed when a
vehicle's insurance is renewed, in most cases once a year. Odometer
audits involve five steps:

1.  Check speedometer and instrument cluster for indications of
    tampering.

2.  Record tire size and check that it is within the specified range.

3.  Attach a small seal to the ends of mechanical odometer cables to
    indicate if it is removed. This is unnecessary on most newer
    vehicles that have electronic speedometers.

4.  Check odometer accuracy and calibrate with a dynamometer. (This step
    is optional, or could be performed on a spot-check basis.)

5.  Record odometer reading and forward results to the vehicle licensing
    agency.

Odometer audits typically require 5 to 10 minutes, or less if performed
with other vehicle servicing, with incremental cost of \$5 to \$10
(assuming chargeout rates of \$60 per hour). Governments would establish
odometer auditor certification programs and incorporate odometer data
into the vehicle registration database. Like many other certification
programs, odometer auditing could be self-supporting through fees.
Odometer auditors would typically be existing vehicle service stations
and emission inspection stations, and some insurance agencies might
become certified as a marketing strategy.

Most odometer fraud could be detected by auditing, through physical
evidence or by discrepancies in readings. Odometer audits should provide
data comparable in accuracy to what is used in other commercial
transactions, and far more accurate than self-reported information
currently used for insurance pricing. It would provide additional
benefits, including accurate mileage information to used vehicle buyers,
and data for transport planning. Other vehicle fees could become
distance-based and therefore more equitable and economically efficient
at minimal cost. Vehicle registration fees and taxes, which average
about \$150 per vehicle year in the U.S., would be particularly
appropriate.

# Comparison of Distance-Based Insurance Options

This section compares the impacts of the distance-based pricing options.

### Actuarial Accuracy

Both Mileage Rate Factor and PATP are significantly constrained in their
ability to accurately price crash risk. Mileage Rate Factor is
constrained by the weight that can be placed on mileage before
self-reported Estimated Future Travel is unacceptably understated. PATP
is constrained because it uses fuel consumption as a surrogate for
vehicle travel and then incorporates rating factors through fixed (not
distance-related) surcharges on vehicle registration fees and drivers'
licenses, resulting in a trade-off between actuarial accuracy and
distance-related pricing.

Per-Mile Premiums is unconstrained in incorporating risk factors.
Virtually any rating factor can be incorporated into the vehicle-mile
price unit. It is inherently superior to other alternatives in terms of
actuarial accuracy.

### Implementation Costs

Mileage Rate Factor using self-reported estimates of future travel has
the lowest implementation costs. PATP would have moderate to high
transition costs, since it requires establishing a new system to fund
basic insurance. It could reduce administrative costs for vehicles with
only basic insurance, but most drivers would need at least some
additional coverage, resulting in little overall savings.

Per-Mile Premiums requires a new rate plan and an odometer auditing
system. The majority (85-95%) of audits would probably be performed with
other scheduled servicing with an estimated incremental cost of \$5.00
per vehicle year, while a minority (5-15%) would pay a \$10 fee plus
another \$10 in travel and time costs, resulting in an average
incremental cost of \$7.50 per vehicle year.

### Travel Impacts

Distance-based insurance pricing provides vehicle owners with a new
opportunity to save money by reducing their driving. The magnitude of
these savings varies, from an average of about 0.7¢ per mile for Mileage
Rate Factor, to 1.7¢ per mile for PATP; up to about 5.6¢ per mile for
Per-Mile Premiums, or 6.9¢ if registration fees are also prorated. This
increase in potential savings effectively increases the variable cost of
driving (offset by a reduction in fixed costs) as indicated in Figure 8.

######## Figure 8 Distance-Based Insurance Impacts On Variable Vehicle Costs

![](media/image8.wmf)

This figure compares how each option increases the variable cost of
driving.

Figure 9 illustrates how the strategies increase perceived variable
costs. This would reduce vehicle travel.[^14] Drivers respond to
financial incentives by consolidating trips, shifting destinations,
changing modes, and foregoing lower-value travel.

