Pay-As-You-Drive Legislation is a Win-Win

Jason E. Bordoff and Pascal Noel
Pascal Noel
Pascal Noel Assistant Professor of Finance - University of Chicago Booth School of Business

February 12, 2009

In these tough economic times, consumers are looking everywhere for places to pinch pennies.

To save on gasoline, for example, drivers reduced miles traveled by 4 percent in 2008 compared to a year earlier. But drivers could have saved even more: they still had to pay the same amount for auto insurance, even though the likelihood of being involved in an accident decreased as they drove fewer miles.

A bill just introduced in the Washington State Senate would fix that disparity by encouraging firms to price auto insurance based on miles driven rather than in a lump sum amount per year. The idea is called “pay-as-you-drive” auto insurance.

Pricing auto insurance this way would not only save money for people who have already cut back on driving, but would also induce people to reduce miles driven even more in order to save, which of course has other benefits as well.

Under our current auto insurance system, drivers of similar characteristics and with comparable safety records pay nearly the same premiums if they drive 5,000 miles a year as if they drive 50,000 miles. Just as an all-you-can-eat restaurant encourages more eating, all-you-can-drive insurance pricing leads people to drive more.

In a study we conducted for the Hamilton Project at the Brookings Institution, we estimated that under pay-as-you-drive, roughly two-thirds of households would save money with an average saving of roughly $270 per car. The numbers are similar in the state of Washington—60 percent of households save money with an average saving of $278 per car.

Inducing people to drive less would not only save them money on insurance, but it would also reduce oil dependence, carbon emissions, accidents, congestion, and local pollution. If all motorists paid for accident insurance per mile driven rather than in a lump sum per year, that extra incentive to drive less would lead to an 8 percent reduction in miles driven, both in Washington and nationwide.

To put that in perspective, it would take a $1-a-gallon increase in the gas tax to achieve the same reduction in driving (based on 2007 gas prices). We estimate the total social benefits to be around $50 billion per year nationwide and around $800 million in the state of Washington alone.

Currently, state regulations often do not permit pay-as-you-drive insurance, which is why the pending legislation was introduced in the State Senate. Other states are also catching on to the idea’s promise. The California Insurance Commissioner recently issued regulations permitting firms to offer pay-as-you-drive. Progressive Insurance recently launched a version of this idea in several states.

Washington has experience with it too; in March 2007, King County used a grant from the Federal Highway Administration (FHWA) to implement a pilot program with Unigard, a Bellevue-based insurance company.

One concern with pay-as-you-drive is privacy. Insurance firms would have to monitor how many miles you drive. But the program is entirely voluntary, and there are ways to do it that do not require use of an electronic device in your car to track miles driven, such as with periodic odometer readings.

Another concern is that per-mile pricing of insurance would adversely affect people in rural areas or with low-incomes. But our study found that an equal proportion of urban and rural drivers would save under this system. The reason is that premiums would still be adjusted for various risk factors, and geography is a key risk factor.

We also found that low-income people actually benefit disproportionately because they tend to drive fewer miles and, currently, low-mileage drivers subsidize insurance costs for high-mileage drivers.

The pay-as-you-drive proposal pending in the Washington State Senate is win-win: it saves most drivers money while also addressing climate change, lowering our dependence on oil, alleviating congested roadways, and reducing a range of other driving-related harms. What’s good for drivers, in this case, is also good for society.