Pay-by-the-Kilometre Auto Insurance: A Proposal
An essay by Robert D. Cameron, November 1995.
Reducing our dependence on the private automobile and
encouraging alternative forms of transportation are widely
recognized as important objectives in maintaining or improving
the safety of our streets and the quality of our air. With a
public sector regime of automobile insurance in B.C., we have a
powerful tool for achieving such public policy objectives. By
switching to a pay-by-the-kilometre system from the present
pay-by-the-year approach, powerful economic incentives can be
created to encourage alternative forms of transportation.
In a pay-by-the-kilometre system there is a marginal cost of
insurance for every kilometre you drive. You pay extra if you
drive extra. You save money if you drive less. A pay-by-the-year
system, on the other hand, imposes a high fixed annual cost of
insurance, but no marginal cost depending on the amount driven.
Indeed, once you have paid your annual insurance fee, you are
virtually encouraged to do unlimited driving: use it or lose it.
To illustrate one approach to pay-by-the-kilometre insurance,
consider the following example. Suppose that Owners A and B have similar
vehicles and driving records and that their cost for
insurance is $800 per 10,000 km, plus a $200 fixed amount per
year. Owner A anticipates driving about 20,000 km in the next
year and hence purchases 20,000 km worth of insurance for $1800.
Driving more heavily than anticipated, however, A uses up the
20,000 km quota within nine months and must renew his or her
insurance early. On the other hand, Owner B, who decides to start
car-pooling and making frequent use of public transit,
anticipates needing only 10,000 km worth of insurance for the
year, costing $1000. At the end of the year, B has only driven
9,000 km and is hence entitled to a $80 rebate for the
unused 1000 km.
These are, of course, merely simplified examples of how such a
system might work; there are many other ways in which a
pay-by-the-kilometre system could be achieved. However, the key
aspect of a pay-by-the-kilometre system is that it creates a
marginal cost for every kilometre driven. Every single decision
to drive bears additional insurance cost while every decision not
to drive reduces insurance cost. Thus, at any point in time,
regardless of past actions, an owner has a further economic
incentive not to drive.
With this simple model in mind, then, I invite your to further
explore this topic and consider all the following claims for a
pay-by-the-kilometre system.
How significant is the disincentive to drive? To get an idea,
let's use some ballpark
figures for an "average" driver. Under the
pay-by-the-year system, let's assume that this driver presently
chalks up 15,000 km on the road, pays $1500 in gasoline and
maintenance and $1400 in insurance. Under a pay-by-the-year
system, the insurance cost is a fixed annual fee and the marginal
cost of each kilometre driven is $1500/15000 or 10 cents. This is
how much additional our driver would pay for each kilometre
driven or how much he'd save by not driving. For example, a
two-person carpool on a 40 km trip saves $4.00 by driving one
vehicle instead of two. Under a pay-by-the-kilometre system,
however, the fixed annual cost of insurance might only be $200,
with a marginal cost of $800 per every 10,000 km. Based on 15,000
kms of annual driving, the marginal cost per km is ($1500 +
$1200)/15,000 or 18 cents. Now the two-person carpool on a 40 km
trip saves $7.20 in vehicle costs, an 80% increase! Thus, under a
pay-by-the-kilometre system, the disincentive to drive should be
dramatically and effectively increased.
Unfortunately, this dramatic increase in the disincentive to
drive will not translate into an equally dramatic reduction in
the total amount driven. In economic terms, the demand to drive
is relatively inelastic of the cost of driving. In other words,
most people consider most of their driving to be a necessity and
will not reduce their overall driving much if the price goes up.
Even with an 80% increase in the marginal cost of driving, it
seems reasonable
to expect that typical drivers would only cut back by 10-15% on
the amount of driving they do. It should also be noted that the
total amount of driving would not be reduced by quite as much,
because the lower fixed annual cost of insurance would allow for Good Driving Records are Still Important.
In the present use-classification system in B.C., good driving
discounts of up to 40% are available for those with long periods
of claims-free driving. A similar program of discounts would also
apply under a pay-by-the-kilometre system. The discounts may even
be higher because they must be earned by actual performance.
Under pay-by-the-year insurance, good-driving discounts depend
on the number of years of claims-free driving. Consider driver A
who has driven safely 2000 km per year for 4 years and driver B
who has driven safely for 20000 km per year for 2 years (no
previous records available for either driver). Driver A qualifies
for a 40% discount based on 8000 km of claims-free driving,
whereas driver B qualifies for only a 20% discount based on 40000
km of claims-free driving. The discount rates do not reflect the
actual driving performance.
In a pay-by-the-kilometre system, it makes sense to base
driving discounts on the number of claims-free kilometres driven.
If, as one would expect, this measure is more accurate in
predicting accident probabilities than the number of claims-free
years, it is possible that safe driving discounts beyond 40%
would be available to exceptionally safe drivers.
Another very appealing aspect of a pay-by-the-kilometre system
is that bad drivers would pay heavily for every kilometre driven.