***Figure 9* Variable Costs Compared**

![](media/image9.wmf)

*This figure compares how perceived variable costs are affected by the
different options.*

Distance-based insurance could increased vehicle ownership since it
reduces fixed costs. However, vehicle travel would probably not increase
significantly. Most additional vehicles are likely to be second
vehicles, such as an old truck or a collector car. These would
substitute for, rather than add to, existing travel. Only drivers who
purchase their first vehicle due to low fixed insurance costs would
increase vehicle travel, and their annual mileage should be low --
otherwise they would perceive no savings.

Some people suggest that Per-Mile Premiums may have little impact on
travel because payments are infrequent, resulting in several months
separating a typical trip and its incremental insurance cost. However,
total charges are large, involving hundreds of dollars per year, and
therefore highly visible to consumers. In a similar pricing situation,
there is little evidence that households using oil or wood fuel
purchased annually are less motivated to conserve heat than homeowners
using gas or electric heat which is paid monthly or bi-monthly. Most
drivers are likely to respond to this financial incentive, although
perhaps somewhat less than a more frequent fee.

***Table 2* Travel Reductions Estimates**[^15]

  ---------- ----------- ---------------- ------ ----------- ---------------
             **Mileage   **Vehicle Travel        **Mileage   **Vehicle
             Fee**       Reduction**             Fee**       Travel
                                                             Reduction**

             1¢          -2.3%                   6¢          -12.6%

             2¢          -4.5%                   7¢          -14.5%

             3¢          -6.6%                   8¢          -16.3%

             4¢          -8.7%                   9¢          -18.0%

             5¢          -10.7%                  10¢         -19.7%
  ---------- ----------- ---------------- ------ ----------- ---------------

Using standard elasticity values, such as those in Table 2, the travel
impacts of these price changes can be estimated, as summarized in Table
3.

***Table 3*** Predicted Travel Impacts

+------------------------+---------+------+-------------+-------------+
|                        | ###     | **PA | **Per-Mile  | **PMP &     |
|                        | # Milea | TP** | Premiums    | Prorated    |
|                        | ge Rate |      | (PMP)**     | Reg         |
|                        |  Factor |      |             | istration** |
+------------------------+---------+------+-------------+-------------+
| Increased variable     | 6%      | 13%  | 44%         | 54%         |
| cost                   |         |      |             |             |
+------------------------+---------+------+-------------+-------------+
| Travel reduction       | 1%      | 6%   | 10%         | 12.5%       |
+------------------------+---------+------+-------------+-------------+
| Avg. annual            | 125     | 750  | 1,250       | 1,563       |
| vehicle-miles reduced  |         |      |             |             |
+------------------------+---------+------+-------------+-------------+

### Crashes and Crash Costs

As previously described, vehicle travel reductions can provide
proportionally greater crash reductions by reducing each vehicles'
chances of causing a crash and being hit by others. Crash reductions of
1.2% are predicted for Mileage Rate Factor, and 7.2% for PATP. Per-Mile
Premiums provides even greater crash reductions because it gives
higher-risk drivers extra incentive to reduce mileage, resulting in a
14% crash reduction alone, and as much as a 15% reduction if implemented
with prorated registration fees.

### Energy and Emission

Mileage Rate Factor would provide little reduction in energy consumption
or emissions. PATP would reduce fuel consumption, and fuel related
emissions such as CO~2~, by up to 15% (depending on fuel switching and
fuel sale "leakages"), but other emissions (such as NOx and
particulates) would decline by smaller amounts. Per-Mile Premiums would
reduce energy consumption and all emissions by 10-12%.

