Basics of Car Insurance Premium Calculation

We are made to believe that auto insurance premium calculation is something very complex and hard to understand. It is something that is done buy super computers with sophisticated programming. We are forgetting something that only few years ago they were done by hand. In any case, there is a basic logic behind these complicated programs that calculate costs. Looking into how rates are determined can help in shedding lights into how vehicle insurers think.

How Is Car Insurance Calculated?

Even the most sophisticated programs are based around basic ideas. Pricing of vehicle insurance policies follows fundamentals of underwriting risks. Here are some of those basics to help you understand how your insurer determines the figure you know as the premium.

  1. Risk Factors: Any risk calculation method must take the key factors into account. There are literarily tens of factors that influence the price of your car insurance. However, 3 key factors are;  how risky driver you and your listed drivers are, how risky to drive the car you want to insure and how much auto insurance you need.
  2. Insurance Company: How a particular insurer assess risks and what they are prepared to accept is the other key determinant in pricing auto insurance policies. Each company has own underwriting principles and rates. For example, Company A can quote half the price for the same risk in comparison to Company B because they have a better understanding on a particular risk group like young drivers.
  3. State Insurance Rules and Demographics: It is a well know fact that it is more expensive to insure cars in certain states in comparison with their neighbors. Demographics, accidents, number of uninsured drivers are some of the reasons behind this. But it may be that strict insurance rules in your state are protecting you well against insurers and therefore insurers have to increase premiums to pay for the larger claims.

We can have a long list here but it wouldn’t serve for the purpose of understanding how vehicle Insurance premiums are calculated. It is best to try and understand these points within context.

Automobile Insurance Calculation Example 1: Basic Liability vs Full Coverage

This example is about the size of coverage required. Many motorists see premiums charged for basic liability auto insurance coverage and get discouraged from asking additional covers. However, the more you buy the lower the rates get that you may only need few hundred dollars more for full coverage. The reason for this reverse correlation is that a basic policy already includes the costs of issuing and administering a policy that you only pay for the coverage when you replace a basic liability policy with full coverage.

Every policy has administration costs. Once you buy the minimum coverage you have already paid for the cost of maintaining your policy, issuing documents and so on. So, these costs will not be added if you buy additional cover. Furthermore, it costs money to find a new customer. Therefore, automobile insurance companies are keen to sell more to their existing policyholders, even it means at discounted rates.

Another important point to note is that most accidents are small ones and is covered by the minimum liability policies. The chances of you causing a large losses to third parties is slim. Therefore, even you buy a million dollar liability coverage what really is important is the likelihood of you actually causing such large losses. Your premium is based on the expected losses. The higher the level of protection the lower the rates applied to these amounts.

For example, if you request a $50,000 coverage your rate may be 0.014;

$50,000 x 0.014 = $700.

When you increase the liabilities limit to $1,000,000 your rate multiplier will go down considerable to say 0.001;

$1,000,000 x 0.001 = $1,000

In short, there is a reverse correlation between the rates applied and the amount of coverage. Hopefully you have a better idea now on how rates are determined.

Always check the quotes for the level of coverage you want before buying the minimum. Of course, the answer would be liability only cover if you ask what is the cheapest car insurance I can buy. However, why not get what you need, rather than buying a bare bone policy since you have to buy auto insurance to drive.

Car Insurance Premium Calculation Example 2: New Driver vs Experienced Driver

This example is about the drivers insured. For example, a young person with a cheap car to insure don’t even think about full coverage for many reasons. One of them is the well-known fact that auto insurance costs more for youngsters. In later years, that young person comes to age and gain sufficient experience. As a result, he/she qualifies for plenty discounts that makes the premium more affordable. This is when most companies are happy to offer a good vehicle insurance policy package for only slight increase in premiums because of the reduced risks.

Vehicle Insurance Premium Calculation Example 3: Typical Car vs Sports Car

This example is about the cars insured. There are a few brands of typical automobiles in wide circulation. Their main characteristics are; they are reasonably prices for everyone to buy, it is easy to get them repaired since there are plenty parts and labor and they are pretty easy to handle even for a young driver. On the other hand, sports cars have totally different characteristics; they are fast and not really for inexperienced drivers, they are expensive that you need a lot of money to replace them and they are costly to repair because of expensive parts.

It is clear that sports cars are higher risk and you would be charged much more if you want to insure one of them. You will have to pay a lot more if you are a high risk driver (or have a high risk driver in your household).

Why Is It Important to Understand How Car Insurance Is Priced?

The problem is that many people don’t take the time to explore their options to the fullest. They somehow make their minds up as to what they can afford or what they should buy due to costs and other factors. Doing a little experiment with coverage and prices can open your eyes up. Today, you can play around as much as you like with the details and find out the prices for each types of coverage.

There are many online quote comparison platforms just like the one we have on this site. You enter the details on your own time and the program calculates the quotation for each situation. You don’t need to talk to anyone and you don’t need to worry about being chased or pressured by sales representatives when buying car insurance online. You can walk away anytime you like or stay and find out more about the companies involved.

Share on Pinterest
There are no images.