Will the Google car end automobile insurance as we know it?

By: Alexander Pui

Introduction

Google’s autonomous car has been portrayed as the latest techno-marvel that will set the

world’s commuters free from the steering wheel. While the technological sophistication built

into the software that enables the vehicle to essentially clock up to 300,000 kms on ‘auto-pilot’

is impressive, certain quarters may be nervous at the far reaching ramifications of the

autonomous car, with some already attempting to formulate contingency plans. However,

there are others simply unaware of the rapid progress being made in this space, or

demonstrating willful blindness, thus exposing themselves to the risk of losing the first movers

advantage – a risk that could prove fatal as evidenced by the demise of former market

leaders such as Kodak and Borders in recent times.

The advent of the autonomous vehicle will drive economic growth, but also has the potential

to unleash disruptive change1. In particular, one of the most susceptible industries is that of

auto-insurance given that driverless cars are likely to bring down accident rates dramatically.

As insurance premiums are a direct function of the frequency and severity of accidents, in a

reality where accidents are significantly curtailed, premiums will face significant downward

pressure. Since insurers make their profits on the float from their premium income, and

unless they can tap alternative sources of revenue, the markedly lower premiums will

adversely impact the profit margins of many insurers2.

The purpose of this essay is not to make predictions, but to serve as a guide to consider the

reach and scope of impact of autonomous vehicles on the auto-insurance industry. This will

enable business leaders to avoid surprise, and to identify pre-emptive strategies before the

technology begins to exert its disruptive powers. It will first explore how technology for

driverless cars will evolve, in particular the likelihood as to the timing and extent of driverless

car adoption. This is highly relevant, as it will determine how industry disruption will play out

and the time frame for insurers to adapt. It will then move to explore the implications arising

from two scenarios, and the alternatives available to insurers in each case; in the nearer term,

the more probable but lower impact shift to semi-autonomous vehicles where the driver still

retains some control over the machine; and further on the horizon, the less probable but

higher impact shift to a fully-autonomous vehicle.

How (and how soon) will the autonomous vehicle replace cars of today?

1 Disruptive technologies: Advances that will transform life, business, and the global economy, McKinsey Global

Institute, May 2013 2Ehrhart B., Important Trends for Insurers, Think ouside the risk, Precedings of the 2013 Aon Benfield Australia

Limited Conference.

Before addressing how the auto-insurance industry could thrive in an era of autonomous

vehicles, it would be instructive to first assess the potential pathways to a driverless society.

Firstly, high cost is a common obstacle to a commercially viable new product. At present, the

Google car is estimated to cost more than a Ferrari3, which would price the car out of reach

for mass adoption. However, if the high costs associated with driverless technology stem

from software components, it is arguable that these costs will diminish exponentially- akin to

how one gigabyte of memory fell from 300k in 1981 to less than 10 cents today4.

Another hurdle to the adoption of driverless cars may be psychological, i.e. that drivers simply

are unwilling to give up control of their cars as it embodies personal freedom and serves as a

status symbol5. Regardless of how persuasive economic and safety statistics may be,

personal habits do not change easily although people could come to trust the cars should

there be increasing evidence of their effectiveness. In contrast, new drivers who are born into

an IT savvy age may more readily trust automation, and an aging population faces the option

of immobility due to diminished driving reflexes or embracing autonomous cars6.

Crucially, autonomous vehicles will pose a unique set of regulatory and legal challenges. In

particular, the issue of liability will become central to how soon and how widely autonomous

vehicles will reign on our roads7. Citing America’s litigious society as an example, auto

makers have erstwhile refrained from offering products that placed control out of the hands of

the driver, as it would precipitate a shift in liability for accidents to themselves8. With the vast

majority of car accidents currently caused by driver error, manufacturers are only liable for a

small proportion which constitutes the remainder. Paradoxically, although autonomous

vehicles will reduce the total number of accidents via the removal of human error, the risk of

liability for the manufacturers increase as it is shifted from the drivers to them9. This is

evidenced in the airline industry, where pilots are still sat in the cockpits of commercial flights

due to liability reasons although computers are perfectly capable of flying planes.