This would create a very strong incentive for bad drivers to
drive the minimum amount possible. Under the present system, bad
drivers face high annual premiums but may nevertheless decide to
buy insurance for the year. Having paid dearly for insurance,
however, the bad driver will be strongly motivated to drive as
much as possible in order to justify the high price paid for
insurance.
The goal of a pay-by-the-kilometre system is to decrease the
overall amount driven by increasing the marginal cost of driving.
A major benefit of this would be to help reduce our high rate of
automobile accidents. In fact, I believe that a reduction in the
amount driven would lead to a more than proportional
reduction in the accident rate. This is because many accidents
occur when two vehicles are crossing paths. For example, if there
are 100 cars each travelling in North-South and East-West
directions, there are potentially 10,000 path crossings. If,
however, the number of cars in each direction is reduced to 90,
there would only be 8,100 potential path crossings. Thus a 10%
reduction in the number of vehicles travelling at any time would
provide almost a 20% reduction in the number of path crossings,
and presumably, a 20% reduction in the number of accidents due to
path crossings. Although this analysis is quite simplistic, I
believe that the "path crossing" phenomenon is an
important contributing factor in accident rates. It also helps
explain why the increase in automobile traffic in the last few
years has been accompanied by a more than proportional increase
in automobile accidents and hence fairly large increases in ICBC
rates.
Public transit is heavily subsidized in B.C and generally has
substantial excess capacity (seats available). If a
pay-by-the-kilometre system for car insurance encourages people
to use public transit more often, the subsidies for transit may
be reduced.
A pay-by-the-kilometre system is more equitable than a
pay-by-the-year system. Every kilometre you drive increases your
risk of having an accident and ICBC's risk of having to pay for
your accident. In a pay-by-the-kilometre system, you pay for each
kilometre you drive and hence each increment of risk you
voluntarily undertake. In total, each driver pays for the risks
of his or her own driving. Conversely, the pay-by-the-year system
has the effect of redistributing wealth from those who drive less
frequently to those who drive more frequently.
The present pay-by-the-year system of insurance tends to shut
out the occasional drivers---ones who would drive only a small
number of times per month. With the high fixed-cost of annual
insurance, occasional drivers must choose to abandon driving
altogether or incur a very high insurance cost for the small
amount of driving they want to do.
As a public policy objective, however, we should be
encouraging people to rely more on public transit and drive only
occasionally. Occasional drivers should not be punished by
denying them reasonably priced insurance; they should be
encouraged! A pay-by-the-kilometre system of insurance would
support this by substantially lowering the fixed annual insurance
costs and allowing people to pay for actual kilometres driven on
an incremental basis.
Another advantage of the pay-by-the-kilometre system is that
it eliminates an inherent injustice due to the arbitrary
boundaries that exist in the use classification system. An
arbitrary boundaries, for example, is a policy that would allow
you to drive your car 6 days per month to work or school under
the pleasure-use only category, but not 7 days.
How would you feel if you used your car for commuting 7 days
per month and hence had to pay a considerably higher insurance
rate than those who commute only 6 days per month? What if your
commute was quite short and you considered that your 7 days of
commuting involved much less driving than the typical 6
day-a-month commuter? Unfortunately, many people would feel
cheated by an unfair system and would feel justified in cheating
the system in return.
A similar arbitrary boundary in the present system is the
discount given for being less than 15 km away from your place of
work. How is it fair that someone living 16 km away from work and
commuting only three days a week is asked to pay more than
someone living 14 km from work but commuting 5 days a week?
In a pay-by-the-kilometre system, there is no need for a use
classification system and the problems it entails. People who
drive for pleasure only would presumably pay less than average
for insurance because they drive fewer kilometres than average.
Full-time business use would require larger insurance payments
proportional to the greater distance driven.
In addition to its other virtues, a pay-by-the-kilometre
system should also encourage people to drive more fuel-efficient
vehicles. The present system of insurance imposes a relatively
high cost for each vehicle owned. If it weren't for the insurance
costs, many people would choose to own and drive two vehicles: a
small, fuel-efficient car for commuting and a second vehicle such
as a truck or van for occasionally hauling loads or a luxury
automobile for driving vacations. However, the present system
discourages this and instead encourages people to own and drive a
single "compromise" vehicle---one which can be used
both for daily commuting and for other tasks. On the surface of
it, this has the apparently desirable effect of minimizing the
number of vehicles in circulation. Unfortunately, it means that
large numbers of fuel-inefficient vehicles are being used for
daily commuting.
This issue really involves a trade-off. Moving to a
pay-by-the-kilometre system should increase the use of
fuel-efficient vehicles, but will also increase the total number
of vehicles being driven. The environmental impact of a shift to
more fuel-efficient vehicles should be significant and positive.