### Congestion and facility cost savings

Reductions in vehicle travel tend to reduce traffic congestion, and road
and parking facility costs. One major pricing study found that a 2¢ per
mile mileage charge would reduce total vehicle travel by about 3.9-4.2%,
but congestion delays would decline by 7.5-10.5%.[^16] In other words,
congestion delay reductions were approximately twice as large as vehicle
travel reductions. Mileage Rate Factor would provide little benefit.
PATP would reduce vehicle travel by about 6%, providing modest benefits.
Per-Mile Premiums would reduce travel by 10-12%.

### Consumer Benefits and Costs

Marginal pricing benefits consumers by allowing them to purchase just
the quantity of goods they want. For example, consumers benefit if they
can purchase pizza by the slice, rather than being forced to buy an
entire pizza pie. Distance-based insurance allows consumers to purchase
just the amount of crash risk they can afford. Figure 10 shows how total
costs vary with mileage under the different pricing strategies. Impacts
on *total* vehicle costs are modest since insurance is just one of many
expenses.

***Figure 10* Comparison of Total Costs By Annual Mileage**

![](media/image10.wmf)

*This graph illustrates the effects different pricing options would have
on total costs of an intermediate-size automobile by annual
vehicle-mileages.*

Most consumers would benefit under Distance-Based Insurance. Motorists
who drivers their vehicles less than the current average for their rate
class (about 10,000 annual miles for urban motorists and 15,000 miles
for rural motorists) would save insurance costs.

***Figure 11* Comparison of Costs For Various Mileage Vehicles**

![](media/image11.wmf)

*This figure illustrates total annual costs for low-, average-, and
high-mileage vehicles. Numbers refer to annual mileage. PMP=Per-Mile
Premiums.*

Motorists are expected to reduce their average mileage by about 10%
under distance-based pricing, providing net savings to the vast majority
of consumers. Even high mileage drivers experience virtually increase in
total vehicle costs if they reduce their mileage as predicted.
Higher-mileage drivers would also benefit most from reduced traffic
congestion, accident risk, and pollution.

### Equity

Current insurance pricing is unfair (horizontally inequitable) since
premiums are not actuarially accurate, and regressive (vertically
inequitable) since lower income households tend to drive less than
average. Mileage Rate Factor slightly improves equity. PATP replaces
current inequities with new inequities: overcharging lower-risk drivers
with fuel inefficient vehicles who do not have access to untaxed fuel.
PATP is likely to be regressive as lower income households end up with
higher fuel consumption vehicles. Per-Mile Premiums is most equitable
because it accurately reflects crash costs (horizontal equity) and
provides the greatest savings to lower income households (vertical
equity).

### Affordability and Uninsured Driving

Distance-based insurance increases affordability by allowing consumers
to purchase just as much accident risk as they can afford. This reduces
the need for distortive cross-subsidies in current pricing to provide
"affordable" unlimited insurance even to high-risk drivers. Mileage Rate
Factor converts only a small portion of fixed costs to variable costs
and so provides minimal affordability benefits. PATP provides moderate
benefits since more than half of insurance costs would still be fixed.
Per-Mile Premiums shifts the most fixed costs to variable charges and so
offers the greatest affordability benefits. PATP reduces uninsured
driving by providing coverage for all gasoline vehicles. Per-Mile
Premiums reduces uninsured driving by making insurance affordable, and
could be particularly effective if matched with better enforcement of
insurance requirements.

### Economic Efficiency, Productivity and Development

Distance-based insurance directly increases economic efficiency by
making prices more accurately reflect marginal costs. It can also
increase economic productivity indirectly by reducing motor vehicle
externalities (congestion, crashes, roadway costs, etc.) and by shifting
consumer expenditures to goods that have greater employment generation.

Mileage Rate Factor provides little economic benefit. PATP does not
reflect marginal crash costs, and so does not increase economic
efficiency directly, but moderately reduces vehicle externalities.
However, PATP imposes significant economic costs to a particular
jurisdiction by increasing cross-border and illegal fuel sales. Per-Mile
Premiums provides the greatest economic benefits by most accurately
reflecting marginal costs and providing the greatest reduction in
vehicle externalities.