Based on the discussion above, there exist several persistent obstacles to the broad

implementation of driverless vehicles. These obstacles will likely be overcome suddenly

rather than gradually, via a ‘killer app’ type jolt10

. This is because an opening for a killer app

will form when the exponential improvement in technology is not mirrored in the incremental

3 Will Auto Insurers survive their collison with driverless cars?

(http://www.forbes.com/sites/chunkamui/2013/03/28/will-auto-insurers-survive-their-collision-with-driverless-cars-part-

6/) 4 Ibid

5 Ibid

6 Ibid

7 Fleming James Jr., Accident Liability Reconsidered: The Impact of Liability Insurance, Yale Law School Faculty

Scholarship Series 8 Strategy: Reshaping Auto Insurance, Volume 5, 2013 , PriceWaterhouse Coopers

9 Martelle S., Self-driving cars and the liability issues they raise, May 2012

(http://www.protectconsumerjustice.org/self-driving-cars-and-the-liability-issues-they-raise.html)

10

Ibid 3

change within social, political, legal and business systems. In addition, the norms and market

dynamics in a driverless society will likely to be very different to what they are at present. To

illustrate, developing auto-insurance markets maybe more receptive to the notion of driverless

vehicles. Although the US is the leading global auto market at the moment, China may

emerge as a future pioneer of autonomous vehicles as it is spurred by greater incentives to

adopt driverless cars to reduce its harrowing accident rate and combat serious traffic

congestion and air pollution in its burgeoning cities. Alternatively, the concept of private

vehicle ownership may lose its appeal as automated taxi fleets are formed. If profit margin

issues due to cars sitting idly during off peak hours are overcome, these fleets may even

substitute private car use as the primary mode of transport, shuttling commuters to and from

work. While the time frame and extent of disruption caused by the autonomous vehicle

remains unclear, the auto-insurance industry must be prepared for several possibilities -

ranging from semi to full automation scenarios -to safeguard its continued viability. The

following sections will explore these scenarios addressing complex issues of liability, new

business lines and new ways to rate risk.

Case A: The Semi-Automation Scenario

In the semi-automation scenario, it is assumed that technology has progressed to the point

where the driver still maintains control over car, although there will be say advanced ABS,

collision avoidance technology built in to improve safety to the point that accidents are

drastically reduced. However, since liability has not shifted away from the driver of the

vehicle, the current business model of auto-insurers based on assumption of personal liability

remains valid. To estimate the impact of semi-automation technology on accident rates and

premiums, insurers could extrapolate from previous trends since the inception of air bags,

anti-theft and basic ABS, but what should insurers do if they expect accident rates to be

significantly curtailed?

The strategic choices facing insurers are stark: Should they delay instituting price reductions

and enjoy short-term profitability? Or price aggressively with the aim of stealing the best

customers to gain market share? The latter choice of being aggressive seems rational. As

premium per customer decreases, one way to address this issue is by signing up more

customers to offset the decrease in revenue per customer, assuming that the costs of

repairing a technologically advanced vehicle does not increase significantly. Importantly, to

sign on ‘good’ customers, a more creative underwriting approach is required by leveraging

improved data capture technology, and acknowledging an increasing reliance on machinery

rather than human driving abilities. Instead of using traditional rating factors such as age,

address, engine size or vehicle purpose, insurers could utilize advanced telematics, whereby

data that describes how, when and where a vehicle is actually driven is used to calculate risk

presented by the driver11

. For example, information such as typical routes taken (safe wide

highways with dividers as opposed to narrow winding beach roads) and the number and age

11

Driverless Cars: Boon or Bane for auto insurers? IBM Global Business Services White Paper, 2013

of occupants in the vehicle (i.e. the expected life span and medical costs of a 5 year old

quadriplegic would dwarf that of a grown adult) could be collected by a beacon fitted to each

vehicle that is relayed to the insurer, enabling dynamic road pricing and the ability to offer

different insurance prices to customers. In fact, basic telematics based insurance products is

already being gradually introduced in the UK and the US, with equipped policy holders

reporting reduced claims sizes and frequencies12

.

An advanced telematics approach to risk rating will not come without its own set of

challenges. For instance, insurers will need to first make a bold and expensive investment in

its data collection and management strategies and carefully consider the operational costs of

telematics especially its impact on claims experience, business volumes and business

retention. This may not augur well with the increasingly widespread outsourcing and cost

cutting strategies. In addition, since it will be easy to track a driver’s movements through

record keeping, prospective users may view it as a fundamental violation of privacy – thus

opening a floodgate of related legal issues. As such, new laws will have to be drafted to

regulate the use of telematics and insurers will need to reassure its customers by tightening

information security before it can be introduced on a broader scale.

