Have you ever wondered why your car insurance premium differs from other drivers, even though you may drive similar cars?
Or maybe you just insured a teen driver on your policy and were astounded at how high the cost was.
Either way, setting the price of car insurance is a complex process, but we are going to attempt to explain it to you in a way that you can understand (although it won’t make your insurance any cheaper).
For a more in-depth discussion, see our Car Insurance 101 article that details many more factors that affect car insurance prices.
To see in real-time how different factors affect the cost of car insurance, see our car insurance rate calculator.
The Basics of Car Insurance Pricing
Insurance companies don’t just pull numbers out of thin air. They actually use sophisticated algorithms and statistical models to determine the likelihood of you making a claim.
Claims cost insurance companies money (which is bad for them), so they need to use as many tools as possible in order to predict the likelihood of a claim as accurately as possible.
It basically boils down to profits (big surprise there). Insurance companies need to not only maintain enough reserves to cover claim expenses, but they also need to make money for their shareholders, while also covering their operating and administrative expenses.
In order to achieve all of these goals, they need to set insurance prices carefully by adjusting the algorithm (that’s just a fancy word for “formula”) that calculates the rates.
Rates are frequently adjusted to reflect updated market costs, claim volume, and other reasons which could increase rates or even decrease rates.
One notable instance where rates not only decreased but companies actually refunded portions of paid premiums was during the Covid epidemic. Drivers were stuck at home and therefore claims plummeted and insurance companies were flush with cash.
Unfortunately, after the epidemic, car insurance prices quickly skyrocketed as the cost for repair parts increased dramatically due to supply chain issues.
When Might Insurance Companies Increase Rates?
Insurance companies may decide to increase their overall rates due to various factors affecting their business and the broader insurance market.
Here are some scenarios that could lead to rate increases:
- Rising Claim Costs: If the average cost of claims increases (e.g., due to more expensive car repairs or medical treatments), insurers may raise rates to cover these higher expenses.
- Increased Frequency of Claims: A spike in the number of claims, perhaps due to severe weather events or a rise in distracted driving, can prompt insurers to increase rates.
- Changes in Risk Models: As insurers refine their risk assessment models with new data, they may identify higher risks that necessitate rate increases.
- Economic Factors: Inflation, changes in interest rates, or poor investment returns can all influence an insurer’s decision to raise rates.
- Regulatory Changes: New laws or regulations that increase the cost of doing business or require more extensive coverage can lead to rate hikes.
- Reinsurance Costs: If the cost of reinsurance (insurance for insurance companies) goes up, insurers may pass this expense on to policyholders.
- Natural Disasters: Major catastrophes can deplete an insurer’s reserves, leading to across-the-board rate increases to rebuild those reserves.
- Market Consolidation: Mergers or acquisitions in the insurance industry can sometimes lead to rate increases due to reduced competition.
When Might Insurance Companies Decrease Rates?
While less common, there are situations where insurance companies might lower their overall rates:
- Improved Risk Assessment Technology: Better data analytics and AI might allow insurers to more accurately assess risk, potentially leading to lower rates for some segments.
- Decreased Claims Frequency or Severity: If there’s a significant drop in the number or cost of claims, perhaps due to safer vehicles or improved road conditions, insurers might pass some savings to customers.
- Increased Competition: New entrants to the market or aggressive competition might force insurers to lower rates to maintain market share.
- Regulatory Pressure: Sometimes, regulators may require insurers to justify their rates, potentially leading to decreases if current rates are deemed excessive.
- Technological Advancements: The adoption of technologies like telematics or automated claims processing might lower operational costs, allowing for rate reductions.
- Favorable Economic Conditions: Strong investment returns or a particularly profitable period might allow insurers to lower rates while maintaining profitability.
- Changes in Driving Patterns: Significant shifts, like a widespread move to remote work reducing commuter traffic, could lead to lower rates if they result in fewer accidents.
- Improved Fraud Detection: Better ability to detect and prevent insurance fraud can lead to cost savings that might be passed on to customers.
It’s important to note that these factors often affect rates gradually and can vary significantly by region, type of coverage, and individual insurance company.
Insurance companies must balance their need for profitability with competitive pressures and regulatory requirements when setting rates.
Now that you have a decent understanding of some of the reasons rates change from a company standpoint, let’s talk about some of the more personal factors that determine the rate you pay.
What exactly goes into these calculations?
Insurance companies consider a wide array of factors when determining your premium. These elements help paint a comprehensive picture of you as a driver and the risks associated with insuring you.
