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How Auto Insurance Rates Are Determined

If you drive a car, you need insurance. Watching an hour of television today, you will likely see at least 4 ads for 4 different insurance company, each vying for your business. But how does auto insurance work? More importantly, how is it that companies arrive at the rate you have to pay. Here are some auto insurance basics.

Insurance Rating

Insurers rate policies based on numerous guidelines using formulas compiled by insurance specialists called Actuaries. The actuaries compile statistical information to develop a rating system. This can differ from company to company, but tends to be very similar across the industry. Some of the factors insurance companies use to rate your policy include your geographic location (determined by zip code), the company’s claims experience with your specific type of vehicle, your age, gender and marital status and, in most cases, your credit history.

Many companies use a Credit Based Underwriting Score (CBUS) to rate your policy. This number is calculated using proprietary formulas (that is, they differ from company to company) which are provided to a credit reporting agency. The agency uses the formula provided to return a score which is then used to rate your policy.

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Your driving history is taken into account as well. Each state has different guidelines for how far back a company can look in using accidents or violations to rate your policy. Typically, however, states allow companies to surcharge accidents or violations within the last three years. A surcharge is a temporary additional charge levied against your policy for an accident or violation. This is the most common way that an accident or violation is seen impacting your policy. However, surcharging is only the tip of the iceberg.

Tiering

Most companies place customers into different rate classifications or “tiers.” The number of tiers differs from company to company and from state to state. The CBUS Score and driving history have a direct impact on how a policy is tiered. This is why Amy, a single 25 year old driver who drives a Hyundai Elantra, might be paying more in premium than her friend Beth, also a single 25 year old driver who drives a Hyundai Elantra even though they live in the same Zip code.

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Tiering also plays an important factor when it comes to accidents and violations. While an accident or violation may incur a temporary surcharge as we discussed earlier. Most states allow insurance companies to look even further back than 3 years, generally between 5 and 7, for tiering purposes.

Let’s use an example:

Mary has an at-fault accident in 2005. Her rate goes up at her next policy renewal but by 2008 when the surcharge comes off of her policy, she decides to switch companies.

The new company will run a motor vehicles report (MVR). Even though the accident is too old to surcharge, the company may use that accident to place Mary in a higher tier so that she will pay more premium. Unlike surcharging, higher tiering does not go away and may not be changed until Mary takes out a new insurance policy down the road, provided there are no accidents or violations within the prior 5 years.

Statewide Rate Changes

All companies do it, but they require the state’s approval first. Periodically, insurance companies will raise rates for all of their customers on the basis on the cost of claims is increasing. This is largely due to the cost of paying medical bills and the cost of repairing vehicles increasing. This seems counter-intuitive to most since each year, their vehicle depreciates. However, each year, medical bills increase. Your Bodily Injury and (if it is available in your state) Medical Payments or Personal Injury Protection (PIP) coverages are going to be directly impacted by these increases. Your ability to cause injury to another driver is not impacted by the value of your vehicle at all.

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While tempting to abandon a company that initiates such a rate increase, it is worth noting that all companies initiate these rate changes periodically to help offset the cost of inflation.

Discounts

Every insurance company offers discounts of various types. These can typically be divided into a few different categories. Vehicle discounts are provided if a vehicle has specific safety features such as anti-lock brakes, engine immobilizer or vehicle recovery systems (i.e. OnStar). Operator discounts can be provided if a driver has years of safe driving, has completed a defensive driving course or if they have certain types of educational degrees or specialty licenses (i.e. Teachers). There may also be policy discounts for bundling Auto, Home and Life, or simply not filing a claim for a certain period of time while with the company.

While there are numerous discounts advertised, not all discounts are offered by every company. And just because a car salesman says a vehicle is eligible for a number of safety discounts does not mean that your carrier offers them.

Policies can also be discounted only to a certain level. Even if all discounts are offered and you are eligible for them, there comes a point when the insurance premium no longer decreases, or the amount of premium decrease is negligible.

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Insurance is a shared risk

This means that, whether you like it or not, you have to pay for other people’s mistakes (and they have to pay for your’s). Insurance can be thought of as a pool of funds. Everyone participating in the insurance contributes to this pool by paying a premium. Those who have accidents which result in the pool paying out on their behalf, or those who exhibit high risk behavior such as incurring traffic violations, typically have to pay more than other drivers to help offset their increased risk. The benefit is that if you start a brand new policy and have just made your first payment, you are fully covered to the limits of your policy even though you may have only contributed say, $50 so far. The downside is that if the company begins to pay out more in claims than is being taken in premium, they will likely need to initiate a statewide rate increase, charging all of their policy holders more throughout your state.

Because of these complex rating systems, rates can typically not be “negotiated” with your agent. Many individuals have canceled their policies thinking that their agent simply refused to negotiate and did not appreciate their business. In reality, the agent or customer service representative can only make changes within the guidelines established by the underwriting department and using the rating factors developed by the company actuaries.

If you drive a car, you need insurance. Watching an hour of television today, you will likely see at least 4 ads for 4 different insurance company, each vying for your business. But how does auto insurance work? More importantly, how is it that companies arrive at the rate you have to pay. Here are some auto insurance basics. Insurance Rating Insurers rate policies based on numerous guidelines using formulas compiled by insurance specialists called Actuaries. The actuaries compile statistical information to develop a rating system. This can differ from company to company, but tends to be very similar across…

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If you drive a car, you need insurance. Watching an hour of television today, you will likely see at least 4 ads for 4 different insurance company, each vying for your business. But how does auto insurance work? More importantly, how is it that companies arrive at the rate you have to pay. Here are some auto insurance basics.

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