### Public Acceptability

There appears to be a modest majority of support for distance-based
insurance pricing as a TDM strategy.[^17] Of the three options there
appears to be least support for PATP. Mileage Rate Factor requires the
least change from current practices, but consumers may be uncomfortable
with pricing based on unverified data. Public acceptance of Per-Mile
Premiums appears to depend on policy makers' ability to demonstrate that
incremental costs (including consumer inconvenience) are significantly
smaller than benefits, and that it is equitable. If this is done there
is evidence that the public would accept this option.

# Summary of Benefits

Table 4 evaluates the three strategies in terms of the twelve criteria.
Mileage Rate Factor has the lowest implementation costs and ties for
public acceptability. PATP ties for reducing energy consumption, and
pollution emission and uninsured driving. Distance-Based Pricing is best
for eleven criteria.

***Table 4* Summary of Impacts (**= Best )

+------------------------------+-----------+-----------+--------------+
|                              | **Mileage | #### PATP | **Per-Mile   |
|                              | Rate      |           | Premiums**   |
|                              | Factor**  |           |              |
+------------------------------+-----------+-----------+--------------+
| Actuarial Accuracy           |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Implementation Costs         |          |           |              |
+------------------------------+-----------+-----------+--------------+
| Travel Impacts               |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Crash Reduction              |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Energy Use & Emission        |           |          |             |
| Reduction                    |           |           |              |
+------------------------------+-----------+-----------+--------------+
| Congestion & Facility Cost   |           |           |             |
| Savings                      |           |           |              |
+------------------------------+-----------+-----------+--------------+
| Consumer Surplus             |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Equity                       |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Affordability                |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Uninsured Driving            |           |          |             |
+------------------------------+-----------+-----------+--------------+
| Economic Efficiency          |           |           |             |
+------------------------------+-----------+-----------+--------------+
| Public Acceptability         |          |           |             |
+------------------------------+-----------+-----------+--------------+
| **Total Bests**              | **2**     | **2**     | **11**       |
+------------------------------+-----------+-----------+--------------+

Figure 12 summarizes estimated monetized benefits and costs in British
Columbia. This analysis indicates that all three options provide
benefits that exceed incremental costs. Per-Mile Premiums has the
greatest net benefits, with an estimated Benefit/Cost ratio greater than
50. This indicates that even if actual costs were significantly higher
than predicted, and benefits were lower, it is still a worthwhile
policy. Any one of the five monetized benefits would justify the
incremental costs of this strategy.

***Figure 12* Summary of Total Benefits and Costs**

![](media/image12.wmf) *This figure illustrates the total estimated
benefits (above the line) and costs (below the line). Only easily
quantified benefits are incorporated.*

# Conclusions

Distance-based insurance has many benefits: increased horizontal and
vertical equity, reduced crashes, increased economic efficiency and
productivity, and various TDM objectives. It achieves insurance
affordability by allowing consumers to purchase just as much accident
risk as they can afford, reducing the need for highly distortive
cross-subsidies from low- to high-risk drivers. Of the three strategies
considered:

-   *Mileage Rate Factor* is easiest to implement but is highly
    constrained. Only a small portion of the actuarially accurate weight
    can be placed on mileage before self-reported estimates of future
    vehicle travel become unacceptably distorted.

-   *Pay-at-the-Pump* has several problems. It is not actuarially
    accurate because payments are based on vehicle fuel efficiency, not
    risk factors. Less than half of insurance payments would be
    distance-based, and cross-border and illegal fuel purchases could
    become major problems. It reduces fuel consumption, but causes
    smaller vehicle travel reductions. It is almost as regressive as
    current pricing. It reduces uninsured driving, but there are more
    effective ways to address this problem. Although PATP is claimed to
    reduce administrative costs, most vehicle owners would need to
    purchase additional coverage, providing little true savings.