The most fuel-efficient vehicles consume gasoline at rates below
5 litres per 100 km, while "compromise" vehicles may
consume gasoline at 15 litres per 100 km or higher. I assume that
a three-fold decrease in the amount of gasoline consumed should
produce a concomitant reduction in the amount of pollutants
produced. Of course, I would not expect a three-fold improvement
on average, but it does indicate the potential for improvement
that exists.
The negative effect of the pay-by-the-kilometre system is that
it would increase the total number of vehicles insured. But this
does not necessarily mean that the total amount of driving
increases significantly. Even if you own two vehicles rather than
one, you can't drive them both at the same time! Furthermore, I
believe that the effect of having an increased number of vehicles
insured should be more than offset by the general disincentive to
drive provided by a pay-by-the-kilometre system. It is premature
to conclude that this particular issue resolves definitely in
favor of the pay-by-the-kilometre system, however; a more
detailed study would be necessary to evaluate the trade-offs
properly.
Because of the inherent fairness of paying insurance premiums
for the actual kilometres of driving risk undertaken, and the
lack of arbitrary, unfair boundaries as in the use classification
system, one should expect that a pay-by-the-kilometre system
becomes more respected than the present pay-by-the-year system
and that the tendency to cheat the system is reduced.
Nevertheless, good enforcement should be in place to keep
cheating to a minimum.
Enforcement of a pay-by-the-kilometre insurance would be based
on odometer readings recorded at the time of initial insurance
purchase and subject to various checks at other times. Random
odometer checks may take place at insurance renewal and/or
AirCare inspection. Police officers may check odometers for proof
of insurance at roadblocks or when issuing traffic citations.
Automobile service shops may be required to report uninsured
vehicles based on odometer readings.
Attempts to cheat a pay-by-the-kilometre system could be made
by buying insurance only for a small number of kilometres at the
start of the year and then winding the odometer back throughout
the year or disconnecting the odometer/speedometer altogether.
Disconnection seems the less likely strategy as it would be
highly visible to passengers. On the other hand, winding the
odometer back would be frequently required to ensure that it
always stays within the insured range. Cheaters are likely to
become sloppy, allowing the odometer to read out of the insured
range at times and subjecting themselves to detection by random
checks.
An additional strong deterrent to odometer tampering is that
evidence of the tampering---especially repeated
tampering---should become quite apparent in the forensic
investigation of any major accident. Furthermore, there will be
many other types of evidence that will show up large-scale
discrepancies in the number of kilometres driven versus the
number of kilometres insured.
Another mode of cheating may be to roll back the odometer by a
large amount just before insurance renewal in order to claim a
large rebate. It seems logical to minimize this by allowing, say,
a maximum 20% rebate at the end of the year (with higher prorated
rebates possible during the year).
Other enforcement mechanisms are possible, including the
possibility of installing tamperproof inertial-motion monitoring
equipment on suspect vehicles.
An alternative proposal for creating economic disincentives to
drive is to place a tax on fuel to pay for automobile insurance.
However, it has several major flaws:
- If B.C. registered vehicles purchase fuel out-of-province
(e.g., in a cross-border shopping trip), they would not
be paying the appropriate insurance fee and would hence
be uninsured. The incentive to buy fuel in the U.S. would
be greatly increased by additional fuel taxation.
- Vehicles registered and insured out-of-province should
not be subject to the fuel tax. This would require a
two-price system at service stations or a rebate system,
both of which seem awkward to implement. Tourism could
suffer.
- It goes overboard in taxing less fuel-efficient vehicles.
A vehicle using 16 litres per 100 km would pay twice the
insurance fees as a vehicle using 8 litres per 100 km,
for the same amount driven (and the same risk of accident
incurred). Although this might seem laudable
environmentally, it would be quite unfair from the
insurance point of view. Trucking firms would be
justifiably furious if they had to subsidize insurance
costs for everyone else.
Note that, on the issue of "taxing" fuel
consumption, the pay-by-the-kilometre approach lies somewhere
between the opposite extremes represented by the present
pay-by-the-year system and the fuel tax proposal.
Concluding Remarks
From the narrow perspective of insurance company executives,
the introduction of pay-by-the-kilometre is likely to be
considered too radical a departure from the present
pay-by-the-year system based on use classification. Public
opposition to the proposal would also come from those whose
insurance costs would rise due to the high amount of driving they
do. However, the negative public reaction should be muted by
several factors: the inherent fairness of the system, the
possibility for high-kilometrage drivers to reduce costs with a
second "commuting" vehicle, the fact that costs rise
most dramatically for bad drivers unless they cut back on their
driving, and the recognition of the overriding environmental and
quality-of-life objectives behind the system.
Further Reading
I apologize for the use of ball park figures in this essay. I
tried to make reasonable estimates based on my personal
knowledge. Therefore, the analysis presented here should only be
considered to indicate the trends that might be expected with a
switch to a pay-by-the-kilometre system, not the precise
quantitative improvements. A better analysis should use figures
based on actual driving statistics and insurance costs,
reasonable projections of these costs for a pay-by-the-kilometre
system and so on. This is an area for further work.
Robert D. Cameron
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