Pay-How-You-Drive Insurance Works

A new paper by Reimers and Shiller documents the effects of Pay-How-You-Drive (PHYD) insurance. The idea is to use telematics to monitor driver behavior and to reward better drivers with discounted premiums. While Progressive initiated monitoring driver behavior for insurance purposes, other companies are getting in on it too. Reimers and Shiller cleverly exploit the staggered rollout across states to observe company profitability and driver fatalities.

First, they find that the first mover earns a profit boost. But this is temporary and dissipates with entry. That is, PHYD offers no sustainable competitive advantage to the first-mover. This seems to meet our expectations as there are few barriers to other insurers implementing PHYD systems. But  profit erosion with four or five firms also suggests that auto insurance markets are pretty competitive.

Second, they find that driver fatalities fall. PHYD could affect either the adverse selection problem (better drivers sign up) or the moral hazard problem (you drive better when it is rewarded). If it was just adverse selection, then good drivers drive no better and bad drivers drive no worse. They are just sorted into insurance plans more efficiently. But if it works on moral hazard too, drivers who sign up drive better and collectively we are likely better off because driving has become safer.

Third, by examining PHYD, Reimers and Shiller have documented one of the many ways that information technology, in this case telematics, is improving market efficiency and saving lives.