How insurance companies determine auto rates

How does an insurance company determine what you should pay for auto insurance? It first starts with the state you live in. Each company annually computes their profitability in a state that they are doing business based on the loss frequency and severity of their insureds. They then must determine if these rates are adequate for the exposure they have and will have with the addition of new business for the next 12 to 24 months.

After calculating whether the rates they have on file with the state insurance department are adequate or not, they file the new rates with the state insurance department for approval. There are different laws regarding the approval of new rates including prior approval, file and use, and use and file. In Georgia, the new rates have to be approved by the Georgia Department of Insurance before the new rates can be passed on to the customers.

So why do rates go up? Remember I said earlier that companies must look out 12 to 24 months to project a profitable rate for the company. To explain that, let me give you this example. If you have a 12-month policy and your policy renews Jan. 1, 2016, and your company takes a rate increase effective Jan. 2, 2016, your premium as a result of that increase will not affect your policy until Jan. 1, 2017. The company will not fully earn that increase until Jan. 1, 2018.

That is why many companies only write six-month policies. They earn the value of a rate increase sooner and can increase rates or decrease rates more often. The consumer is better served with a 12-month policy for rate protection.

Once a company determines the amount of a statewide rate increase, it then must spread that increase to its rating territories across the state. Rating territories are made up of zip codes that are adjoining and typically carry the same demographic makeup. Insurance companies contract with companies that compile census data such as average household income, home ownership percentage, percent of college graduates, etc. to help them align territories for marketing and pricing. Companies have loss ratios down to the zip code level.

As a consumer, you hope that the other insureds in your zip code and rating territory are not driving up a rate indication. In major metropolitan areas such as Atlanta, rating territories are smaller due to population density, where as in South Georgia, the rating territories are geographically larger. Rating territories have to have enough exposures in them to be statistically significant.

Remember, rates are based on accident frequency, severity and trend of the group of insureds, not just you. To be continued next month.

This story was originally published April 19, 2016 at 5:45 PM with the headline "How insurance companies determine auto rates."