Study by Quality Planning Corporation Reveals Major Discrepancy Between Reported and Actual Mileage

Analysis By Insurance Expert Highlights Problems Insurers Face When Trying To Determine Fair and Appropriate Auto Insurance Premiums

SAN FRANCISCO, Jan. 26 -- Would you believe 40% or nearly 4,000 miles? That's how much auto insurance policyholders underestimate their annual mileage, according to a recent study by San Francisco-based Quality Planning Corporation (QPC). Most auto insurance companies simply ask policyholders to estimate annual mileage driven and provide details of their daily commute. It's no secret that the more one drives or the further one commutes, the higher the insurance premium. As a result, many policyholders appear to exhibit a form of amnesia when asked to estimate how far they drive each year.

For auto insurers, the discrepancy between estimated/reported mileage and actual mileage is costly. Audit results of over 14 million policies from 16 major carriers estimated 2003 industry premium leakage at over $1.5 billion due to commute rating error and $1.4 billion due to annual mileage error (i).

"Annual mileage and commute rating error are a major cause of premium leakage -- that is, lost revenue -- for the personal auto insurance industry," remarked Daniel Finnegan, president of QPC.

Chart 1 (available from Tim Cox, tim@zingpr.com) highlights the dramatic contrast between "estimated" annual mileage and "actual" miles driven by the customers of a typical auto insurance company. It clearly illustrates why allowing policyholders to estimate their own mileage or commute distance leads to extreme inequities in auto premium rates.

  Of particular interest:

  1.  Mileage is systematically underreported for several groups of
      policies.
  2.  "Spikes" of reported mileages occur at five and ten thousand,
      representing common consumer behavior of reporting round numbers and
      reporting mileages that are just under known rating "cut points."
  3.  High-mileage drivers significantly underreport the miles they actually
      drive.

QPC's Finnegan observed, "Our audits found 17 percent of insured vehicles were driven more than 20 thousand miles per year, yet only four percent were actually rated in this category."

Reported commute distances are prone to similar errors. It is not uncommon for QPC to find insurance companies where more than 60 percent of vehicles are rated at a commute of three miles or less. This contrasts with seven percent reporting a commute of three miles or less to the Department of Transportation on its Nationwide Personal Transportation Survey.

The costs of mileage and commute rating error are not limited to lost premium. Rating error also produces "moral hazard" costs. One example: policyholders who drive or commute short distances are forced to subsidize those who use their cars more. Honest policyholders are in effect forced to subsidize the dishonest. Worse, those drivers who underreport mileage are also more likely to make fraudulent claims.

There are also associated risk-management costs since rating error undermines the integrity of the entire rating plan and creates unknown exposure for the insurer. Maintaining rating integrity for mileage and commute data is particularly difficult given constantly changing vehicle usage. For example, 48 percent of household auto policies change a vehicle or driver each year. Changes of jobs, household composition, residence, and other factors directly affect mileage and commute.

"Our experience with millions of auto policies has shown that simple renewal questionnaires are inadequate to correct mileage and commute data. There is a strong response bias where policyholders will report a change that decreases premium but will neglect to report a change that increases premium. However, it is important to provide the insured with the opportunity to review and correct the results as a necessary component of the process," noted Finnegan.

The proof of any data validation procedure is in the results. Quality Planning conducted several studies to test the quality of audit results. In one study, actual annual mileage was calculated using third-party odometer readings for over 200,000 vehicles. This was compared to self-reported mileage estimated at the beginning of the period, and estimated mileage after re-underwriting the policy. Self-reported mileage estimates proved to be both highly error-prone and systematically low.

Finnegan added that the insurance industry needs to better understand the driving habits of its policyholders in order to make fair and profitable underwriting decisions -- and for those who have removed annual mileage from their rating plan, possibly even reconsidering the merits of using annual mileage as a primary rating variable.

Rating integrity and competitive advantage

QPC assists auto insurers in their efforts to minimize rating error. QPC takes an auto insurance company's book of policyholders and processes it through a battery of more than 150 proprietary tests, cross-reference checking and pattern-matching algorithms to identify errors and discrepancies that might suggest fraud and misrepresentation on the part of consumers. QPC also provides insurers with additional services such as policyholder phone interviews to discover missing drivers, verify garaging addresses, determine annual mileage and other key rating information. Over time, insurance companies with accurate rating information are better able to compete and are more financially stable.

About Quality Planning Corporation

Quality Planning Corporation (QPC), the Rating Integrity Solutions Company, was founded in 1985 and is headquartered in San Francisco. A member of the ISO family of companies, QPC is focused exclusively on providing decision integrity solutions to the insurance industry. QPC works with insurance companies to identify areas of significant premium leakage using sophisticated database management, statistical analysis and modeling, customized survey design, and highly targeted customer interaction. For more information, visit www.qualityplanning.com.

(i) Private Passenger Auto Premium Rating Error: Industry Estimates for 2003, Quality Planning Corporation, 2004 (see www.qualityplanning.com)