In order to understand auto insurance rates, it’s important to be clear about the distinction between insurance rates and insurance premiums. An insurance rate is a dollar amount of premium per unit of coverage, such as $15.00 per $1,000 of coverage. An insurance premium is the total amount paid for a chosen level of coverage, such as $1,200 per annum for $80,000 of coverage. The relationship between the two can be expressed as follows:
Insurance Premium = Insurance Rate x Amount of Coverage
The distinction is important because you often hear statements such as "you can reduce your auto insurance rate by excluding collision coverage", or "you can reduce your auto insurance rate by choosing a higher deductible", whereas neither are true. You can certainly reduce the premium you pay by excluding collision coverage or increasing your deductible, but that does not change the rate which the insurance company assesses for you. It is quite unhelpful for commentators to use the terms ‘rates’ and ‘premiums’ as though they were interchangeable, because doing so tends to mask the fact that you only get what you pay for. If you succeed in having your rate reduced by your insurance company, then you have secured a win because you will pay less for the same amount of coverage, but if you reduce the premium you pay by reducing the amount of your coverage then you have gained nothing from your insurer at all.
Auto insurance premiums are normally composites of a number of component premiums made up of several insurance rates and coverage amounts. For example, an auto insurance premium can be made up of the product of a personal liability rate and coverage amount, a PIP rate and coverage amount, a UIM rate and coverage amount, a collision rate and coverage amount and a comprehensive rate and coverage amount. However, the principle is always the same: the premium is arrived at by calculating the product of a rate and a coverage amount.
Underwriting is the term given to a process which insurance companies follow to determine whether they will accept an insurance application, the terms of acceptance if they do, and the premium rates that will apply. That is, insurance companies will firstly assess the degree of risk which an application represents, then decide whether to accept the risk. If it is accepted, they will set the terms of acceptance, and then price the risk by calculating a rate which is to apply to each type of coverage requested. When assessing and deciding on risks, and in calculating auto insurance rates, insurance companies consider three major types of factors:
Each of the above factor types consists of a number of elements which insurance companies refer to as rating factors. For example, your characteristics include the rating factors of your age band, your gender, your marital status, your occupation, your level of education, your number of years as a licensed driver, your insurance and claims history, your history of traffic violations, the average weekly distance you drive and your credit score. Rating factors for your location include your state, your zip code and the street you live on. Rating factors for your car include its make, model, year of manufacture, safety features, added options, type of use and garaging. These rating factors are discussed further as follows:
Insurance rates are based on statistical analysis of claims data over many years, and insurance companies have found that crash rates are higher at younger ages. Those crash rates tend to decrease through to age 65, after which they steadily increase again. Insurance companies don’t as a consequence apply a strict rate for age system, but they group policyholders into age bands, each being of 5 to10 years duration.
One age band, for example, consists of those aged 18 to 25. Insurance rates are set at high levels for that group to reflect its high incidence of car accidents, and subsequent age groups have progressively lower rates through to age 65, after which they rise again.
Similarly, claims data reveals that males have a greater propensity to cause car crashes than females, and consequently auto insurance rates for males tend to be higher than those of females of equivalent age.
Marital status is a further factor which influences claims rates, and which has a consequential effect on insurance rates. Insured persons who are married tend to have lower claims rates than those who are not.
Nationwide claims data indicates that there is a correlation between the two factors of occupation and education, and the frequency of claims. Consequently insurers routinely ask for details of an applicant’s occupation, and for the highest level of educational qualification achieved. The specific nature of an applicant’s qualifications is not usually enquired into (other than for law and medicine), rather the highest level achieved, such as ‘High School,’ ‘Bachelor’s Degree’ and ‘Master’s Degree’ is specified.
Claims rates are also correlated with driving experience, with greater experience indicating a lower probability of claims and the assignment of a correspondingly lower premium rate. This factor is causative with respect to decreasing accident rates with increasing age, as most licensed drivers first become licensed at a young age. To that extent age can be over-weighted by insurers as a factor in accident rates.
