The current system for setting car insurance rates is inequitable, with low-mileage drivers subsidizing the rates of high-mileage drivers. This pricing structure encourages drivers to drive more, congesting roadways and contributing to pollution.
To discourage nonessential driving, states could pass legislation allowing annual mileage rates to be a factor in car insurance, while the federal government could expand existing pilot projects that test the pay-as-you-drive (PAYD) model. Finally, as most benefits accrue not to insurance companies but instead to consumers or broader society, a tax credit for each PAYD policy issued by an insurance company, to be phased out once 5 million vehicles nationwide are structured as PAYD policies, is also recommended.
The current lump-sum pricing of auto insurance is inefficient and inequitable. Drivers who are similar in other respects — age, gender, location, driving safety record — pay nearly the same premiums if they drive five thousand or fifty thousand miles a year. Just as an all-you-can-eat restaurant encourages more eating, all-can-drive insurance pricing encourages more driving. That means more accidents, congestion, carbon emissions, local pollution, and dependence on oil. This pricing system is inequitable because low-mileage drivers subsidize insurance costs for high-mileage drivers, and low-income people drive fewer miles on average.
In this discussion paper, we propose and evaluate a simple alternative: pay-as-you-drive (PAYD) auto insurance. If all motorists paid for accident insurance per mile rather than in a lump sum, they would have an extra incentive to drive less. We estimate driving would decline by 8 percent nationwide, netting society the equivalent of about $50 billion to $60 billion a year by reducing driving-related harms. This driving reduction would reduce carbon dioxide emissions by 2 percent and oil consumption by about 4 percent. To put it in perspective, it would take a $1-per-gallon increase in the gasoline tax to achieve the same reduction in driving. Unlike an increase in the gas tax, PAYD would save most drivers money regardless of where they live. We estimate almost two-thirds of households would pay less for auto insurance, with each of those households saving an average of $270 per car.
Despite the large social benefits from PAYD, there are currently several barriers to its widespread adoption, including the cost to monitor miles traveled and some state insurance regulations. In order to facilitate the spread of PAYD, we propose a three-part strategy. First, states should pass legislation permitting mileage-based insurance premiums. Second, the federal government should increase the funding available to PAYD pilot programs by $15 million over five years. Finally, since the monitoring costs may exceed the expected benefit of PAYD to insurance firms but are much smaller than the social benefit, the federal government should offer a $100 tax credit for each new mileage-based policy that an insurance company writes, to be phased out once 5 million vehicles nationwide are covered by PAYD policies. In short, PAYD represents a win-win policy. What is good for drivers, in this case, is also good for society.