The Determinants of Auto Insurance Premiums

The premiums that insurance companies charge for auto insurance depend on many factors. Premiums for auto insurance are high because of medical costs, motor vehicle repair costs, unrealistically high jury awards in liability cases, and insurance fraud. However, other factors also affect the price of auto insurance. Major rating factors for determining private passenger auto premiums include the following:

Outside of Hawaii, which is the only state that does not allow insurance companies to use marital status as a premium determinant, married people pay less than single people, but the difference is larger for younger people. According to a new study, the difference is 21% for 20-year-olds, 7% for 25-year-olds, dropping to 2% for those older than 30. - Car Insurance Rates Penalize Single People - MarketWatch

Ironically, having a valid drivers license is not a requirement for insurance in most states, although higher insurance premiums may be charged. In most states, if you drive a car, then you must have auto insurance, even if you are an illegal immigrant without a valid drivers license. The public policy is that it is better to have insured unlicensed drivers than uninsured unlicensed drivers, since they are going to drive anyway. Indeed, some insurers even prefer illegal immigrants, since their preference for avoiding authorities makes it less likely that they will report small claims.

States are divided into rating territories, which largely determines premiums. City drivers generally pay much higher rates than rural drivers because of the increased number of accidents, increased number of vehicles involved in the accidents, higher claim costs, increased litigation, and higher jury awards, especially in large cities. Consequently, certain states, such as New Jersey and New York have the highest auto insurance premiums in the United States. Larger cities also have higher rates than in surrounding areas as evidenced by the high rates charged in the District of Columbia. In contrast, sparsely populated states, such as Wyoming, have much lower rates.

Age and Marital Status

Drivers under the age of 25 account for a large proportion of all accidents, especially accidents that have caused a fatality, so they pay higher premiums. The accident rate continually declines with age until after age 80 when it starts increasing.

Line graph showing 2009 statistics of the number of all accidents as a percentage of licensed drivers by age.
Data Source: Motor Vehicle Accidents and Fatalities - The 2012 Statistical Abstract - U.S. Census Bureau

Historically, gender has been used as a basis for charging different premiums, because males accounted for more accidents, especially those in which someone is killed. However, the courts have struck down using gender as a basis for the premium charged, so insurance companies may no longer use gender as a rating criterion. Hence, women now partially subsidize the auto insurance premiums charged to men. Young married male drivers tend to have fewer accidents, so their premiums are slightly less.

Auto Use

Use of the auto is another important rating factor and is generally classified into the following categories of ascending risk, with concomitant increasing premiums:

Good Student Discount

The good student discount is based on the fact that a good student is generally a better driver, since a good student is generally considered more intelligent and therefore able to handle diverse driving situations that may arise and also because they tend to spend more time studying, and thus, not driving, so the premiums for a good student will be lower than others in the applicable age cohort. To qualify, the student must satisfy at least one of the following:

Typically, a school official must sign an insurance form indicating that the student has satisfied the applicable requirements.

Driver education can also reduce premiums, especially for a young person, where the discount may be as much as 10 or 15%.

Number and Types of Cars

A multi-car discount is generally available, especially if the vehicles are owned by one person, since, by necessity, each car must be driven less than if the person only had one vehicle. However, the type and age of the vehicles can also be a major factor. Factors that increase the premium include the cost of repairing the vehicle and the safety of the vehicle. Another factor that may increase the premium is if the car is a sports car or other equivalent type where the driver may be tempted to take unnecessary risks, such as driving fast.

Individual Driving Records

Most insurance companies price their premiums based on the individual driving record, since this is the strongest indicator of risk. Insurance companies charge the lowest premiums for those with a clean driving record, which generally means that the driver was neither involved in an accident where he was at fault nor had been convicted of a serious traffic violation in the last 3 years.

Most states have a point system, where points are assessed for accidents or traffic violations, such as drunken driving, failure to stop to report an accident, driving on a suspended or revoked driver's license, and numerous other offenses. Insurance companies assess a premium that is commensurate with the number of points that a driver has — the more points, the higher the premium charged.

Most insurers also impose a surcharge for an accident that exceeds a given amount, such as $1000. The surcharge is added on to the premium for 3 years. Generally, the surcharge is lowest for the 1st accident, but increases for subsequent accidents.

States regulate chargeable accidents, which are the least payouts that auto insurers are permitted to consider in calculating premium rates. Although the amount varies, damages of $500-$1000 or less are not chargeable accidents in most states, which means that insurance companies cannot increase insurance rates for claims below the threshold amounts. Most insurance companies also have a loyalty program, where they will absorb the cost of an accident up to a certain amount, depending on how long the insured was a customer of the company and whether the customer paid their premiums timely.

Insurance Scores

Another major factor in determining the auto insurance premium is the driver's insurance score, which is much like the credit score and based on the same factors, but the factors have a slightly different weighting. Insurance scores, like credit scores, only depend on the information within the credit files of the individual, which are held by the 3 major credit reporting organizations.

The use of the insurance score is based on various studies that have shown that people with a higher credit risk also tend to file more claims. Higher scores indicate less credit risk, and therefore, a lower driving risk, so the higher the insurance score, the lower the premium charged.

The use of insurance scores to set premiums is highly controversial, since it often makes insurance more expensive for low income drivers and minorities. Hence, some states place restrictions on the use of insurance scores in setting premiums.

FICO and LexisNexis Risk Solutions, formally known as ChoicePoint, are the major organizations that provide the algorithms to calculate the insurance scores that insurers use most often.

Tips for Shopping For Auto Insurance

Seeing what factors account for insurance premiums, it is easy to see how you can save when buying auto insurance. Foremost, you should carry adequate liability insurance, which generally means that coverage should exceed the state minimums, since state minimums do not usually provide adequate coverage. It is often recommended to carry enough insurance to protect your assets, but even if you have a low net worth, higher coverage can prevent a lot of hassles, including protecting your creditworthiness. An umbrella policy can also provide extra coverage for very low cost.

Higher deductibles may also greatly reduce the premium. Drop collision coverage for older vehicles, but only if you can afford it. Shop around for auto insurance, since there is wide variation in prices charged, and shop periodically, to ensure that you are receiving the lowest rates.

Take advantage of the numerous discounts offered by auto insurance companies, including discounts for:

Most of these discounts generally range from 5% to 15%. Finally, don't speed or do anything else that may result in a police citation and assessable points.

An accident should be reported, even if it seems to be minor, since the extent of the damage may not be evident. Moreover, some people may not feel any effects from an injury until later, when they may later file a claim. But if the damage is to your own vehicle or your own property, and the cost is likely to be below the deductible, then it would be best not to file a claim.

The Future of Premium Pricing

Underwriters continually seek to segment the population into ever finer classifications to be able to charge those where statistical analysis indicates higher claims. So it is only natural that underwriters would start to use the tools of data mining. For instance, it has been recently reported that auto insurers are charging more for less educated people. So those without a high school diploma pay more — in some cases, substantially more — than college graduates. For instance, the New York Public Interest Research Group found that people with non-professional, non-managerial jobs paid almost $1000 more in premiums annually than those with college degrees.

Another interesting trend is that insurers are gradually increasing their rates for their long-term clients, to see how many people leave and how many stay, probably because they don't shop around, thereby maximizing the revenue by using the most profitable combination of premium prices and the number of insured.