Your insurance rates will tend to be set at a high level if you are not insured at the time at which you apply for auto insurance.
Being involved in an accident or receiving a moving violation (such as a speeding ticket or a DWI/DUI conviction) can adversely affect your premium rates for several years. Most insurance companies will look at your driving history for at least the past three years, and often up to five years. If your rates have been impaired due to a car accident or traffic violation, and you have no further occurrences of those, your premiums will eventually reduce, but it could take some years for that to occur.
Clearly there is a correlation between the distance you drive in any given period and the probability of being involved in an accident. If the primary purpose of your car is to commute to and from your place of work, insurance companies will want to know the distance between your home and work, and the number of days per week you make that trip. This will then be factored into the calculation of your insurance rates, with greater distances resulting in higher rates.
Some years ago, with the cooperation of FICO, insurance companies found a correlation between insurance scores and claim rates, namely that higher scores tended to correlate with lower claim rates. Most insurance companies do not actually use your credit score, rather they calculate a specific insurance score that is derived from your credit score and your credit history. Your insurance score places different weightings on certain items in your credit data that are deemed to be more relevant to your insurance risk (such as the extent to which you have used alternative financing).
Your premium rates will vary according to the state you live in, your zip code and even the street you live on. In fact, the state you live in is one of the most important factors in determining auto insurance rates, and a major reason for this is the particular insurance laws which apply in your state. For example, the most expensive states for car insurance in 2010 were (in descending order) Louisiana, Michigan and Oklahoma, with average premiums of around $2,500, $2,100 and $1,900 per annum respectively. In Louisiana, industry sources point squarely to the state’s tort system as the primary reason for its number one ranking. Similarly in Michigan, the state’s requirement for unlimited medical benefits for accident victims is identified as the main reason for its number two ranking.
If you live in an area with greater rates of car theft, vandalism or car accidents, you are likely to have higher insurance rates. In general, this means that people living in cities and urban areas pay more than those in smaller towns and rural areas.
Predictably, cars that are worth more cost more to insure, due to the greater cost of repairs or replacement following damage or theft.
But it’s not just the value of the car that affects insurance rates. Some types of cars attract a higher rate due to the increased risk which they represent. For example, high performing sports cars tend to be driven at greater speeds, potentially causing greater injuries or more damage in an accident, therefore a higher rate will tend to be charged. Similarly, open-top convertibles tend to cost more to insure than hard-top coupes due to the increased risk of more serious injuries to the occupants if they roll in an accident.
Cars that are more likely to be stolen also attract higher premium rates. Visit the National Insurance Crime Bureau to see which vehicles are most commonly stolen.
As the Insurance Institute for Highway Safety has wryly observed "The least expensive vehicles to insure are the ones you have to drive but don’t want to, while the most expensive vehicles to insure are the ones you don’t have but want to drive."
While having no effect on underlying premium rates, the following are the three principal factors which can influence the total premium which you pay for your auto insurance policy:
Understandably, the greater the level of coverage you choose, the greater the premium you will pay. Additionally, taking extra coverage such as roadside assistance or rental car coverage will also increase your total premium. Reducing or removing particular types of coverage from your policy is therefore one way to make your premium more affordable. This is simply an example of reducing the price by reducing the quantity.
Auto Insurance deductibles can be a very effective way to reduce your overall premium. Although this is really another example of reducing the price by reducing the quantity of coverage, choosing a higher deductible does have a leveraging effect. What this means is that you can reduce your total premium by 20%, for example, without your coverage limit reducing by anywhere near that percentage. The reason for this is that the bulk of auto insurance claims are of low value, and the increase in your deductible will be a much greater percentage of the insurer’s average claim payment than the percentage reduction which it applies to your premium.
Utilizing one or more of the many auto insurance discounts available can reduce your total premium. These include discounts for safer vehicles, long no-claim periods and membership of affinity groups which not only have a track record of lower claims than average but which provide insurance companies with free marketing services.