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What’s a fair way to price auto insurance?

My question begins from a personal financial setback.

My 16 year-old got her driver’s license in August, which I just learned will double our household automobile insurance premiums. We previously paid $678 every six months but will now pay $1,276 every six months.

Yay.

Now I know where I’ll spend the automatic child tax credit that I was so happy about recently.

This new, egregious, pricing is typical for youthful drivers, who are guilty until proven innocent, from the perspective of insurance companies.

Another guilty until proven innocent factor used by auto insurance coverage is credit scores. The worse or thinner your credit, the more you pay for auto insurance. This feels unintuitive. Why should a person with a flawless driving record pay more for insurance if they were late on their credit card bill, or don’t have a credit record? Driving and using credit responsibly are clearly separate skills.

Using credit scoring in insurance products and pricing is an active debate at the federal and state level. New Jersey Senator Cory Booker has proposed banning credit scoring as a factor in auto insurance. Michigan Congresswoman Rashida Tlaib has done the same in the House.

The insurance industry maintains that the historic correlation between lower credit scores and a higher number of claims and a higher dollar value of damage claims justifies the use of credit scoring in pricing.

In June of this year entrepreneur Nestor Hugo Solari moved his startup auto-insurance company Sigo Seguros to Austin and launched a new program in the state, targeting the state’s Spanish-speaking population.

One of Sigo Seguros’ selling points is that they do not consider personal credit scores when underwriting auto insurance. They consider credit-scoring discriminatory, especially against Spanish-speaking Texans. To further appeal to his target audience, the company will not require a traditional state driver’s license either. Customers can provide a foreign driver’s license and still receive coverage from Sigo Seguros, without any surcharge.

The most typical customer for Sigo Seguros, according to Solari, seeks liability-only coverage, and may forgo collision coverage because they drive an older, less-valuable car.

I’ve previously written about this, but from a personal-finance perspective, I favor this flavor of auto insurance. We need solid protection against catastrophic liability. But we don’t need protection against car damage because, for personal finance reasons, people shouldn’t drive valuable cars. Especially, I hasten to add, with a new 16 year-old driver behind the wheel. I decline to insure against damage to my 2009 Hyundai, which has a trade-in value of maybe 2 thousand dollars. At that kind of value, what’s the point of damage insurance? The thing is nearly worthless, on purpose, just the way I like it. So I save a little by declining collision coverage, as do many Sigo Seguros customers.

I asked Solari what his issue was with credit scores. Solari pointed out to me that the Spanish-speaking Texans his company seeks to serve may have thin or no credit files because of recent immigration status or because the community is relatively under-banked, compared to native English-speakers in the state.

I confirmed with my own auto insurance company that they do consider personal credit as one of the factors determining my premiums. Texas insurance rules allow credit scoring as a factor for pricing, in a regulated way, and as long as it’s not the only factor considered. Some states, including California and Massachusetts, have banned personal credit as a factor because of their potentially discriminatory effects.

Other factors also always matter, such as miles driven, car-density as measured by zip code, and of course past driving record.

In theory, what is a fairer method for pricing auto insurance?

Critics of the use of credit scoring argue that observed driving behavior and driving record is what should count most. They have a point as well.

In recent years auto insurance companies have experimented with telematics, which provide data directly to the companies on your particular driving style, based on a mobile phone app that tracks everything from acceleration and hard-braking to late-night driving and texting-while-driving.

Sigo Seguros offers a discount for customers who sign up to its mobile-phone based telematic system, as a better way to measure driving risk.

I was interested to learn this because I had previously enrolled about a year ago in an app that offers me a discount for letting my insurer track my driving experience. My insurance company’s app even reports to me about my sudden braking as well as my phone use while driving. It’s probably tracking overall miles driven as well.

This kind of driving data strikes me as quite fair, since it measures factors that could increase the likelihood of auto accidents which credit scores, for example, do not. This is the ultimate goal – fairness in auto insurance – based on observed risky behaviors. And fairness is good.

The downside of telematics is that Big Brother – in the form of my auto insurance company – is totally watching me drive around everywhere.

This makes me paranoid about my ability to get away with doing crimes in the future, which is a real negative. On the plus side, I get 3 percent annual savings on my auto insurance premiums!

We are now paying through the nose because of my teen driver. Eventually I will need to rob banks just to pay for the auto insurance, but the auto insurance telematics will increase my likelihood of getting caught for this behavior. A classic Catch-22.¹

A version of this post ran in the San Antonio Express News.

