Despite mandates requiring motorists to carry car insurance, 13 percent of US drivers operate vehicles without any coverage—a problem that exposes uninsured drivers to catastrophic financial risks and leads to higher premiums for insured drivers.
Many uninsured drivers take these risks on the road because they can’t afford the insurance contracts offered by legacy carriers, which often require purchasing several months of coverage up front.
Insurance technology can enable cash-strapped drivers to access shorter and more affordable durations of coverage.
But there may be a solution: Insurance technology can enable cash-strapped drivers to access shorter and more affordable durations of coverage. My research finds that many low-income drivers jump at the opportunity to buy coverage when they’re offered the ability to “pay as you go,” allowing them to purchase just a few days of insurance at a time and only pay for coverage on the days they actually drive.
The high cost of the uninsured
While 13 percent of drivers nationwide are uninsured, the problem is even worse in some states like California (17 percent), Michigan (26 percent), and Tennessee (24 percent), according to the Insurance Research Council.
Drivers without insurance face catastrophic financial risks in the event of an accident and risk thousands of dollars in fines and impoundment of their vehicles if they are caught driving without insurance. And they’re not the only ones who suffer—drivers with insurance also pay a price because their premiums have to incorporate the risk of getting into an accident with an uncovered driver. Uninsured drivers increase premiums for drivers with insurance by $27 billion annually and $6 billion in California alone, according to a 2016 study.
Yet for drivers without any assets or savings to protect, coverage may provide minimal benefits. Low-income drivers also may not see insurance as a great deal, since they drive less often but are rarely rewarded with lower premiums because it is too costly for insurers to monitor their mileage.
Plus, drivers seeking a state’s minimum coverage are relegated to shopping in the higher-priced “nonstandard market,” which pools them with high-risk drivers who have been denied coverage by standard carriers, even if they have a clean driving record.
These nonstandard drivers frequently lapse on their payments in order to pay for basic necessities, then incur high fees when they re-enroll in coverage. Nonstandard carriers earn 13 percent of their premium income from fees and often require drivers to pay the full coverage term up front, which can require drumming up hundreds of dollars households may not be able to afford.
How technology can help
Innovations in insurance technology can address the problems of high fees by automating away many of the transaction costs, indexing the amount drivers pay to the days they actually drive, and reducing the large required up-front payments to help make insurance coverage more affordable. Legacy insurers are often using systems that evolved from the traditional approach of hand-processing contracts and checks, which makes adapting to the flexibility enabled by technology difficult.
In 2019, I ran an experiment with Hugo Insurance, a California-based insurance technology company, to introduce a new “pay-as-you-go” contract for uninsured drivers in the state’s auto insurance market. The contract allowed drivers to purchase just a few days of insurance at a time and to pay for coverage only on the days that they drive. This type of contract is common in other markets, for instance in cell-phone contracts, where pay-as-you-go enabled the proliferation of smartphone adoption across the world by allowing consumers to “top up” their balance when they were liquid and flexibly adjust their cell phone use.
Drivers valued the option to pause their coverage, taking advantage of the flexibility to turn it off every three days on average.
Uninsured drivers who applied for an insurance quote were randomly offered either a traditional contract that required three months of premiums to be paid up front or the pay-as-you-go contract. The results showed that drivers offered the pay-as-you-go contract were three times more likely to purchase the insurance and had about five more days with coverage during the three-month experiment, even after accounting for take-up through carriers outside of the experiment.
Drivers valued the option to pause their coverage, taking advantage of the flexibility to turn it off every three days on average. Charging for the incremental day driven, pay-as-you-go contracts also provided an incentive for drivers to drive less frequently, which may have other benefits by reducing emissions and traffic congestion.
Providing an affordable insurance option
To test how strongly uninsured drivers valued the option to buy fewer days of coverage at a time, we randomized whether or not drivers got a “bulk discount” for buying more days at a time. The discount was designed to be big enough that forgoing the bulk purchase to buy a smaller number of days implied a cost of credit at least as high as a typical payday loan. Seeing a lot of drivers who prefer to buy smaller bundles would imply they might not have access to the cash on hand or access to affordable credit to purchase in bulk, which is the only option provided by traditional insurers.
The pay-as-you-go contract met a real consumer need and accelerated insurance coverage the most for drivers who had no history of traditional coverage.
I found that even when drivers were offered the bulk discount, the vast majority still made purchases for just three or seven days of coverage. This was all they could afford: 81 percent of applicants had zero dollars of available credit on their credit report. Even more sobering, 19 percent of drivers in the study had at least one attempted purchase rejected due to insufficient funds, and this was the last insurance action I saw for a number of the uninsured drivers in the study.
Changing the contract terms alone is not enough to solve the economic hardship faced by most uninsured drivers, but the pay-as-you-go contract met a real consumer need and accelerated insurance coverage the most for drivers who had no history of traditional coverage.
Since the study in 2019, Hugo Insurance has gained traction with its pay-as-you-go contract and has expanded into 10 states, with plans to enter five more soon. As regulators approve new insurance company entrants and entrepreneurs continue to innovate, new technologies have the potential to reduce administrative costs and better tailor contracts to help drivers afford coverage, bringing down the high cost of car insurance for everyone.
Raymond Kluender is an assistant professor in the Entrepreneurial Unit at Harvard Business School. He studies the causes of financial distress among American households and how technology, private markets, and public policy can reduce those risks.
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