Auto Insurance Premium Rates

14.4 Auto Insurance Premium Rates

Learning Objective

In this section we elaborate on how auto insurance premiums are influenced and perceptions thereof.

Pricing factors of auto insurance include the make of the car, age of the car, whether the car is driven to and from work, age and gender of the driver, marital status, and location of the car. The location is critical because in some markets, insurers are pulling out due to large losses. These factors are underwriting factors. Additionally, the driving record is an important factor in classifying a driver as a preferred driver or substandard risk. The industry uses the data presented in Table 14.1 "Average Expenditures on Auto Insurance, United States, 1997–2006" and Table 14.2 "Auto Insurance Claims Frequency and Severity for Bodily Injury, Property Damage, Collision, and Comprehensive, 1998–2007"For all limits combined. Data are for paid claims. in the introduction to this chapter. Fraudulent claims also affect rates; see the box “How to Combat Insurance Fraud?” for a discussion.

How to Combat Insurance Fraud?

Does your car have any dings or scratches on its exterior? Any car older than a few months probably has a few. Small scratches usually aren’t worth getting fixed on their own, but what if you had a minor accident? Couldn’t you just ask the body shop to include the cost of repairing the scratches in its repair estimates? The insurer is a big company; it won’t even feel the effects of another couple of hundred dollars on your claim. Or will it?

Fraud is very costly to society as a whole. The Insurance Information Institute estimates that fraud accounts for 10 percent of the property/casualty insurance industry’s losses with loss adjustment costs of about $30 per year. The states are making efforts to combat insurance fraud. The key state laws against insurance fraud and the number of states that adopted each law are listed below.

Insurance fraud classified as crime—“A fraudulent act is committed if information in insurance applications is falsified in an attempt to obtain lower premium rates, or to inflate the amount of loss in a claim.” This law was adopted by all the states. Alabama, Hawaii, and Oregon adopted this law for workers’ compensation, healthcare insurance, or auto insurance only.
Immunity statutes—“Individuals or organizations are exempt from libel or unfair trade practices lawsuits which could be brought against them for releasing information on prior claims.” All states adopted this law. In Alabama, Hawaii, Mississippi, Rhode Island, and Wyoming, it applies to workers’ compensation, arson, or auto insurance only.
Fraud bureaus—“The main purpose of the bureau is to set up documented criminal cases that can be readily prosecuted. Some bureaus have law enforcement powers.” All states have instituted fraud bureaus for all lines or limited lines of insurance, with the exception of Alabama, Illinois, Indiana, Michigan, Oregon, Tennessee, Vermont, and Wyoming.
Mandatory insurer fraud plan—The plan has to include remedial actions. Only twenty states adopted this plan.
Mandatory auto photo inspection—This is designed to eliminate claims for damage sustained prior to the issuance of a policy and the purchase of insurance for nonexistent vehicles. This law was adopted by five states.

Occupying an entire floor of a New Jersey skyscraper, ISO ClaimSearch, a sophisticated computer system, cross-references millions of claims every second. When a claim is entered, ClaimSearch automatically finds relevant public and insurance-related information about the claimant. In addition to flagging multiple claims, the system allows in-depth searches that help find links among claimants, doctors, and lawyers. When ClaimSearch investigators believe they have found a fraud case, they turn their information over to law enforcement. In 2001, for example, the Hudson County, New Jersey, prosecutor indicted 172 people for allegedly staging automobile accidents and filing false medical claims for more than $5 million. Nationwide, insurance fraud prosecutions and convictions are on the increase. According to the Washington, D.C.-based Coalition Against Insurance Fraud, state insurance fraud bureaus have doubled their criminal convictions of insurance scams since 1995.

The Insurance Research Council reported that fraud and inflated descriptions of injuries added between $4.8 to $6.8 billion to the cost of auto insurance in 2007. However, the laws described above act to lower the cost of fraud. For example, the overall loss ratio for private passenger auto insurance in New York fell from 0.86 in 2002 to 0.61 in 2003. This reduction points to the success of new laws that fight the padding of claims.

Questions for Discussion

How far should the insurer go in its investigations of claims?
What should be the insurer’s response when it finds out about overcharging for a claim?
What is the relationship between some of the forms of no-fault laws and fraud in auto insurance? Do you think reform would combat fraud?

Sources: Insurance Information Institute, The Insurance Fact Book, 2009, 160–162; Insurance Information Institute, “Insurance Fraud,” February 2009, accessed March 21, 2009, http://www.iii.org/media/hottopics/insurance/fraud/; “IRC Study: Details Billions in Injury Fraud,” National Underwriter Online News Service, January 13, 2005; Ron Panko, “Making a Dent in Auto Insurance Fraud: Computer Technology Drives Auto Insurers’ Efforts to Stall Fraud Rings,” Best’s Review, October 2001.

Data show that younger drivers and male drivers cause more accidents. In 2006, drivers age twenty-one to twenty-four were responsible for 11.2 percent of accidents with fatalities and for 10.7 percent of all reported accidents. For drivers age twenty and younger, the ratios were alarming, with 6.4 percent of the driving population responsible for 13 percent of the fatal accidents and 16.6 percent of all reported accidents. The data are from the National Safety Council, as cited by the Insurance Information Institute. The national safety data estimated that there were 202.8 million licensed drivers in 2006; 50.1 percent of them were male who accounted for about 74 percent of all accidents with fatalities and 58 percent of total reported accidents.Insurance Information Institute, The Insurance Fact Book, 2009, 138–139.

The general public’s perception is that auto insurance rating is unfair. California drivers decided to take matters into their own hands and in 1988 passed Proposition 103, legislation that set strict guidelines for insurance pricing activities. Proposition 103 also called for an elected insurance commissioner and provided that commissioner with expanded powers. A major selling point of this legislation to voters was the imposition of limitations on insurer use of geography as a rating factor. Specifically, Proposition 103 requires insurers to set prices primarily based on driving record, years of driving experience, and annual miles driven. Insurers are further restricted in their ability to incorporate age, gender, and zip code in their rating process.

It is important to note that there are also discounts for drivers, including ones for good students, nondrinkers, second car, driver training, and safety devices. Furthermore, having more than one car and not using it to drive to work but for pleasure use only is cheaper than driving the car to and from work.

As noted in Chapter 13 "Multirisk Management Contracts: Homeowners", which discussed the homeowners policy, regulators in each state created well-designed booklets that inform consumers of the specific requirements in their states and the different rates for a typical automobile in many major locations. When purchasing auto insurance, it is advisable to read the booklet or explore the Internet for the best rates and the rating of insurers.

Key Takeaways

In this section you studied pricing factors affecting auto insurance premiums and problems with some of those factors:

Typical pricing factors include make, age, and use of the car; age, gender, location, driving record, and marital status of the driver.
Young male drivers account for a disproportionately large percentage of accidents.
California Proposition 103 in 1988 limited the use of geography, age, and gender as rating factors in that state.
Discounts are available for good students, nondrinkers, those who have taken driver training, and others.

Discussion Questions

Do you think it is socially desirable to do away with age, gender, and marital status as classification factors for auto insurance premium rates? Why or why not? What would be the implication if everyone paid the same rate?
Why might insurers allow for a good student discount? Is this factor any more legitimate to use in rating than marital status, for example? Explain.