How Are Auto Insurance Premiums Calculated?
By: Eric Kricher (Capstone Brokerage, Private Client Advisor) December 2014
Clients call in all the time wondering why their rates have gone up or why they have to maintain coverage once a vehicle is paid off etc. Insurance is a necessity to legally drive in the United States. The main reason for insurance is to pass a risk on to someone else, most often, the insurance company. There are risks involved with driving a car, and most of us couldn’t afford to pay the costs involved in the event of an accident. Therefore, we agree to pay a monthly fee in order to have the insurance company assume this risk.
The insurance industry has improved over the years, however the primary goal has remained the same, cover the risks it assumes while also being able to cover its own expenses and make a profit. Consumers have the greatest impact on the premiums that companies charge.
There is an equation that is constantly being analyzed by individual insurance companies. The basis of this equation are premiums collected (what consumers pay) plus investment income minus claims paid (what insurance companies pay out when a customer has an accident) and underwriting costs. With so many competitors in the industry, the carriers try to keep their premiums as competitive as possible in order to attract more business.
Claims paid out are the biggest factor in consumer’s insurance costs. Claims not only cost a company in the money they pay out, but they also pay adjustors, investigators, lawyers and other personnel behind the scenes. For example a $20,000 claim costs the insurance company more than that because they have to process it. However, legitimate claims are factored into the companies’ equations and can be predicted.
Other issues like fraud can cause insurance companies to have to up the consumers cost as well.
According to the FBI, over $40 billion is incurred annually and the average family spends an extra $400 to $700 per year because of it. When a person commits insurance fraud it is like stealing money out of fellow consumers pockets.
The method for calculating insurance premiums depends on a number of factors as you can see. The only area that consumers really have control over is claims. As a collective group if Americans slow down and become more cautious driving our rates may go down.
Be on the look out for my next insight “We recommend higher automobile insurance limits than legally required…But Why?”
