How Car Insurance Companies Price Policies

How insurance companies price your policy is an incredibly complex process. It’s important for insurers to have accurate pricing because they need the premiums they collect to balance out the cost of paying claims and running the company. To do that, they use information about their customers to predict how often they’ll file claims and how much those claims will cost.

No two insurers will have the exact same pricing method, so no two will have the exact same price for you. Still, all insurers analyze three main things to determine your premiums:

  1. Your risk profile
  2. The type of car you drive
  3. Your coverage choices

Your risk profile

The first thing insurers look at when pricing your policy is your risk profile. Your risk profile is based on the likelihood that you or someone living in your house will file a claim.

To analyze your risk profile, insurers first gather information from you about your age, gender, driving history, and other personal characteristics. Then, they take that information and look at how many claims people similar to you tend to file as a group.  If you’re similar to drivers who file fewer claims, you’ll probably get cheaper prices. If you’re similar to drivers who file more claims, you’ll probably get higher prices.

Insurers look at many different pieces of information during this process. All of them must be “actuarially sound,” which means they must have a proven correlation with higher or lower claims rates. The pieces of information insurers use and how they use them differ from company to company and state to state. Some types of information get used more than others. Here are some of the most common pieces of information and how they usually affect your prices:

Driving history

Prices are usually lower if you have a relatively clean driving history. If you have the opposite (a history of speeding and getting into accidents) it tells your insurer that you might be a risk-taker behind the wheel. If that’s the case, your chances of filing a claim are probably higher and the same goes for your prices.

Insurers look at not only the quality of your driving record but also the length. Premiums are usually lower if you have a long, established driving history than if you’re a new driver. With decades of experience behind the wheel, you’re probably less likely to get into an accident than someone who just got their license last year.

Age

Prices are usually higher if you’re younger. Insurers, just like parents, are wary of young teenagers getting behind the wheel, and they have a good reason to be. Drivers between 16 and 19 years old are three times more likely to be in a fatal accident than drivers who are 20 and older, according to the Centers for Disease Control and Prevention. As drivers mature into their mid-20s and 30s, their prices are likely to drop.

Gender

Prices are usually higher if you’re male. Statistically, men tend to get into accidents more often than women. Department of Transportation data show that, in 2011, male drivers got into 1 million more accidents than female drivers. That’s despite the fact that female drivers outnumbered male drivers by about 2 million.

Gender’s effect on prices tends to get smaller as you get older. The price difference is biggest if you’re a teen or in your early 20s.

Marital status

Prices are usually lower if you’re married. That’s because, for whatever reason, married drivers tend to file fewer claims than single drivers. Like with gender, this pricing factor becomes less important as you age.

Where you live

Your prices will probably be higher if you live in an area where drivers tend to file more claims for accidents and theft. This is usually true in urban areas where large numbers of drivers are packed into a relatively small area. In those areas, there tends to be more traffic and vehicle thefts, which means more car insurance claims. For example, more than 95% of people living in New Jersey and Washington, D.C. live in urban areas, and both areas are regularly ranked as having some of the most expensive insurance prices in the country.

On the other hand, if you live in a rural area where cars are regularly pulverized by tornadoes and hail, you could see higher rates also.

Annual mileage

Prices are usually lower if your car spends more time in your garage and less time on the road. That’s because claims data show that you’re more likely to get into an accident over the course of a year if you have a higher annual mileage.

Progressive data included in a Brookings Institute study showed that drivers with an annual mileage of 25,000 miles filed about 66% more collision claims per year than customers with an annual mileage of 6,000 miles.

Credit history

Prices are usually lower if you maintain a clean credit history. It may seem strange that credit can affect your rates, but the Federal Trade Commission (FTC) confirmed in a 242-page report to Congress that credit info can in fact help insurers predict how many claims you’ll file in the future and how big those claims will be. Even though the FTC confirmed that credit and claims data have a correlation, they couldn’t explain why the correlation exists.