-   *Per-Mile Premiums* is the most effective strategy for achieving
    most objectives because it is most actuarially accurate and has the
    greatest impact on prices and vehicle travel. Virtually any risk
    factor can be incorporated into this price structure. It causes
    about twice the vehicle travel reduction as other distance-based
    insurance strategies, providing twice the reduction in traffic
    congestion, roadway and parking costs, and much greater consumer
    welfare benefits. It approximately equals PATP in pollution
    reduction. It is most effective at reducing vehicle crashes. It is
    the most fair (horizontal equity) and would provide the greatest
    financial benefit to lower income households (vertical equity).
    Odometer auditing could provide additional benefits, including a
    mileage record for used vehicle buyers, data for transport planning,
    and the ability to implement other distance-based pricing at
    virtually no added cost.

Since Per-Mile Premiums is theoretically best for achieving most
objectives, the question is whether it is technically, economically and
politically feasible. Our research indicates:

-   The only additional technical requirement is the collection of
    accurate vehicle-mileage data. Odometer audit accuracy could be
    comparable to other common commercial transactions if it includes
    reasonable measures to prevent and detect fraud. Much larger average
    financial transactions are currently based on odometer readings. By
    creating an accessible database of each vehicle's annual odometer
    readings, total odometer fraud should decline.

-   The incremental cost of an odometer audit is about \$10 when
    performed alone, or about \$5 when performed in conjunction with
    other scheduled vehicle maintenance, such as an oil change or
    emission inspection. The majority of vehicles (85-95%) would
    probably have audits integrated with other scheduled servicing.
    Total incremental costs, including vehicle owners' travel and time
    cost, are likely to average \$7.50 or less per vehicle year. The
    incremental costs of Per-Mile Premiums are much less than that of
    typical vehicle Inspection/Maintenance programs while providing much
    greater benefits.

-   There appears to already be willingness by consumers to consider
    distance-based pricing, despite the fact that most have only a vague
    idea of how it could be implemented, excessive estimates of
    implementation costs, and underestimates of total benefits. Since it
    has a number of favorable features that would result in net benefits
    to most households there seems to be considerable political
    potential if the full benefits can be effectively communicated to
    citizens.

***Appendix***

###### Answers to Common Concerns About Distance-Based Insurance

"But vehicle travel is already incorporated in insurance pricing."

Although some insurance companies incorporate mileage factors in their
pricing, none begins to approach actuarially accurate, marginal pricing.
Current pricing is unfair, since lower-mileage drives overpay, while
higher-mileage drivers underpay their true insurance costs. Current
pricing also fails to encourage efficient travel. Nobody wakes up in the
morning and says, "I'll take the bus today rather than drive to work
this morning to save insurance costs." Per-mile premiums would provide a
significant additional financial incentive to reduce driving.

"Shouldn't automobile insurance reform should focus on affordability and
safety?"

Distance-based insurance *does* significantly improve insurance
affordability and safety. It allows motorists to reduce their insurance
costs by limiting their vehicle use. It can reduce traffic crashes,
casualties and related costs by as much as 17%%, making it one of the
most effective traffic safety programs currently under consideration.
Per-mile premiums provides accurate crash rate information which will
allow more effective crash prevention programs and more precise
insurance pricing.

*"Wouldn't distance-based insurance unfairly increase costs to
high-mileage drivers (rural drivers, business drivers, etc.)?"*

High mileage motorists tend to have relatively low per-mile crash rates,
so their per-mile fees would be low. Drivers would only pay more for
insurance if they drive more than average *for their class*. For
example, a rural motorists who currently pays \$300 annually for
insurance would only pay 2¢ per mile, assuming that vehicles in their
class are driven an average of 15,000 miles annually. They would save if
they drove "only" 14,000 per year, even though that is greater than the
provincial average.

