Pay-as-you-drive, or PAYD, car insurance ties your annual premium to the amount you drive, but there's some controversy about how insurers are handling the new concept. The way it works is that the less you drive, the less you're charged for insurance, since a portion of your insurance fee is changed from a flat rate to a per-mile fee.

According to the Victoria Transport Policy Institute, auto insurance averages about $800 per vehicle per year in the U.S. -- a significant portion of a person's total vehicle costs. Its research indicates that the more miles driven, the higher the crash rate. Applying the PAYD concept in setting rates makes for a more equitable price structure by rewarding those who reduce their chance of having a crash by driving less.

It replaces the current system that overcharges drivers who drive less than average (also disproportionately low-income people) and undercharges drivers who drive more than average. Since a greater portion of low-mileage drivers are uninsured (thus reducing the funds to subsidize higher-mileage drivers), current pricing drastically overcharges people in lower-income areas, according to the Institute.

Other risk factors such as driving history and vehicle type would still apply in combination with PAYD. For example, someone with a good driving record might pay six cents per mile for coverage, while someone with a bad driving record might pay ten cents per mile. The Environmental Defense Fund advocates this new approach to insurance pricing in its October 2006 (updated May 5, 2008) Pay-As-You-Drive Auto Insurance article, stating that PAYD "is expected to reduce driving and congestion by 10 to 12%.

Driving less reduces air pollution, toxic runoff from roads, and climate impacts. Additionally, PAYD is expected to reduce accidents; a 10% reduction in driving is estimated to result in a 17% decrease in crashes." Oregon, Minnesota, Texas, Washington, and California are all in various stages of promoting the implementation of PAYD insurance as an option for consumers. GMAC Insurance, a subsidiary of General Motors has a mileage discount program for drivers with GM vehicles and its OnStar system. Drivers earn a discount for the miles they drive.

Progressive Direct Insurance Company, a unit of Progressive began a pilot program in Minnesota in 2004 offering 5,000 policyholders an incentive to install a device that collects information on their driving habits. The results and feedback from this will be used to determine if the program should be offered on a wider basis and to potentially advance the PAYD initiative.

Progressive worked with the North Central Texas Council of Governments to conduct a similar pilot program with more than 200,000 drivers. The final report analyzing the results of the program, which began in August 2005, is expected out soon. Progressive also initiated pilot programs in Michigan and Oregon. This new pricing concept seems perfectly logical in theory, but pitfalls can become apparent in the implementation.

Three common payment structures are: have policyholders prepay for estimated miles at the beginning of the year and then settle up the difference at the end of the year; ask policyholders to pay their regular premium, then get a rebate at the end of the year if mileage is below a certain limit; or insurers bill policyholders monthly for actual mileage. Regardless of how insurers choose to apply the payment structure, miles driven must be verified.

Verifying mileage is where critics step in. Consumer WatchDog, a California advocacy group, vehemently opposes a bill currently in the California legislature that would give consumers the option of applying a monitor to their car to track mileage under a PAYD system.