Telematics. The New Auto Insurance

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1 Telematics The New Auto Insurance By Alex Laurie Telematic technologies are approaching a tipping point as obstacles to their widespread application are overcome in rapid succession. How are these technologies changing insurance pricing and value-added services for customers? Alex Laurie Specializes in pricing and reserve review support for P&C insurers. Towers Watson, St. Louis Telematic applications are becoming increasingly important for auto insurers in numerous countries as they seek to control claim costs, enhance pricing sophistication, improve profitability, and differentiate their policyholder products and services. Meanwhile, commercial fleet operators are increasingly harnessing the power of telematics not only for basic and enhanced vehicle tracking, but also for routing, fuel expense reduction, accident response, stolen vehicle recovery, and improved safety through driver education and behavior modification. The adoption of telematics offers significant benefits to multiple constituents (Figure 1). For years, carriers have understood the potential benefits of measuring how much, when, where and how vehicles are driven. While large fleets have led the early adoption of these technologies, the cost of telematic devices, mobile communication bandwidth and data storage have fallen to a point where many insurers believe mass rollout of telematics-supported auto insurance products and pricing is now (or soon will be) feasible. Telematics will fundamentally change how auto insurance is priced and, like predictive modeling over the last decade or two, could reshape the competitive landscape. It s no wonder, then, that so many auto insurers are testing telematic technologies and developing new products to harness the power of this information. Auto Insurance Pricing Opportunities For decades, insurers have competed vigorously to identify and measure risk characteristics that are predictive of loss propensity. The insurer that can best measure the expected cost of claims for individual policies holds a tremendous competitive advantage in risk selection and pricing. Without the benefit of actual driving behavior data, insurers have relied on proxies such as driver age and credit-based insurance score. Recent studies indicate that directly measuring driving behaviors can significantly improve pricing accuracy when combined with traditional rating factors. A few of the particularly useful characteristics in predicting claims are: What Is Telematics? Vehicle telematics is the technology of sending, receiving and storing information via telecommunication devices in vehicles. As Figure 1 shows, this technology has numerous applications. For auto insurance, setting premiums based on actual driving data is one important application. This practice has many names, including pay as you drive (PAYD), pay how you drive (PHYD) and usage-based insurance (UBI). Verified mileage and garaging Speeding Hard braking and cornering Day of week Time of day Type of road To underscore the predictive power of some of these characteristics, Figure 2 illustrates the disproportionate number of fatal crashes that occur on Friday and Saturday nights in the U.S., while Figure 3 shows that in Great Britain, road types have very different accident rates per mile traveled. 20 towerswatson.com

2 Figure 1. Benefits of adopting telematics Benefits to society Reduce accident frequency and severity (e.g., via driver incentives and education) Reduce accident response time Track and recover stolen vehicles Establish fault to improve equity in settling claims Reduce driving, pollution, traffic congestion and energy consumption Additional benefits to Insurers Consumers Fleets Correct risk misclassifications Enhance pricing accuracy Attract favorable risks Retain profitable accounts Fight fraudulent claims Reduce claim costs Enable lower premiums Replace proxy variables with intuitive variables directly related to loss exposure Differentiate brand Market environmentally friendly programs Reduce premiums Demonstrate safe driving habits following an accident Enjoy value-added services, including: Teen driver monitoring Emergency services Navigation/infotainment Stolen vehicle recovery Vehicle diagnostics Optimize routing Enhance customer service (on-time delivery and appointments) Reduce payroll Save fuel Reduce maintenance costs Reduce towing and repair costs via preventive diagnostics Monitor and improve driver safety Reduce premiums and self-insurance costs Auto liability Auto physical damage Workers compensation Inland marine Dispute parking and speeding tickets Figure 2. Distribution of fatal crashes by time of day and day of week U.S., 2009 Day of week Time of day Sunday Monday Tuesday Wednesday Thursday Friday Saturday Total 12 midnight to 2:59 a.m. 3.5% 1.0% 0.9% 1.1% 1.4% 1.7% 3.3% 12.8% 3 a.m. to 5:59 a.m. 2.1% 0.8% 0.7% 0.8% 0.9% 1.1% 2.0% 8.4% 6 a.m. to 8:59 a.m. 1.1% 1.5% 1.3% 1.3% 1.4% 1.4% 1.2% 9.1% 9 a.m. to 11:59 a.m. 1.3% 1.4% 1.3% 1.2% 1.3% 1.5% 1.6% 9.5% 12 noon to 2:59 p.m. 1.8% 1.9% 1.8% 1.6% 1.7% 2.0% 2.2% 12.9% 3 p.m. to 5:59 p.m. 2.3% 2.2% 2.2% 2.2% 2.1% 2.5% 2.6% 16.1% 6 p.m. to 8:59 p.m. 2.5% 2.0% 1.9% 2.0% 2.2% 2.6% 2.9% 16.2% 9 p.m. to 11:59 p.m. 1.7% 1.5% 1.6% 1.8% 1.9% 2.9% 2.9% 14.2% Unknown 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.2% 0.8% Total 16.2% 12.3% 11.7% 12.1% 13.0% 15.8% 18.8% 100% Source: National Highway Traffic Safety Administration, Fatality Analysis Reporting System Encyclopedia Figure 3. Accident rates by road type Great Britain, 2002 Road type Relative accident rate per mile Motorway 1.00 Urban A roads 8.26 Rural A roads 2.82 Source: Office for National Statistics Emphasis 2011/1 21