Even very high-mileage drivers would pay only slightly more in total
vehicle costs under distance-based insurance, since their other vehicle
expenses are relatively high. For example, although total vehicle costs
for a low-mileage (5,000 miles per year) driver would decline an average
of 14-17%, total costs for a high-mileage vehicle would increase just 1%
on average, due to the relatively small portion of total costs that
insurance represents for high-mileage vehicles, and the expected
reduction in mileage. Incremental costs would be even lower as a
percentage of costs for businesses, which pay wages and per diem in
addition to vehicle expenses.

Per-mile premiums more accurately reflect individual motorists' crash
risk than is possible with current pricing. Any price increase that does
result from a shift to distance-based insurance indicates that
higher-mileage drivers are currently being subsidized at the expense of
lower-mileage motorists in their rate class. Since vehicle use tends to
increase with income, distance-based insurance is progressive. It is
therefore inaccurate to argue that price increases for higher mileage
drivers are "unfair."

*"Wouldn't it require an enormous increase in administrative costs to
insurers, and inconvenience to vehicle owners?"*

Per-mile premiums require odometer audits, which are predicted to have
an average incremental cost of about \$7.50 per vehicle year. Most
audits are expected to be performed in conjunction with other vehicle
servicing at minimal extra cost. This represents an incremental cost of
only about 1%, and a net savings of \$62.50 for average drivers who
reduce their mileage the expected 10%. Similarly, incremental
administrative costs to insurance companies should be more than offset
by the predicted 10-15% reduction in claim costs.

To put this cost into perspective, vehicle emission inspections
typically cost \$10-20 plus drivers' travel and time costs, to achieve a
reduction in tailpipe emissions that is approximately the same as what
would be provided by Per-Mile Premiums. Thus, current inspection
programs impose incremental cost three to four times greater than what
is predicted for Mileage Pricing, while providing only a small portion
of the total benefits, since they do nothing to reduce accidents,
traffic congestion, infrastructure costs, or consumer costs.

*"Won't odometer fraud will become a major problem."*

A number of financial transactions already depend on odometer readings,
including warranty determinations, rentals and leasing charges, vehicle
resale value, and expense reimbursement. Vehicle owners can often gain
thousands of dollars by rolling back odometers, but most would never do
so. The benefits are simply not worth the risks. Odometer fraud is
primarily a problem among used car dealers, particularly when selling
high-mileage, late model vehicles. Fraud is likely to be significantly
lower for distance-based insurance, because:

1.  New vehicle odometers are increasingly tamper-resistant. Within a
    few years the majority of new vehicles sold are likely to have
    digital odometers that are extremely tamper resistant.

2.  Vehicle owners would have a relatively small incentive for fraud, a
    tenth of what vehicle dealers typically gain.

3.  Private vehicle owners don't have ready access to professional
    "clockers." Amateurs often damage equipment or leave marks,
    resulting in high costs and penalties.

4.  Discovery of odometer fraud would void insurance coverage. Most
    forms of fraud can be detected during a crash investigation, voiding
    the coverage. This would discourage odometer tampering and reduce
    insurance company's risk of losses.

5.  Annual odometer audits would provide a database that would allow
    used vehicle purchasers to identify discrepancies, making tampering
    easy to spot. It should virtually eliminate odometer tampering by
    vehicle sellers, so total odometer fraud is likely to decline.[^18]

Although some odometer fraud is likely to occur under distance-based
pricing, it is not expected to occur at a particularly high rate, and
the overall rate of odometer fraud is expected to decline due to regular
odometer audits. Even if as many as 2-4% of vehicle owners altered their
odometers to disguise half their true mileage each year (actual fraud
rates are likely to be lower), only 1-2% of mileage charges would be
"stolen," and if the tampering is discovered during a claim
investigation, insurance coverage would be void, resulting in no theft
at all. Fraud rates are likely to be within the range of other common
consumer transactions, and far lower than with current insurance
pricing, which is based on self-reported estimates of annual mileage or
commute distance, and other factors that are seldom verified and which
have minimal penalties.