Case B: The Fully Automated Scenario

Further into the future, there may be another more potent step shift from heavily assisted

driving to ‘full’ automation where the human no longer controls the vehicle. At this juncture,

the actions of drivers will effectively cease to be a predictor of premium rates as control of the

vehicle is completely ceded to machines. Even if accident rates do not vary much between

semi and fully automated scenarios, there will still be a profound impact on the auto-

insurance industry owing to a shift from personal to product liability. As a consequence, the

insurance sector will be compelled to change their current business-operating model as the

need to locate an alternative source of premium arises. This is where the business of insuring

car manufacturers as well as those who build driverless automation software for product or

tort liability assumes paramount importance.

As an example, it is not difficult to imagine that there will be the potential for low frequency but

high impact incidents if cars travelling at high speed (say on the German Autobahn) suddenly

suffer from a software malfunction and innocent lives are lost. Where would fault be

attributed in this situation – the car, or the software, or both (i.e. the failure to seamlessly

integrate between physical automobile function and software)? The fallout from such an event

for the car maker could be immense, especially if entire model lines have to be recalled and

decommissioned, or risk further class actions taken by other parties that would escalate

business interruption costs very quickly. If fault was determined to lie with the software

producer, a similar set of problems to the car maker could unfold, and worse – as the barriers

to entry in software manufacturing are substantially lower than the production of vehicles, if

consumers lose trust in the software, other competitors may emerge to permanently gain a

12

Adams G., The Future of Motor Insurance, March 2014, Finity Consulting

market lead. Given the gravity of the consequences in the unlikely event of a software glitch,

the premiums of any insurance product to safeguard against these events will be high, thus

making the arena of product liability a potentially lucrative field – one that may even eclipse

traditional motor premiums due to lower overheads such as low distribution costs and small

but specialized claims handlers. Another potential issue involves the deliberate decision of

the driverless car to swerve into the path of a large oncoming truck to avoid an errant

pedestrian as it was programmed to make the decision that reduces harm to human life as a

priority13

. Where would liability lie in this instance, and how can auto insurers step in to

provide financial relief in the event that ‘grey’ decisions are made by computers?

Aside from product liability to auto and software makers, other avenues may become

available to insurers. As mentioned earlier, if the norms of car ownership change in a

driverless future, and consumers turn to cars as a purely commuter service, fleets of taxis and

freight vehicles will be established and there will in turn be insurance opportunities within this

space. Alternatively, since cars will be entirely automated and presumably controlled via an

online source, it will not farfetched to see a need to insure against crimes of hacking and

cyber security breaches.

From just a few hypothetical examples stipulated above, it is clear that insurers will need to

be nimble and flexible to explore these alternatives. In the advent of improving technology

and increasing complexity in both software and hardware of the driverless car, insurers

should consider shifting from their current broad scale auto insurance model to focus on

specialty lines with a team of legal and technology underwriting experts to pricing one major

line (say product liability) and pricing it well. In addition, insurers could also forge stronger

ties and business relationships with the likes of the main auto makers or Google as they may

find it more practical and economical to offer insurance up-front upon the purchase of a

driverless vehicle. The risk of not doing so may be that the creators of these products emerge

as competitors themselves should they see greater benefit in offering insurance internally

instead of transferring risk to the insurers.

Conclusion

Each new technological milestone achieved by Google edges the auto-insurance industry

precariously closer to a head on collision with the driverless car –a collision that will provide

openings for new players and upset established order. With inevitable shifts in profit pools

between companies and industries, the severity of this collision will depend on a number of

mitigating factors, many of which are within the control of insurers. The fear that the traditional

motor insurance market may shrink permanently remains a real one, although there is

considerable optimism that premiums in new liability driven sectors (in addition to other lines

such as natural perils that are still required) may emerge as a viable offset. As such, the first

mover’s advantage will be crucial in devising new lines of business with the right underwriting

13

Light D., Is Tort Law a Roadblock for Driverless Cars, Insurance Experts Forum, Dec 2013. (http://www.insurancenetworking.com/blogs/insurance-tort-law-driverless-cars-33576-1.html)

human capital as well as new ways to conduct business by forging powerful partnerships with

software and auto makers, and quickly establishing reputation in the new markets of product

liability insurance. In short, regardless of how profitable auto-insurance is at the moment in its

current form, firms should adopt a longer-term view instead of focusing solely on immediate

financial incentives. Those that are receptive to the advent of the autonomous vehicle and

plan ahead should be able to successfully navigate the teething issues when disruptive

change arrives.