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Understanding Automobile Insurance

In order to truly understand automobile insurance one must look at the proposition from all angles, not just from their own perspective. That is to say that understanding automobile insurance will also require understanding the factors that motivate any given insurer and how risk distribution works on a fundamental level.

All forms of automobile insurance are essentially risk distribution of some sort. 100 people pay automobile insurance premiums to a given insurer though few of those 100 automobile insurance policyholders will ever file claims as a result of an automobile accident. If only 4 of those automobile insurance policyholders file claims then anyone seeking to understand automobile insurance might feel as if 96 people paid their automobile insurance premiums for nothing, but that is not actually the case. The essence of risk distribution is that nobody can truly predict the future. The future is full of risk, and the risks associated with operating and owning automobiles include theft, bodily injury, property damage and possibly even death.

All 100 of those automobile insurance policyholders did, in fact, indeed receive something valuable. What they received in exchange for their monthly automobile insurance premiums was a form of security in the knowledge that had they been one of the 4 policyholders that was involved in an accident that they would have been able to file an automobile insurance claim with the insurer and expect to have it honored if the circumstances warrant it. Payments on automobile insurance claims can help one pay for extremely expensive hospital stays, repairs to their vehicles, damages resulting from a law suit or any other a hundred different things that could potentially deplete one’s savings and leave them in debt that could last a lifetime. That protection alone is worth the automobile insurance premium in the eyes of insurers and anyone interested in understanding automobile insurance.

Now that the fundamentals of risk distribution have been made clear, the next step to understanding automobile insurance is being aware of the factors influencing monthly automobile insurance premiums. This is the part of the mental exercise where it is best to look at the problem from the point of view of a hypothetical insurer. Assume that consumers are clamoring for automobile insurance to protect themselves from the aforementioned risks. How can a fair, equitable and profitable system be created that allows the insurer to cover medical expenses, repair damaged automobiles, handle court cases and so on?

Obviously the first step is to ensure that far more people are paying their monthly automobile insurance premiums than are making claims. That statement is quite obvious, but what is not obvious is that policyholders with low credit scores are statistically more likely to file automobile insurance claims than automobile insurance policyholders with average or high credit scores. This may be due to consistently poorer judgement and decision making skills or practices or fraud, but all claims need to be investigated and that means an insurer needs to spend money out of their pocket. So, does it make sense to charge two potential automobile insurance policyholders that are in every single way identical other than their credit rating the same exact monthly premium?

Taking this logic one more step, consumers with low credit scores that are interested in understanding automobile insurance generally have low credit scores because they either have no history of paying bills on time or they have a history of paying whenever (or even if) they feel like it. This translates to greater staffing needs in accounts receivable as well as the risk of an account going into collection and being sold for pennies on the dollar. Taken together with the risk of additional automobile insurance claims, it is easy to see why insurers offer more favorable rates to consumers with excellent credit scores.

Further understanding automobile insurance requires examining why certain types of vehicles are more expensive to insure than others. Assume that identical twins come into an automobile insurance brokers office and one drives a brand new Porsche 911 while the other is driving a slightly used Dodge minivan. Obviously the Porsche owner will pay more for automobile insurance, but the question is why?

Firstly, sports cars are more likely to be involved in accidents due to their ability to accelerate quickly and be driven at speeds that no minivan could ever attain. Secondly, the parts required to repair a semi-exotic sports car such as a brand new Porsche 911 probably cost significantly more than the parts to repair a slightly used Dodge minivan. Exclusivity works against the Porsche owner in this case, but safety is also a concern. Larger, heavier vehicles tend to fare better in accidents which often results in less damage to the vehicle and less risk of serious or fatal injuries to the occupants of the vehicle. Both of these are very favorable characteristics for insurers who have a vested interest in paying out on automobile insurance claims as infrequently as possible.

The amount insurers need to pay on claims is directly related to the deductible one has in their policy. There are different types of deductibles but in essence the practice is very simple to grasp. If one has a $500 deductible and their vehicle is damaged in an accident, the insurer pays anything above and beyond the $500 that must be provided by the automobile insurance policyholder. If the damage is very minor, such as a scratch from the local parking lot, then the cost of repairs may be less than $500 and the insurer is not expected to pay anything.

Families with multiple drivers and/or multiple cars often qualify for discount on their automobile insurance premiums for reasons related to operating costs. If an insurer spends $84 paying their rent, advertising and other operational costs per customer that signs a policy with them, then they need to add $84 to each policy’s value to cover their investment in attracting customers and keeping their door open. Multiple drivers still operating one vehicle offer less risk than two drivers with two vehicles and a family with two vehicles still costs less in terms of advertising fees than attracting two different customers. Additionally, families tend to bundle other forms of automobile insurance such as property and life insurance which also serve the interests of the insurer.

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