*"Isn't vehicle insurance an inappropriate way to address transportation
problems?"*

There are compelling insurance fairness, affordability and safety
reasons to implement distance-based insurance. The current insurance
pricing system is less fair, less affordable, and results in
significantly more crashes than would occur under distance-based
pricing. Society has long recognized that it has an interest in
regulating vehicle insurance for a variety of objectives, virtually all
of which are achieved by implementing distance-based insurance.

*"But this type of pricing has never been used before."*

It is true that distance-based vehicle insurance has not been
implemented exactly as proposed here, but there is nothing unique or new
with such pricing. Most goods are priced based on some measure of
consumption. Imagine what would happen if electricity, fuel or food were
sold with a fixed price that allowed virtually unlimited consumption.
Vehicle insurance is unusual among major consumer goods for having
pricing that allows unlimited consumption. In fact, a portion of vehicle
insurance is already distance-based: Insurance rates for vehicle fleets
and commercial vehicles are commonly based on annual mileage. Insurance
companies have tried various forms of distance-based pricing in the
past. However, they have found that self-reported mileage data is
unreliable. The unique feature of this proposal is the use of verified
mileage readings using an odometer audit.

"Drivers will not actually respond to this incentive." "There will be no
reduction in vehicle use or crashes." "It is paid too infrequently to
affect travel decisions."

Per-mile premiums would significantly increase marginal vehicle costs,
approximately equivalent to a doubling of fuel prices. There is
extensive evidence that price incentives affect consumption patterns,
particularly over the long term. Consider how consumers respond to
advertised sales, the various measures that homeowners take to insulate
their homes to save heating costs, and the enthusiasm for marketing
strategies such as frequent-flyer benefits. Standard estimates of the
effects of price changes on vehicle travel indicate that per-mile
insurance pricing should reduce vehicle use by about 10%.

"If it makes vehicle ownership more affordable, won't that lead to
increased traffic?"

Distance-based insurance would significantly reduce vehicle ownership
costs, allowing some households to own more vehicles, but this is not
expected to increase total vehicle travel. Since most drivers in North
America already own a vehicle, most of the increased vehicles are likely
to be second vehicles that are owned for special uses, such as an old
truck used occasionally to haul gardening supplies, or a sport vehicle
that is only used for recreational travel. Most of this driving will
therefore substitute for other vehicle use, rather than add to total
household automobile travel.

A small number of households may use this opportunity to purchase their
first vehicle, but these will receive little use. After all, if they are
used more than a moderate amount, households would perceive no savings
over current insurance pricing. Thus, the total increase in vehicle
travel that results from reduced vehicle ownership costs should be
overwhelmed by the total reduction in vehicle use from higher vehicle
operating costs.

"Wouldn't odometer auditing be an invasion of privacy?"

Odometer auditing simply records odometer readings. It does not identify
when or where a vehicle has been used. Odometer readings are already
collected on vehicle sales, during emission inspections, and by vehicle
service businesses.

"Consumers may dislike not knowing their total insurance charges in
advance."

Distance-based insurance would be like most goods, the more you use, the
more you pay. While this makes insurance bills slightly less
predictable, it allows consumers to control their expenditures.
Consumers could easily calculate and predict their annual insurance bill
based on their odometer readings.

"Such a radical change will face too much political opposition to be
implemented."

Virtually any innovation is bound to face political opposition from
those who benefit from existing practices, regardless of how beneficial
overall. However, political opposition to distance-based insurance
should be minimal once citizens learn about the proposal, because it
offers so many benefits. Per-mile insurance is fairer than current
pricing, and reduces a broad range of problems. It benefits consumers,
drivers, local governments, businesses and the environment. Low mileage
drivers would benefit directly, and high mileage drivers would benefit
from reductions in congestion, accident risk and pollution. It can gain
support from a broad range of stakeholders and political groups.

[^1]: *Towards Fair and Efficient Pricing In Transport*, European
    Commission (Brussels;
    <http://europa.eu.int/en/record/green/gp9512/ind_tran.htm)>, 1997.

