Usage Based Insurance: Modelling and Implications

Usage based insurance (UBI) is an exciting innovation that benefits both individual customers and society as a whole. We develop a dynamic model to study UBI from the policyholder's utility maximization perspective. An optimal decision process is formulated for an individual driver who is offered a choice between UBI and traditional insurance policies. We demonstrate that UBI does benefit the policyholder by reducing premium paid and increasing utility obtained from wealth. UBI may also improve overall social welfare by reducing the mileage of the policyholder. We further find that UBI is more (less) efficient than fuel price taxes in reducing mileage for low (high) mileage drivers due to the concavity of premiums. Finally, we derive a cut-off value of mileage below which policyholders drive with traditional insurance should switch to a UBI policy.