Telematics Limitations

With the amount of buzz around telematics you would think that we had just discovered free energy. The entire industry is scrambling to figure out what telematics means to the future of insurance and how to benefit from its arrival. As with any new technology, we need to look past the buzz and view the opportunity in context.

How much will telematics truly benefit the insurer versus the insured? Will the data be used to provide true usage-based insurance or will telematics simply become another discounting tool? Has the industry stumbled upon a perpetual motion machine or, once the dust settles, will telematics simply become an additional tool for insurers to segment their book in an attempt to manage their loss ratio?

The risk is that telematics may prove to be a red herring, tying up considerable insurer resources while ultimately not providing a significant differentiator for the policyholder value proposition. Will the costs required to implement and manage a telematics program, combined with the discounts offered to entice and retain policyholders, really benefit an industry looking to reduce its costs and shore up its bottom line?

Will the impact of telematics be any different than the introduction of credit scoring? My guess is probably not.

How the industry plans to leverage telematics in its day-to-day business is still unfolding. Some insurers may provide automatic discounts for those policyholders who opt into the program.

And it would make sense that additional discounts would be available as an incentive for good driving habits. At the end of the day, this approach really only provides the insured a discount on a traditional automobile policy.

In contrast, some companies may look to create true usage-based products based on the technology. Instead of looking at the typical risk factors and driver history, a true usage-based approach would calculate premiums based on current driver behaviour. Drive well this month and pay less; speed next month and pay the price.

In either case, the potential savings will need to take into consideration the insurer-borne costs of procuring, distributing and managing the devices. Progressive, the pioneer of telematics, uses the approach of taking “snapshots” of driver habits to minimize operational and communication costs.

With traditional credit scoring, there is the notion of predicting an individual’s risk-profile by looking at his or her ability to manage his or her credit. Consumers with a credit score exceeding an insurer’s internal threshold are offered a discount. Those who fall short pay more.

Like telematics, there are costs involved in managing a credit score program; namely the fees to access a third-party credit-scoring service. The incremental expense is viewed by the industry as a cost-effective way of segmenting portfolios given that there is no automatic discount and the cost of credit scoring is a fraction of the cost of telematics.

In Ontario, where credit scoring is not permitted on auto policies, telematics may be the next best option to effectively segment risk, provided that the insurers can manage the program in a cost-effective manner. Early adopters could benefit from the ability to capitalize on the new-found risk-profiling, but will need to continue to evolve to maintain actuarial advantage as others jump on the band-wagon.

One model of providing auto insurance using telematics is the broker-based approach, whereby a brokers’ association contracts with a computer software and services vendor. In this approach, the association would assist in managing the telematics data, devices and support.

While I would compliment such a partnership on its intent to try and provide a solution that benefits brokers and consumers, I worry that with this particular model, the overhead related to this middle layer would need to be picked up by the insurers.

The other challenge with this model is that insurers will also lose the operational control and ability to manage the data. It is more likely that an insurer would want to own its telematics data and use it as a competitive advantage as opposed to purchasing it from a third party. It came as no surprise that insurers such as Intact and Desjardins have launched their own, self-managed, telematics programs. Data is king and insurers are going to want as much of it as possible.

Another factor to consider is the longevity of the program compared to its up-front investment. This is not to say that telematics information will not prove valuable; but how the data is generated, stored and managed will change quickly and substantially over the next couple of years. Will insurers continue to distribute individual third-party devices or will the industry begin to standardize on the vehicle manufacturer’s robust on-board navigation and computing capabilities? As cars become “smarter” with technology such as automated collision prevention, the window of opportunity for an insurer to recover its investment on providing hardware is already starting to close. As an example, the recently announced 2015 GMC Canyon will include a Teen Driver Mode that allows parents to set a maximum speed as well as generate a “report card” of their teenagers’ driving. It is a very small leap for GMC to enter the telematics arena.

What is evident is that telematics is here and it will likely continue to generate buzz for some time. If it becomes more than an expensive discounting tool, this has yet to be seen and the insurers who seize the opportunity to focus on reducing their operational costs and improving ease of doing business may be better off than those out chasing a “red herring.”

In the end, only time will tell. Interested insurers looking at telematics will need to be cautious not to take the plunge too early, because the pricing model, providers and technology are quickly evolving.