Shuman Roy is an entrepreneur, business owner, and musician. He started RoysNoys, LLC in 2013 as a music production and education service company. He also offers small business consulting and advisory services to help businesses get from start-up mode to turn-key operations. Shuman earned his M.B.A from the Stern School of Business in 2001 and has an undergraduate degree from Manhattan College in ...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He has an MBA from the University of South Florida. Joel...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Oct 11, 2021

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Mobile phone companies rake in millions of dollars each year on overage charges, lovingly known as “overages.”

You buy a specific number of minutes to save a few bucks on your bill, then you unknowingly “go over” and are hit with a bill that costs hundreds more than the “unlimited” plan you didn’t opt for. We buy these plans with the best of intentions. We think we’ll save money, and we don’t talk on the phone that much…until we do.

Can you see where this is going? While a select few benefit from predetermined limits of “usage” for various products, there is always an inherent risk of the unexpected…which leads many to second guess their attempt to save a few bucks by imposing limits on products in which the potential final usage is unknown.

Usage-based insurance for your car can run into the same basic issues. Trying to save money, drivers are overly optimistic about how little they drive. Depending on the plan, the estimate you make up front could come with overage charges if you go over. Other companies offer the same rates on set mileage markers no matter what. They just use your estimate as a formality.

What is mileage-based car insurance?

With “mileage-based insurance,” you estimate the mileage you plan on racking up within your policy term and pay in advance (or by installments) based on that usage amount. Your bill can change month to month with usage-based insurance.

The general idea is that if you don’t drive very much, so won’t pay as much. Perhaps you drive significantly fewer miles than the average individual and don’t want to have to pay for the “base” limit of coverage, which may be 5,000 miles per year. The company will use this to give you a quote. But what you end up paying could vary based on your everyday driving habits. Many of these companies operate on a pay as you go basis rather than a base rate paid on a regular schedule.

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How does mileage-based insurance work?

You start by estimating the mileage you would drive within your policy term. This may be six months or 12, depending on the company you choose. This is most effective for drivers who have a set schedule and either don’t drive or have other ways to get to place outside of set activities. If they do drive to work throughout the week, it’s on a predictable schedule and close by. The idea behind this type of coverage for insurance companies is less money for less risk. In other words, the less time you spend on the road, the less likely you are to get in an accident that would require them to pay a claim. The more miles you drive, the more your risk of filing a claim grows.

The insurer then calculates your insurance premium by assigning a “per mile” charge for each coverage type you choose. It may look like this (note: you can purchase any coverage available on a typical auto insurance policy).

COVERAGE LIMIT COST PER MILE MILES PURCHASED TOTAL COST
Bodily Injury Liability 100/300 $.0557 2000 $111.40
Property Damage Liability (included in BI Limit) 100
Physical DamageComp  & Collision $1,000 deductible $.0589 2000 $117.80
Personal Injury $10,000 $.0557 2000 $111.40
TOTAL $.1703 2000 $340.60

Could this turn into a financial disaster?

Just like the phone bill alluded to earlier, if you go over your predetermined mileage, you are hit with a HUGE over-charge.

How much? You may expect to pay as much as $12.50 or more PER MILE you drive over the 2,000 you purchased (using the example above). The “fee” may be broken down to additional mileage and a “per mile” administrative fee. Even if they don’t charge extra overage fees, the cost per mile can add up quickly. If you only budgeted for the original estimate, you could get in trouble even if the difference is small. In many cases, it’s not.

These plans are designed to be based on a low-mileage discount. They charge you a fraction of the normal premium based on your driving record and other factors because you’re removing one of the biggest risk factors: drive time.

What’s the difference between pay as you go and mileage-based insurance?

First, we’d like to point out that these are not a “pay as you go car insurance” programs in which you submit your mileage monthly or yearly and are charged accordingly. Pay as you go insurance requires the insurer to put some trust in each insured as they have to pay on a less predictable schedule. Much like pay as you go phones, they could theoretically turn your insurance off until you purchased more. But given the nature of car insurance, companies typically just send the bill as they go and take on some risk by continuing to offer some coverage up to a point.

Also, this is not the same as the Progressive Snapshot program, where your mileage (and driving habits) is monitored for a period of time BEFORE your premium is adjusted based on the recorded data.

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What drivers do best with these insurance companies?

If your annual mileage is low and you have a few marks on your driving record driving up costs, this may seem appealing. They offer low estimates on your car insurance for what frequently looks like generous coverage. Of course, if you pay for a little more than you actually drive and you have alternative transportation methods if you’re getting close to your mileage limit for the month, this is one way to control costs. For many people, though, it’s not so clear cut.

Safe drivers with a clean driving record may not save much, if anything, with this type of annual mileage-based insurance. If everything’s in line, low-mileage drivers will spend about the same amount on this type of plan as they would on a standard insurance plan. The difference is a standard auto insurance plan doesn’t come with a risk of unexpected overage charges. Your insurance costs are set for 6-12 months depending on the length of your plan. While mileage changes may not seem like a big deal, life is often not as predictable as we’d like to think. While some may be stable, changing jobs could require more driving. Even for retired seniors, moving to a new house could require more driving just to get to the store or meet other everyday needs. If you’re on a mileage-based insurance plan, even a small increase in distance could lead to significant increases in your monthly rates.

Most “normal” auto insurers will take your word for it and only second guess you if your mileage seems out-of-whack in the event of a claim. They’re looking at other factors that could affect your likelihood of getting in an accident. If you’re a low-mileage driver, you can still save money on gas and other car-related costs.

You will still be charged slightly less than those with longer commutes, but won’t be subject to bankruptcy in the event you have to drive a little more than you expected at any point during the year.

Tip: 10 ways to lower your car insurance premium.