3 Insurance Pricing Alternatives With Telematic Data Particularly for personal auto insurance, state-of-theart pricing entails the application of multivariate statistical techniques to large, clean sets of historical data. Typical data sets contain fields representing all of the risk characteristics to be included in the pricing plan and records comprising many thousands (or millions) of vehicle-years of data and thousands of claims. The telematic data available to most carriers today fall short of these high standards in quantity, quality, structure and/or relevance. Until these data mature, actuaries will continue to face additional challenges in competing to best leverage the power of telematics to enhance pricing plans. Some alternative information sources to support creative solutions during this transition period include: Risk scores from external models or built with third-party data Publicly available pricing algorithms and studies Risk scores from external models or built with third-party data Some vendors offer scores designed to quantify the risk associated with a driver s or vehicle s telematic data, which enable carriers to use telematic scores without first gathering or modeling the data internally. This is analogous to purchasing off-the-shelf credit-based insurance scores. Externally supplied scores for driving behavior risk hold many of the same advantages, but, like the early versions of insurance scores, it is important for insurers to understand how they are developed in order make informed judgments about their relative quality and application. Some insurers that initially relied on vendor-supplied credit-based insurance scores later developed customized, proprietary scoring algorithms. It is possible that some carriers may rely upon external telematic risk scores initially, as a stepping stone to later generations of pricing plans that have greater customization to the insurer s book of business and specific telematic applications. Many carriers would prefer to analyze telematic data in-house, even if they rely on an external model initially. Insurers may acquire existing telematic databases from vendors in an effort to learn from telematic data before their own pilots provide sufficient data. These databases often contain driving data from vehicles they do not insure, so it may not be possible to associate these driving data with all of the policyholder characteristics that a carrier would ideally include in its analysis. However, analyzing external data can provide insights about relationships between driving behavior and accidents before data specific to the carrier s book are available. Publicly available pricing algorithms and studies Several carriers in various countries have introduced products that use telematic data to adjust pricing. In some jurisdictions, pricing algorithms are kept private by regulators; in others, the pricing plans enter the public domain. While a pricing plan used by another insurer may not be ideal for a carrier s book of business or its particular goals, it may suggest useful structures, variables and applications for telematic data. Often, me too filings serve as a reasonable starting point when an insurer lacks credible internal data for certain rating factors or geographies. Governments, academic institutions, insurers and other organizations have published studies that contain quantitative information about the relationships between driving behavior and accidents, or between driving behavior and other policyholder characteristics. Such studies may not provide a carrier with a ready-to-use pricing algorithm, but they can supply useful information to an organization seeking to assemble a complex new puzzle. 22 towerswatson.com

4 Figure 4. Alternative telematic strategies Challenges Carriers that offer telematics-based insurance products must address various challenges. History has taught us that these challenges cannot become excuses the advantage to early adopters is simply too great to forgo. (Recall the introductions of credit-based insurance scoring and predictive modeling.) Below, we outline several key challenges. Cost Simply put, the long-term benefits of the telematic program must exceed its costs. A program should not be introduced unless it makes economic sense for the carrier and some subset of its policyholders. Much has changed since the early days of telematics, when only large commercial fleets could afford widespread implementation. Thanks to the relentless advancement of technology, telematic devices have become smaller, faster, smarter and cheaper (as have the accompanying telecommunication services and data storage). These trends will continue. Judging by the considerable activity in the insurance telematics space in the past year, leading carriers clearly believe that the benefits will exceed the costs for sufficiently large policyholder segments. Insurers have important decisions to make about a telematic program s cost and value. There are many positions from which to choose on a spectrum that ranges from limited applications with minimal cost, to those that offer value-added services that appeal to customers (Figure 4). Of course, the right choices depend on the carrier s goals and the needs and preferences of its customers. Needs vary by geography and customer segment and differ for consumers versus fleets. Data management Insurers need to decide what type and quantity of data they want to manage internally, and what they want to outsource to telematic data providers to manage on their behalf. Minimize costs. Collect limited data. Applications of data will be limited (e.g., collect odometer readings for mileage-based pricing). Low cost Telematic technologies can generate volumes of data that are orders of magnitude larger than what insurers have dealt with historically. (Consider, for example, that some telematic devices generate second-by-second location data and sub-second accelerometer data for every vehicle in which they are installed.) Some insurers may wish to collect this raw data for internal analysis, while others may prefer to receive less voluminous data that have already been processed (such as recorded driving incidents that fall outside certain parameters). Also, having an independent intermediary collect, store and process the telematic data may allay concerns about insurers access to sensitive policyholder data. Privacy Many consumers are hesitant to share information about their driving behavior (such as speed and braking) with their insurers. Consumers are even more reluctant to share location data. Regulators, legislators and public policy personnel have concerns about the potential for mishandling or abuse of this type of information. Maximize value to policyholders and insurer. Consumers/fleets receive multiple services (as shown in Figure 1). Insurer collects data using flexible platform to support operations and analytics for pricing, underwriting, claims, loss control, marketing, etc. High value The long-term benefits of telematics must exceed the cost and should not be introduced unless it makes economic sense for the carrier and some subset of policyholders. Emphasis 2011/1 23

