The insurance industry has recently started offering usage-based automobile insurance (UBI), also known as pay how you drive insurance (PHYD) or pay as you drive insurance (PAYD), and it could mean substantial savings for some drivers.

What Is Usage-Based Insurance?

Usage-based insurance is a new development that has revolutionized underwriting. Insurers reward good driving with lower rates on the assumption that better drivers are likely to be involved in fewer accidents and file fewer claims. Traditional underwriting methods determine premium costs by assessing drivers based on aggregated data, such as driving records, insurance scores, and demographic categories like age, gender, and marital status (find out what are The Top 5 Factors That Affect Your Auto Insurance Premium).

Usage-based insurance, on the other hand, electronically tracks individual driver behavior and transmits the collected data wirelessly, allowing policies to be priced based on how well the individual policyholder drives—not how well other people in their demographic drive.

Tracking Your Driving Behavior

Telematics first appeared in North America about a decade ago, and it’s now beginning to build steam. Europe already uses it extensively and SMA Research estimates that about 70% of all U.S. auto insurance carriers will use telematics by 2020. According to the Center for Insurance Policy and Research, as of May 2014 insurers in every part of the country, save for California, New Mexico, Puerto Rico, the Virgin Islands, and Guam, offer UBI policies.

Usage-based insurance relies on driving data transmitted from a small on-board diagnostic device (OBD-II) to the insurance company. This data allows insurers to fine-tune the alignment of risk and insurance premiums. Every car and light truck built and sold in the United States after January 1, 1996 is equipped with an OBD-II diagnostic port for use with diagnostic devices. While OBD-II capabilities are widespread, some insurance companies use a GPS unit or a cellphone to stream data instead.

When you purchase UBI, the insurer normally charges you an up-front fee if you need a device and then gives you a quote for your annual premium. Adjustments to the premium usually occurs annually, although some companies offer monthly adjustments if their state permits it.

Drivers can access their driving data online or through an app to monitor their performance and make adjustments to earn discounts. Policyholders can usually opt out of a UBI policy at any time without penalty.

What Do Insurers Track?

Insurance companies use telematics to track driving patterns such as speed, acceleration, braking, distance traveled, time of day driven, and cornering. If you tend to drive during peak hours or at high speeds, your premium will be higher than it would be if you drove short distances and traveled at or under the speed limit.

Potential Benefits

Safe drivers could see immediate savings without having to spend years building a positive driving history. This is especially welcome news for young drivers, who often pay the most for automobile insurance and are typically very comfortable with technology. Nielsen’s 2015 Insurance Track survey found that Millennials are 44% more likely than others to use UBI for discounts.

Drivers also see the results quickly, especially if their state allows monthly premium adjustments. Drivers whose premiums are high as a result of traffic violations can reduce them by adjusting their driving habits and demonstrating safer behavior on the road.

UBI policies are also advantageous for those who drive outside peak hours or do not drive many miles, since these safer driving tendencies have, until now, been invisible to insurers. Some drivers have seen their premiums decrease up to 25% after switching to usage-based insurance.

Monitor itself encourages safer, smarter driving, which has the potential to make the roads a lot safer. This is especially so as UBI increases in popularity and drivers know that their conduct behind the wheel will directly affect their insurance costs. Telematics can also promote safer driving by allowing parents to monitor their children's driving behavior.

The data collected from tracking driver behavior also helps insurers combat insurance fraud, review accident data, and improve prevention measures against theft. All of this lowers the likelihood of policyholders filing claims, which translates to lower premiums.

Business owners with a fleet of vehicles can also enjoy benefits beyond lower rates, such as improved fleet safety and security, stolen vehicle tracking, and emergency crash response.

Important Considerations

Those interested in purchasing UBI should review the policy carefully so they understand what data the insurer tracks and whether they limit data collection. Without restrictions in place, telematics can collect almost any vehicle-related data. Privacy legislation may or may not protect you in your state, so it is extremely important that you understand what you are buying into.

You’ll want to know who can access your data and what measures the insurance company uses to protect it. Some states—but not all—have legislation that requires insurers to disclose their tracking practices and devices.

It's also important to note that telematics track behavior, but they do not track the causes of that behavior. For instance, if you slam the brakes because a child runs across the road, the tracking device will record your abrupt braking but not the reason that justified it. If you’re considering a UBI policy, you’ll want to inquire about how they will interpret your data, whether they will penalize you for occasional or unusual incidents, and whether there is an appeal or review process if you want to challenge a premium increase.

Also, be sure to check the period used to calculate your premium (monthly, bi-annually, or annually) so you can anticipate adjustments. Some policyholders will discover that a UBI policy costs them more than ordinary automobile insurance, so you’ll want to be able to withdraw penalty-free if needed.

Of course, you will want to know how the company calculates discounts and rate increases based on your data. Make sure that they cannot refuse a claim or cancel your policy because of the data they’ve collected, too.

Summary

Even though tracking driving behavior may sound ominous, usage-based insurance can offer fairer pricing for many drivers. Since it’s based on performance, not statistically-based assumptions, you can be sure that the insurance rate you pay is the one you earned.