While some factors may seem obvious, others might surprise you. Here’s a quick break down of the key components that insurers plug into their algorithms:
Your Driving Record
Your history behind the wheel plays a crucial role. Have you been in accidents? Received speeding tickets? Past driving behavior is a good indicator of future claims.
Blemishes on your driving record lead to more expensive car insurance, while a clean driving record is an indicator of responsible driving behavior and is a key factor in keeping rates down.
Age and Experience
Young drivers are more likely to be involved in accidents, which means higher premiums. As you get older and have more driving experience under your belt, you start to see rates decrease.
It stands to reason that teenagers are the most expensive age group to insure, with rates declining until around age 65 when they start to creep back up.
Location
Where you live matters. Urban areas with high traffic and crime rates? Expect to pay more. Rural drivers, you might just catch a break here.
However, weather-related claims like hail, wildfires and hurricanes can impact rates significantly. If you live in an area that is prone to these natural disasters, chances are good that you’re paying a higher rate.
Vehicle Type and Safety Features
The car you drive affects your premium. High-end vehicles with expensive parts can drive up costs. However, cars equipped with safety features like anti-lock brakes, airbags, and collision warning systems can lower your rates.
Also, the age of your vehicle is also a factor. Newer vehicles have a higher replacement value compared to older models, so the expense for the insurance company is greater in the event of a total loss.
If you drive a compact car, the chances of being injured in an accident are generally greater than if you drive a large SUV or pickup. This can create higher costs for the medical or PIP coverages on your policy.
Credit Score
In many states, your credit score can impact your insurance premium. Insurance companies have found a correlation between credit scores and the likelihood of filing a claim. A higher credit score could mean lower premiums.
Some states prohibit credit scores from being used as a rate-determining factor, so depending where you live, this could be either good or bad.
If you have great credit and live in a state that does not allow credit-based pricing, then you are probably paying more than if you lived in a state where credit can be used as a factor. Essentially, drivers with good credit are subsidizing drivers with bad credit.
Coverage Choices
The amount and type of coverage you choose significantly impact your premium. Liability coverage is the bare minimum coverage required by law. If you wish to protect damage to your vehicle, then full coverage is needed, which consists of comprehensive and collision coverages.
The more coverage you buy for your vehicle, the higher your rates will be. Companies offer a variety of limits that you can choose from as well as many optional or add-on coverages like rental reimbursement or zero deductible glass coverage.
Deductible Amount
Your deductible is the amount you pay out of pocket before your insurance kicks in. The deductible generally applies to the comprehensive and collision coverages on your policy, and not to liability coverage.
Opting for a higher deductible can lower your premium, but if you have a claim that means more money out-of-pocket. So make sure you have adequate savings to be able to cover this expense in the event that you do have a claim.
Annual Mileage and Use of Your Vehicle
How much you drive matters. The more time you spend on the road, the higher the chances of an accident.
Also, how you actually use your vehicle can impact rates. Make sure your vehicle is rated properly on your policy for how you use it.
Occupation and Education
Some insurers consider your job and education level when calculating premiums. Certain professions are associated with lower risk, and some companies offer discounts for higher education levels.
This can vary considerably by company as to whether or not they rate based on your occupation. But it doesn’t hurt to inquire if there are discounts based on your occupation or even membership in a professional organization.
Claims History
It’s not just about accidents. Any claims you’ve made in the past, including those for theft or weather damage, can affect your future premiums.
When damage happens, it’s a good idea to consider the impact that filing a claim will have on your rates. If the repair cost only exceeds your deductible by a small amount, then it may be in your best interest to just pay for the repairs rather than filing a claim. It may cost you a little more than if you did file a claim, but it can save you money down the road by keeping your rates in check.
Putting It All Together
Insurance companies use complex formulas to weigh all these factors and determine your premium. They’re constantly adjusting their models based on new data and trends.
Remember, while some factors are out of your control, others aren’t. Maintaining a clean driving record, choosing a safe vehicle, and being smart about your coverage can all help keep your premiums in check.
Understanding how car insurance is calculated empowers you to make informed decisions. Knowing what influences your premium allows you to take steps to potentially lower your costs.
During his career as an independent insurance agent, Ryan Grabenstein was appointed with Progressive, Allstate, Nationwide, Travelers, and many smaller regional and mutual companies. He has a Bachelor's degree in Finance from the University of Nebraska at Lincoln and Certified Insurance Counselor (CIC) personal and commercial lines training.