How your homeowners and auto insurance rates are determined

Homeowners and auto insurance rates are determined in many different ways. The process is not nearly as cut and dry as many people tend to believe. In fact, it’s a rather complicated algorithm of sorts that can be effected by many different variables.

My experience in the industry is that most people are misinformed and really don’t understand why their rates are what they are, especially if they increase, so this post will hopefully set the record straight for you.

Ready to dig in?

Have you ever seen this commercial:

You may not like to hear this, but it’s true. Insurance companies actually do try to determine your socioeconomic status when determining your rates.

It’s not nearly as malicious as this commercial makes it out to be, but the main reason as I mentioned here is, insurance companies are basically legally representing strangers, so this is their way of trying to get to know who they’re insuring and what type of risk they are taking on.

Although it may seem somewhat intrusive at times, I really can’t argue with that logic.

Here are some things you may be asked if you get a quote on your insurance:

  • marital status
  • education level
  • how many household members/drivers in household
  • vehicle type and mileage one-way to work
  • birth date, drivers license number and social security number of all household drivers
  • length of time at current residence
  • information on physical attributes of your house to determine replacement cost
  • do you have a dog, or other pet

Outside of these questions, there are three main pillars that insurance companies use to determine your rates…

1.) Credit (Insurance Score)

Customers ask me sometimes why their rates went up pointing out the fact that their cars are now one year older, and how they hadn’t had any accidents in a while. It’s important to understand though that the age of your car and loss history alone, are only parts of the equation.

The insurance company isn’t just insuring your car. More importantly, they are insuring you as a person–as a driver of the automobile, and your potential neglectful acts that may result in bodily injury, or worse–death.
For this reason, they need to get to know you, as a person, not just what car you drive.

Have you heard the term “insurance score” before? A lot of people don’t realized how much credit has to do with an insurance rate, and an insurance score is basically a combination of your credit history as well as loss history (claims). There are obviously many different variables that go into a rate, but the insurance score might be the biggest one of all, and this is how the insurance company can in some ways, “get to know you”.

I’ve seen companies base as much as 80% of their rate solely on the person’s credit. Understand that insurance companies don’t actually “pull” your credit like a lender would do if you were applying for a loan. They do what’s called an “inquiry” which is the equivalent of taking a peek at your credit score so there is no negative impact on your credit history or score.

Also, the insurance company doesn’t divulge their findings with anyone, so as an agent, I have no idea how good, or how bad a persons credit is.

Through the years, insurance companies have done extensive research on the relationship between credit and loss frequency and have come to the conclusion that folks who have poor credit are more likely to submit claims. Wrong or right, every insurance company uses this “system” so if you have mediocre or poor credit, you are not going to get the most favorable rate, and there’s not much you can do about it.

I’ve quoted folks before who lived in a low-risk area, had no accidents or claims history, but because their credit wasn’t good enough, the rate came in way higher than normal or worse, they were declined. This of course can come as a shock to someone especially if they thought their credit was good.

I’ve found that people in general like to believe that their credit is very good, when in reality, it’s not. Maybe it was at one point, but you can’t go off of a credit report that was pulled 5 years ago.

2.) Loss History

This is one of the obvious ones so I won’t go too far into this. There has been much debate over insurance companies using this against you. Many people say, “Well, that’s what insurance is for. It pays if I have an accident, so why would having an accident be held against me?”

I’ve had this discussion many times with folks who just can’t wrap their head around it, or simply don’t agree with it. This is something that you must be aware of though because if you have too many accidents within a short period of time, you may not only be surcharged, but your insurance carrier can drop you.

Another thing to keep in mind is that losses stay with you for 3-5 years (depending on the carrier) so if you try to move to a different company, they are going to see your loss history and will rate accordingly.

When I do a quote for someone, I almost always verify accidents and/or violations ahead of time by running some-behind-the-scenes reports. This way there are no surprises later. The price I give the client up front is a “firm” price, not just a ballpark.

3.) Location

This obviously plays a pretty big role in the rate. I’ve seen rates increase and decrease dramatically when a person moves to a different zip code. Different areas are statistically more risky than others with regard to natural disasters, as well as overall loss statistics and claims frequency. You don’t necessarily have to live in an area prone to natural disasters to live in a risky area.

Your zip code plays a huge role in your rate(s), and in particularly, the last four digits of your zip code. This allows a company to essentially pin point where you live, and thus determine if you are in a statistically higher-risk area.

Way back when I worked at AIG, we were licensed in 40 different states. I used to take a ton of calls from folks who lived in Louisiana shortly after Hurricane Katrina. If they lived below Interstate 10, they were not eligible for insurance with AIG. Obviously it wasn’t my decision and I felt terrible for denying people insurance, but just because you can’t see the ocean from your front door doesn’t mean you aren’t close to the water. That hurricane was 400 miles wide. Even if your 20 miles from the water, it’s not far enough.

Of course, if you have any questions or comments, feel free to leave them below in the comment section!

About Chris Langille

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