[^2]: Todd Litman, *Socially Optimal Transport Prices and Markets*,
    Victoria Transport Policy Institute (Victoria;
    www.islandnet.com/\~litman), 1998.

[^3]: Todd Litman, *Transportation Cost Analysis; Techniques, Estimates
    and Implications*, Victoria Transport Policy Institute (Victoria;
    [www.islandnet.com/\~litman)](http://www.islandnet.com/~litman)),
    1998.

[^4]: Jack Faucett Asso., *Cost of Owning and Operating Automobiles,
    Vans & Light Trucks, 1991*, FHWA.

[^5]: *Facts and Figures 95*, Motor Vehicle Manufacturers Association,
    1995, p. 58.

[^6]: William Vickrey, "Automobile Accidents, Tort Law, externalities,
    and Insurance: An Economist's Critique," *Law and Contemporary
    Problems*, 33, 1968, pp. 464-487.

[^7]: Aaron Edlin, *Per-Mile Premiums for Auto Insurance*, Dept. of
    Economics, University of California at Berkeley
    ([http://emlab.berkeley.edu/users/edlin)](mailto:edlin@econ.berkeley.edu)),
    1998.

[^8]: *Foundations of Casualty Actuarial Science*, 3^rd^ Edition,
    Casualty Actuarial Society (Arlington; www.casact.org), 1996, p. 35.
    Also see p. 242 and 250.

[^9]: Mary Janke, "Accidents, Mileage, and the Exaggeration of Risk,"
    *Accident Analysis and Prevention*, Vol. 23, No. 3, 1991, pp.
    183-188; Gerald Wilde, *Target Risk*, PDE Publications (Toronto),
    1994.

[^10]: Data from the Insurance Corporation of British Columbia (North
    Vancouver), 1998.

[^11]: Lyn Hundstad, Robert Bernstein, and Jerry Turem, *Impact Analysis
    of Weighting Auto Rating Factors to Comply with Proposition 103*,
    California Dept. of Insurance (Sacramento), 1994.

[^12]: Andrew Tobias, *Auto Insurance Alert*, Fireside (New York), 1993;
    Stephen Sugarman, *"Pay at the Pump" Auto Insurance*, Institute of
    Government Studies Press (Berkeley), 1993; Tom Wenzel, *Analysis of
    National Pay-as-you-Drive Insurance Systems and other Variable
    Driving Charges*, Energy & Environment Division, Lawrence Berkeley
    Laboratory (Berkeley), July 1995.

[^13]: Patrick Butler, *Operation of an Audited-Mile/Year Automobile
    Insurance System Under Pennsylvania Law*, National Organization for
    Women (Wash. DC; www.now.org), 1992; Todd Litman, "Distance Based
    Vehicle Insurance as a TDM Strategy," *Transportation Qrtly*, Vo.
    51, No. 3, Summer 1997, pp. 119-138.

[^14]: Olof Johansson and Lee Schipper, "Measuring the Long-Run Fuel
    Demand for Cars," *Journal of Transport Economics and Policy*, Vol.
    31, No. 3, 1997.

[^15]: Elizabeth Deakin and Greig Harvey, "The STEP Analysis Package,"
    in *Guidance on the Use of Market Mechanisms to Reduce
    Transportation Emissions*, USEPA (Washington DC;
    www.epa.gov/omswww/market.htm) Sept. 1997, Appendix B.

[^16]: Elizabeth Deakin and Greig Harvey, *Transportation Pricing
    Strategies for California: An Assessment of Congestion, Emissions,
    Energy, and Equity Impacts*, Calif. Air Resources Board
    (Sacramento), 1996. 7-16.

[^17]: Viewpoints Research, "A Comprehensive Overview of TDM Public
    Opinion Research," Greater Vancouver Regional District (Burnaby),
    1995.

[^18]: Many used vehicles purchasers pay as much as U.S.\$29.95 for
    vehicle odometer data (www.autocritic-us.com/autofacts.htm).