With a GPS system attached to each insured vehicle, insurance companies are able

Question

With a GPS system attached to each insured vehicle, insurance companies are able to charge

usage-based insurance rates," depending on how (e.g., hard breaking, fast acceleration), how

much (mileage), when, and possibly where the insured vehicle is driven. Autograph (then

associated with Progressive), a rm that was awarded a U.S. patent in 2001, was shown to save

policy holders in Houston an average of 25% of what they were previously paying. (i) Why are

usage-based insurance rates lower than

at-rate insurance fees? Give two separate reasons and

explain. [Hint: One is associated with hidden information, one associated with hidden action.]

Explanation / Answer

reasons for usage based insurance rates being cheaper are:

1)The simplest form of usage based insurance bases the insurance costs simply on the number of miles driven. However, the general concept of pay as u drive includes any scheme where the insurance costs may depend not just on how much you drive but how, where, and when one drives.

Pay as you drive (PAYD) means that the insurance premium is calculated dynamically, typically according to the amount driven.

2) usage based insurance (i.e. the latter two types, in which vehicle information is automatically transmitted to the system) provides a much more immediate feedback loop to the driver, by changing the cost of insurance dynamically with a change of risk. This means drivers have a stronger incentive to adopt safer practices. For example, if a commuter switches to public transport or to working at home, this immediately reduces the risk of rush hour accidents. With usage based insurance, this reduction would be immediately reflected in the cost of car insurance for that month.

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