How does car insurance pricing work?

By Team Clearcover  5 minute read

By Team Clearcover

5 minute read

Insurance is famous for being a bit of a black box. Those of us who own cars know we need insurance to drive—and we faithfully send our payments every month—but when it comes down to it, most of us don’t think much about how insurance works. (Or we’re just not that interested in finding out because, let’s face it, car insurance isn’t the most exciting thing in the world.)

Still, most of us spend a portion of our hard-earned money on car insurance, and if you’d like to know how your rate is assigned (and how your money is spent), we’re going to break it down for you.

Here’s how your insurance rate is calculated.

It only takes a few minutes to get a car insurance quote from Clearcover, but that’s a deceptively short amount of time. Setting a car insurance rate is an enormously complex process.

Why? Well, let’s illustrate with a quick experiment.

The next time you’re in a public place, take a look around, choose a stranger at random, and ask yourself: How likely is this person to be in an auto accident? (It’s a hard question, but don’t give up right away. Think about it for a few minutes. Make the call.)

It's tricky, isn't it? And maybe a bit uncomfortable?

It's also important because that question you just asked yourself—How likely is this person to get into an accident?— is the same question an auto insurer must answer about you when you request an auto insurance quote.

Keep in mind: there's a lot riding on the answer. To be sustainable, an insurance company must be sure to take in enough money to cover the cost of all insurance claims—while keeping prices low enough to attract new customers. So, if the insurance company over-estimates your likelihood of an accident—in other words, your risk—they’re likely to quote a price that's unnecessarily high and lose your business. On the other hand, if they underestimate your risk, they stand to lose money. Sometimes a lot of money.

So, how do insurance companies answer this question? Insurance companies figure out your risk in two ways:

1) First, they gather information.

If you tried the experiment, you have firsthand evidence that it’s impossible to assess a person’s driving risk without any information. It wouldn’t be fair. That’s why every insurance company gathers information about you before they make the call on your rate.

Here are some factors which could affect your rate (depending on your state and insurance company):

  • Your past driving record

  • Whether you’ve maintained car insurance consistently

  • The vehicle you drive

  • Credit score (in most states)

  • Where you live and how your neighbors drive

  • How many miles you drive per year

  • Your gender and age

(How do insurance companies know your driving history? Click here to learn about the CLUE report.)

2) Then, they use math.

Here’s where it gets really interesting.

The thing with insurance pricing is that it’s functionally impossible to figure out an individual driver’s exact level of risk. Think about it: your age, gender, and location really have nothing to do with whether you’ll get into an accident. An accident can happen to anyone, in any location, and of any age, gender, and experience level. No matter what information you provide, it’s impossible to know whether you’ll make a claim during your insurance term.

So how do insurance companies figure out how risky you are? The answer: they don’t. At least, not directly.

It’s impossible to figure out how likely you are to get into an accident. So, instead, insurance companies use the information they know about you to put you into a group of drivers—commonly called a class or a risk pool. For example, if you’re a thirty-two year-old female who lives in the center of Santa Barbara and has made one claim, you’ll be put into a risk pool with other thirty-two year-old females who live in Santa Barbara and have made one claim each. Then you’ll pay a rate that’s roughly associated with that group.

Insurance math is intricate, complicated, and ever-changing.

See, while insurers know some information about you, they don’t actually know how risky of a driver you are. They don’t know whether or not you check your side mirrors, maintain a safe following distance, or look both ways before you pull into an intersection. They don’t know if you like to eat lunch, apply makeup, or send texts on the road. And, even though they have your street address, they don’t know which roads you drive on.

See, while insurance companies don’t know your personal risk, they do know a lot about how risky your group or pool is. (See above for an illustration depicting the risk pool assessment.)

Over the years, actuaries — the people who do insurance math and assign risk — have processed lots of data about when, where, and how accidents happen. They incorporate that data into mathematical models which allow them to predict how many people within a risk pool will make a claim. Then, they use those predictions to assign rates for each group.

If you think this process sounds complex, you’re right. Actuaries are constantly tweaking their models, adjusting factors, and checking their predictions against what actually happens (which is one reason why rates fluctuate, by the way).

Insurance math is intricate, complicated, and ever-changing.

The important takeaway for you? If your insurance rate is low, it’s not because you are a low-risk driver (although that might also be true), it’s because you’re in low-risk pool—a group of drivers that probably won’t make many claims this year. And when your rate changes after you move or have an accident, know that it’s not you personally—it’s that you’ve just moved from one risk pool to another.

It’s also important to know that while the rate you get might seem personal, it's really not. It’s just math. (Probability and statistics, mostly.)

Ready to see what your Clearcover rate would be? See what you could save.