5 Patents and liabilities Prudent insurers should seek the advice of legal counsel to understand the risks associated with various insurance telematic options. For example: However, many people, especially younger people, are growing accustomed to location-based services. Devices such as smartphones, GPS units and toll collection devices are common in many countries. While some consumers may be unaware of how their location data are collected and used, others are aware and comfortable sharing these data in exchange for services they want. Consumers also tend to accept location-based services when they know the data will be used for limited purposes and will not be used against them. Telematic programs are generally voluntary, and they need not appeal to all consumers. A recent Towers Watson survey in the U.K. indicated that 64% of drivers would be prepared to alter their driving to achieve a 10% discount, and a majority of consumers would be willing to share speed, braking and location information. Some personal auto insurers in the U.S. have chosen to limit the information they collect by excluding location-based data. However, as societal understanding of telematic programs grows, it is likely more regulators will allow consumers to participate in location-based programs. For fleets, there are also important privacy considerations for example, a fleet s location data can contain sensitive competitive information. However, privacy issues are different when the driver is an employee who must accept certain company policies as a condition of employment. A number of auto insurers are conducting telematic pilots collecting driving data from employees, corporate vehicles and/or a subset of policyholders. Patents related to insurance telematics have been filed by companies in the insurance, automotive and technology sectors in various countries, and legal disputes have arisen regarding some of them. When an organization has access to dangerous driving or accident data, questions exist about whether they have a duty to analyze and act on them. Data sets with location information may include personally identifiable information, and additional laws and regulations may govern their treatment. Telematic Pilots A number of auto insurers are conducting telematic pilots collecting driving data from their employees, their corporate fleet vehicles and/or a subset of their policyholders. These pilots will provide the carriers with helpful information for evaluating telematic products, programs and strategies. However, due to the varying goals and designs of these pilots, some will be more effective than others in shaping telematic programs. Most telematic pilots seek to address fundamental operational and logistical questions. A few sample questions include: How promptly and successfully are policyholders installing/activating the devices (or having them professionally installed)? Are installation/activation challenges disproportionately affecting certain makes, models and model years of vehicles? What is the quality of the collected data? Does the data quality vary by vehicle type, policyholder type or geographic location? Do any unusual patterns exist in device disconnections or periods of missing data? 24 towerswatson.com

6 Some carriers see these pilots as opportunities to develop insights into additional areas such as customer motivations, driving behavior benchmarking, actuarial analysis and risk reduction effectiveness. Additional questions include: Which of my customers are most (and least) interested in these products? What do my customers like (and dislike) about these products? How could I make this product more appealing to my customers or more relevant to additional customer segments? What driving behaviors are normal versus indicative of high or low risk for a given type of customer, vehicle and geography? How different are claim frequency and severity for participants in the pilot versus otherwise comparable customers? What driving behaviors are most strongly correlated with claim activity? What types of driver feedback are most effective at reducing risky behavior and/or claims? Carriers that undertake telematic pilots to better understand how to market, design, operationalize and price their products will enter the next generation of auto insurance with a distinct competitive advantage. The Future of Auto Insurance Is Here There has been much speculation about when insurance telematic products will gain a significant share of the auto insurance market. While projections vary, it seems clear that the next three to five years will witness: Increasing consumer awareness, receptivity and demand Increasing clarity about the parameters for regulatory acceptance The introduction of first-generation telematic products by many more carriers (and secondand later-generation products by others) Competitive gains for insurers with leading telematic products at the expense of rivals More than a decade ago, leading insurers adopting credit-based insurance scores reaped great rewards as their competitors faced adverse selection and struggled to catch up. The same is occurring with telematics. While telematics presents a number of issues to overcome, the value proposition for insurance telematics is at least as compelling as that for credit-based insurance scoring. Policyholders (and regulators) understand the logical connection between driving behavior and accidents, and many like the idea of being able to influence their insurance costs through their own driving behavior. The pace of change is accelerating for insurance telematics, and the carriers that are acting now will be best positioned to attract and retain desirable policyholders for years to come. For comments or questions, call or Alex Laurie at , alex.laurie@towerswatson.com. Carriers that undertake telematic pilots will enter the next generation of auto insurance with a distinct competitive advantage. Emphasis 2011/1 25