Which Factors Are Taken Into Consideration When An Insurance Company Calculates Premiums?

When an insurance company is determining what premium to charge for a policy, there are many factors taken into consideration. The premium amount is calculated based on the risk profile of the insured and the likelihood that a claim will need to be paid out. By analyzing relevant data and statistics, insurance companies are able to price policies appropriately.

Key Factors That Influence Premium Calculations

Here are some of the main factors that insurance companies look at when calculating premiums:

Type of Coverage

The type of insurance coverage being provided is a major determinant of the premium amount. Liability coverage, collision coverage, comprehensive coverage, and uninsured/underinsured motorist coverage all come with different levels of risk for the insurer. More extensive coverage types will require higher premiums.

Policy Limits

The limits set on policies directly impact potential payouts in the event of a covered loss. Higher limits mean the insurer is on the hook for more money if a claim is filed. Therefore, policies with greater liability limits, higher coverage caps, and larger benefit maximums will have higher premiums.

Deductibles

A deductible is the amount the policyholder pays out-of-pocket before insurance coverage kicks in. Policies with higher deductibles represent less financial risk for insurance companies, enabling them to charge lower premiums. The lower the deductible, the higher the premiums tend to be.

Driver Factors

For auto insurance, characteristics specific to the driver are very influential in determining premium rates. Age, driving experience, motor vehicle record, and claims history are heavily factored into premium calculations by insurance companies.

Vehicle Attributes

The make, model, year, value, and safety ratings of the vehicle being insured have a significant impact on premium costs. Vehicles that are more expensive to repair or replace typically require higher premiums. High-performance cars are also likely to have pricier premiums.

Geography & Location

Premium rates are affected by the location where the policyholder lives as well as where the vehicle is garaged. Urban areas typically have more expensive auto insurance premiums than rural areas due to higher risks of accidents, vandalism, and theft.

Credit History

Many insurance companies use credit-based insurance scores as part of determining premiums. These scores are calculated based on information in the insured’s credit report. Individuals with poor credit tend to get charged higher premiums.

Prior Insurance Lapses

Gaps in insurance coverage are seen as a sign of irresponsibility by insurance companies. As a result, applicants with lapses in prior insurance may be subject to higher premium rates.

Intended Usage

How an insured vehicle is used can impact premiums. For example, vehicles used for commercial purposes often require pricier premiums than personal use vehicles.

How Different Types of Insurance Price Premiums

While the above factors apply broadly, the specific data used to calculate premiums varies across insurance product types.

Auto Insurance Premiums

Auto insurance premiums are primarily based on attributes of the driver and vehicle. Key rating factors include:

• Age, gender, marital status of driver
• Years licensed and driving experience
• Driving record and motor vehicle history
• Make, model, year and value of vehicle
• Primary usage of vehicle
• Where the vehicle is garaged
• Amount of annual mileage
• Selected coverage types and limits
• Chosen deductibles
• Location and driving environment

Many insurers also consider the insured’s credit history and prior insurance coverage. Discounts are commonly applied for protective features like air bags and anti-theft devices.

Homeowners Insurance Premiums

For homeowners insurance, the characteristics of the property and residence play a bigger role in determining premiums:

• Value and size of dwelling
• Construction materials and age of home
• Located in coastal, hurricane, or wildfire prone area
• Proximity to fire hydrant and fire station
• Local weather patterns and disaster frequency
• Security systems, smoke detectors, sprinklers, etc.
• Amount and types of personal property
• Selected dwelling and personal property limits
• Chosen deductibles
• Insured’s credit-based score

The age, claims history, and credit score of the homeowner can also impact premium costs. Discounts may apply for alarm systems, protective landscaping, and storm shutters.

Life Insurance Premiums

With life insurance, the policyholder’s demographics and health are the main premium rating factors:

• Age of insured
• Gender of insured
• Tobacco use or smoking status
• Medical history and exam results
• Family medical history
• High-risk hobbies or activities
• Beneficiary designation
• Selected coverage amount and duration
• Type of life insurance product

The health, driving record, and family medical history of the applicant all play a significant role in determining life insurance premiums.

Health Insurance Premiums

For health insurance plans, the premium calculation formula is regulated but still utilizes:

• Age of covered individuals
• Geographic location
• Whether coverage is individual or family
• Tobacco use of insured
• Specific plan category and coverage details
• Provider networks and healthcare costs in area

The Affordable Care Act prohibits the use of health status, gender, or other factors in setting health insurance premiums. Discounts may apply for participation in wellness programs.

How Insurers Determine Risk Profiles

Insurance companies utilize mountains of data to develop policyholder risk profiles, categorize drivers, properties, individuals, and ultimately assign appropriate premium rates. Hundreds of data points spanning multiple factors are weighed and analyzed via predictive analytics programs and advanced algorithms.

Some of the insurance industry data sources feeding these profiling systems include:

• Extensive claims databases
• Motor vehicle records
• State insurance department filings
• Reinsurance company figures
• Consumer credit reports
• Criminal and public record databases
• Geographical information systems
• Financial stress indices
• Climate and weather data
• Real estate analytics
• Forensic investigations
• Medical records and mortality data

By assimilating these massive and diverse sets of data, insurers are able to classify and select risks efficiently. Sophisticated pricing models allow premiums to be adapted to ever-changing risk exposures.

Ultimately, the premium that an individual or business pays for coverage is a reflection of how the insurer’s statistical models assess their relative likelihood of incurring a loss. The greater the risk, the higher the premium charged.

How Insureds Can Save on Premiums

Policyholders and applicants do have options when it comes to managing their premium expenditures:

• Shop around to compare quotes from multiple insurers
• Choose higher deductibles to lower rates
• Seek out all available discounts you may qualify for
• Ask about bundling different policies with same insurer
• Improve credit score and history
• Take defensive driving course for auto insurance
• Enhance home security features for discounts
• Lead a healthy lifestyle to control life and health premiums
• Cut unnecessary optional coverages from policies
• Maintain continuous insurance coverage
• Modify vehicles or driving behaviors to become lower risk
• Move vehicles or apply for policies from less risky ZIP codes

Being an educated insurance consumer, improving risk factors within your control, maintaining continuous coverage, and comparing multiple carrier rates can enable you to find the best premium rates.

Key Takeaways

• A wide array of factors related to risks and projected losses contribute to insurance premium determinations.
• Premium rates are set using extensive data analysis, predictive modeling, and proprietary insurance company pricing algorithms.
• Different insurance product lines utilize somewhat distinct pricing factors aligned to their specific coverage risks.
• While premium costs are largely outside an insured’s control, some steps can be taken to potentially reduce rates.
• Finding the optimal balance between premiums, deductibles, and coverage limits is an important component of being properly insured.

At the end of the day, the premiums charged by insurers directly correspond to the likelihood they will have to pay claims. Though the calculations are complex, the basic premise is simple – the riskier you appear based on available data, the more you will pay for coverage.