The type of car you drive

The type of car you’re insuring has a huge effect on the price of your insurance. Some models have higher or lower repair costs and claims rates, which means insurers need to adjust their claims forecasts accordingly.

If you want to know which cars tend to have the best and worst claims records, there’s a tool you can use to do so. Check out the “Insurance losses by make and model” page from the Insurance Institute for Highway Safety (IIHS). It includes an interactive chart that lets you see which models have the best and worst insurance claims records.

Repair and replacement costs

Your prices will probably be lower if the type of car you drive is relatively cheap to repair or replace.  This is pretty easy to understand. If you drive a 2005 Dodge Neon worth $3,500, it’ll cost a lot less for your insurer to replace it than if you have a $40,000 Cadillac.

Claims rates

Your prices will probably be higher if the car you own is frequently involved in accidents or thefts.

Theft is the best example of how claim rates vary based on the type of car you drive. For example, the latest rankings from the IIHS showed that the Ford F-250 was the most-targeted vehicle for thieves. The data showed that F-250 owners filed theft claims at a rate that was 6 times higher than average. As a result, F-250 owners may pay more than the average driver for comprehensive coverage, which insures cars against theft.

But this is true for all types of coverage, not just those that protect your car. For example, the IIHS showed in a 2012 report that owners of certain types of cars are more likely to file personal injury protection (PIP) claims. The report showed that a 2011 Jeep Grand Cherokee owner had a 1-in-167 chance of filing a PIP claim, which was one of the best performances that year. On the other hand, drivers of the Toyota Yaris had a 1-in-35 chance of filing a PIP claim, the worst odds that year. As a result, the cost of PIP for a Yaris may be higher than for a Jeep Grand Cherokee if all other factors are the same.

Your coverage choices

Another thing that affects your prices is your coverage choices. The greater protection that you have, the more risk your insurer is taking on. They need to charge more in exchange for taking on that extra risk.

The price of your insurance generally tends to go up as you add more and more protection to your policy. However, you may be able to add more protection for less money than you think. Don’t let the possibility of a price increase stop you from getting a quote for higher levels of protection. The price bump could be minimal, and the extra coverage could end up being crucial after a serious accident.

There are three main choices that will affect your price:

  1. Types
  2. Limits
  3. Deductibles

Coverage

If you buy only the coverage types required by law, your prices will probably be cheaper. For example, if you don’t insure your car against theft, your insurance company doesn’t have to worry about it getting stolen. If a thief does take it, they won’t have to pay for replacement you will. Since leaving that coverage off your policy reduces their risk, your price will be lower than if you had added it.

Even though skimping on optional coverages could save you a lot on your premiums, you need to realize what you’re giving up. Choosing not to buy collision coverage will save you a lot when you pay your premiums, but if you cause an accident and wreck your car, you may be fully responsible for the repairs.

Limits

If you buy a minimum policy with the lowest limits possible, your prices will probably be cheaper. This is because when you have lower limits, your insurer is taking on less risk. As a result, they won’t charge you as much as if you had bought higher limits.

Here’s an example to show why this is: If you have a $100,000 limit on your liability insurance and cause $75,000 in damages in accident, your insurer will probably have to pay the whole $75,000. But if you had bought only $25,000 in liability insurance, your insurer would have to pay at most just $25,000, leaving you responsible for the extra $50,000. In the second example, the insurer’s risk is much lower, so prices will also probably be lower.

Skimping on coverage limits could save you some money, but you need to realize the extra risk you’re taking. If you get low liability limits and cause a serious accident, it has the potential to be a financial disaster for you.

Deductibles

If you choose higher deductibles, your prices will probably be lower. A deductible is the amount of money you have to pay out of your own pocket before your coverage actually kicks in. So when you raise your deductible, you agree to pay more when you file a claim, which reduces the amount your insurer will have to pay. As a result, higher deductibles usually mean lower prices.

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Did You Know?

Credit and your rates

Your credit history can affect how much you pay for car insurance. The reason is credit information can help insurers predict how likely you are to file a claim. Three states, however, do not allow this practice, which is called "credit-based insurance scoring."

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