How Are Auto Insurance Premiums Calculated?
Last updated in April 2016
You might think that if you’ve been driving for many years without an accident and with few speeding tickets that insurance companies will offer you their best rates. Unfortunately, that’s not necessarily the case. Insurers increasingly are offering their best rates only to customers who meet criteria that have nothing to do with their driving histories. For example, most companies offer their lowest rates only to customers with excellent credit scores and who are college graduates and homeowners. And companies are increasingly using secretive and opaque methods to calculate rates. The figure below reveals that some of these factors have huge effects on the rates you pay, but so do several other facts about you and your cars.
The Company You Keep
As we’ve already discussed, your choice of insurance company has a huge effect on your premiums, with some companies charging more than twice as much as others for the same drivers, cars, and coverage.
If you have been “loss free” with your current company for a while, it is probably giving you discounts. Another benefit of longevity is that if you’ve been with a company for several years and been accident- and ticket-free, an accident or ticket might not increase your rates, whereas a new company will consider your driving record for only the last three years or so, and impose a penalty if you’ve had an accident or received tickets.
The accident rate for those who have had accidents in the past few years is far higher than it is for those without accidents. Similarly, the accident rate for individuals with two speeding tickets during a three-year period is twice as high as the rate for drivers with no tickets. It will come as no surprise, then, that your driving record has a big impact on the premiums companies offer you.
Drivers who have not caused an accident or had traffic violations in the previous five or six years pay lower auto insurance rates than those who have caused accidents or had traffic violations. Although with many companies, a single speeding ticket won’t affect their rates, with others a ticket more than doubles their rates. Accidents can be even more costly than tickets. One at-fault accident in the last three years will on average cost an extra 54 percent in premiums.
Most companies consider the driving records of everyone driving your car or cars. Therefore, if you have a perfect driving record but your spouse has had violations or accidents, you may not qualify for the companies’ best rates.
Fortunately, insurance companies don’t hold recent accidents or tickets against you forever. After three to five years, companies cancel penalties for previous accidents and tickets if you’ve been accident- or ticket-free.
Many companies now offer further discounts if you allow them to install a tracking device in your car that measures how much you drive, how far, how fast, and whether you often do knuckleheaded things like suddenly accelerate, brake, or turn. Under these programs, everyone gets a discount (10 or 15 percent) for playing along; after six months of tracking, companies offer a bigger discount (on average, an additional 10 to 15 percent) for being safe—or nothing if you’re a maniac. Of course, in our world of Big Data and big data breaches, these potential discounts come with big-time privacy concerns.
Age, Gender, and Marital Status
Drivers under 25 have the highest accident rates; after age 30, accident rates drop and remain fairly constant up to age 65, but then get worse. Men have more accidents than women. And married drivers have fewer accidents than single drivers.
This does not mean that women or older men are better drivers than, say, 25-year-old men. They may have fewer accidents simply because they drive fewer miles. Nonetheless, low accident rates result in lower premiums.
Many companies offer special rates, usually four to 10 percent lower, for youths who have taken approved driver training courses. Studies have shown that these courses do not produce better drivers, but because “good risks” seem to take them, they serve as a convenient screening.
Many companies also give a break—often 10 to 20 percent—to youths who earn good grades (usually a B average or better). The combination of discounts for driver training and good grades may total 15 to 30 percent of a family’s premium.
Most companies also cut premiums dramatically if a youth goes to school more than 100 miles from home without taking a car. In addition, by agreeing to restrict a youth’s driving to a single less-expensive car, a family may be able to cut the rates on other cars it owns.
Credit History, Education, Homeownership, and Secret Factors
All insurance companies use credit history as a factor in setting rates. Some companies also offer lower rates to college graduates, homeowners, and persons in certain occupations. Insurance companies increasingly are charging customers very different rates depending on secret formulas they’ve developed that are based on data that have nothing to do with consumers’ driving histories.
Using these complicated formulas, insurance companies—or credit bureaus, on their behalf—calculate an insurance score that is used to determine rates, or even whether to cover a driver at all. The insurance formulas are not the same as those used by lenders (such as banks or mortgage companies) to calculate credit scores, but they draw on the same types of data and are becoming increasingly more opaque. The formulas vary from company to company, since different insurers (or scoring companies) weigh factors differently.
The appropriateness of using credit histories and other similar data in setting insurance rates is a hotly debated topic among the insurance industry and consumer groups such as ours. Companies clearly charge far higher rates to customers with poor credit scores than they do for persons with good scores. As the figure above reveals, our illustrative 38-year-old female driver with excellent credit would pay, on average, $903 more per year if she had a “fair” credit score. Compare that huge increase to the $356 penalty for having a recent at-fault accident or the $589 penalty for having two recent speeding tickets.
Our view is that all states should ban the use of credit scores and other financial information to set insurance rates, for several reasons:
- There’s increasingly an alarming lack of transparency. When insurance companies don’t have to disclose the formulas they use to set their rates—even though these formulas have a huge impact on the rates they charge—they circumvent the laws put in place by states to oversee the industry and prevent discrimination and other abuses.
- By relying on credit reports and scores, the insurance companies are relying on data that is filled with errors.
- By making auto insurance unaffordable for many poor drivers, these policies have a large effect on the number of uninsured drivers, which in turn raises rates for everyone else who buys insurance.
- By relying so heavily on credit scores and other financial factors, these pricing policies fail to punish lousy drivers and reward safe ones.
- Most Americans need to drive to get to work, get kids to schools, and shop, and auto insurance is a required purchase if you drive. The poor shouldn’t have to pay a disproportionately large penalty when they buy required coverage just because they’re poor.
If you have had a lapse in insurance coverage at any time in the last five years—including for non-payment of premium—expect your rates to skyrocket. Insurers view potential customers who have had insurance lapses as high-risk policyholders and most will not offer them their lowest rate plans. As the figure above shows, companies on average charge a $366 penalty for having a 90-day insurance lapse.
Similarly, many insurance companies will not offer their lowest rate programs to potential customers who have recently maintained liability coverage limits below the 300/100/50 level.
Where You Live
Some localities present more chances for accidents, experience a higher incidence of auto theft and vandalism, or have higher repair costs or medical and legal charges than others. These differences sometimes result in higher auto insurance rates in some parts of the area than in others.
The Car You Drive
Insurance companies charge more for insurance on cars that are relatively expensive to replace and repair, or prone to damage and theft. Some companies charge extra for, or refuse to insure, high-performance cars because their owners may be less responsible than other drivers.
Your insurance premiums may also be slightly reduced if your car is equipped with safety devices or anti-theft features. For example, most companies offer small discounts for cars with four-wheel anti-lock brakes, passive disabling systems (which deactivate the car’s ignition system when the key is removed), and anti-theft tracking devices. But these discounts are usually very small—typically only one to three percent of the total premium.
How Much You Drive
Premiums are higher for drivers who put a lot of miles on their cars, but surcharges for high-mileage drivers and discounts for low-mileage drivers typically are small.
Companies also consider the number of cars they are insuring for a family. The second car usually costs considerably less than the first because companies assume you will drive each car less than you would drive a single car.
Some companies love to tout the big discounts you’ll get by signing on with them to insure both your cars and home. Some knock off five percent, 10 percent, or even more from either the auto rate or the homeowners rate; some knock off a percentage from both. But keep in mind that dual-policy discounts usually are offered by companies that charge high prices for coverage. A 15 percent dual-policy discount isn’t really much of a discount if it’s offered by a company that charges twice as much as its competitors.
From a consumer’s point of view, this dual-policy pricing is an undesirable practice because it makes shopping more difficult; to find out the exact savings you could realize by switching companies, you have to shop for both types of coverage at once. Click here to compare companies’ rates for homeowners insurance.