Please see related stories:

Yup, My 16 Year-old Got a Credit Card (Need to link here)

Auto Insurance and My Personal Finance Theories

Buy the Least Amount of Car

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Speaking of Big Brother watching, and as a total aside, I have really enjoyed the idea that Bill Gates can track my every move, ever since I got the Pfizer vaccine against COVID. You know what’s nuts about that worry in particular? We all carry smartphones everywhere! That is the actual tracking device recording all of our movements, people! It’s not the vaccine. Please, for the love of McKenzie Scott and all that is beautiful in this world, get vaccinated if you haven’t already. ↩

I’ve written before about carried interest taxes, estate taxes, and real estate tax policy using the contrasting lens of what is ‘fair to me,’ (typically, If I don’t have to pay it, it’s fair to me) versus what is ‘fair to society,’ (My attempt to take the broad view, even if it hurts me personally.)

Another common way of thinking about tax policy – today’s way – would be to think specifically about what behaviors the policy would encourage and discourage.

Now, I understand you may resent the idea that Big Brother imposes its will on you via tax policy. I don’t have a big problem with it myself. The way I figure it, behavior-modification is one of the main things that determine good or bad tax policy.

My state and local governments already discourage me from using tobacco and gasoline through targeted sales taxes on those products. The federal government discourages me from working for a living through income tax policy. In addition, the federal government encourages me to be born into a wealthy family via the $5.43 million estate tax exemption.[1] All of these behavior modifications are just part and parcel of tax policy, forming part of what we use to think about what makes for a good or bad tax.

Democratic Party candidate Hillary Clinton recently proposed behavior modification through changes in the capital gains tax.

I expect I’ll have plenty of critical things to say in the future about Clinton as she moves from candidate to President, but I actually dig this proposal.

Before getting into her tax proposal, however, I’m troubled by the insufficiency of the title I just used, “Democratic-Party candidate.” Because she is far, far more important than that title implies.

Can we instead go with something like “Hillary Stormborn, First Lady of the House of Clinton, Democratic Senator from New York, Secretary of State, Encourager of Benghazi Jihadists, Webmaster of Clinton.com, Queen from Across the Narrow Sea, First of the Andals, and Unburnt Mother of Dragons?”

I think that about covers all of her past experiences accurately, no?

Anyway, back to tax policy.

Clinton’s campaign proposes capital gains tax changes for the highest income tax bracket that would step down each year that an investor holds securities.

Currently, taxpayers in the highest tax bracket pay 39.6% in taxes on gains for securities held less than a year, and 20% for holdings held longer than that. Taxpayers in lower tax brackets currently pay their regular income tax rate for holding securities less than a year, then 15% for anything held longer than one year.

Clinton’s proposals would incrementally lower the capital gains tax rate on the highest taxpayers, for each year that those investors hold securities. The tax rate on capital gains would drop to 36% by year 2, then step down to 32%, 28%, 24%, and finally to 20% by year 6.

Have I lost you yet? I’m not trying to. Here’s the deal. If you make a lot of money each year, the Clinton proposal would encourage you, via tax incentives, to hold on to securities for a long time horizon, of at least six years or more.

This behavior modification tax has two explicit targets. The first target is investors, who would be rewarded for holding stocks for six years or more. If investors find they can lower their taxes by holding stocks for a longer amount of time, they likely will approach stock ownership with a greater emphasis on long-term wealth creation.

The second target is public-company managers.

“It’s time to start measuring value in terms of years – or the next decade – not just next quarter,” she announced in her speech proposing these changes, according to the Wall Street Journal.

Longer-term investors, the idea seems to be, will encourage longer-term thinking among the management of public companies. Without the pressure to perform on a quarterly basis, maybe, public companies will avoid short-termism in their decision-making.

By the Clinton campaign’s own telling, the capital gains tax modification would not raise much additional federal revenue.

One reason is that her proposal only affects investors already in the highest tax bracket, earning above $464,850 for married couples, or $411,500 for singles, or somewhat fewer than 1% of all income earners in the United States.

The second reason this would raise limited revenue is that many investors hold a majority of their investments in tax-protected accounts such as IRA and 401Ks, Investors do not need to pay taxes on capital gains on securities held within these accounts.

So again, the entire point of this is behavior modification, not revenue generation. If you already hate behavior modification via tax policy, you’re not going to like this idea as much as I do.

Since I feel so strongly that the correct time horizon for equity investments falls somewhere in the range between five years and forever, I think Clinton’s on to something good here in encouraging a six-year minimum holding period for securities, via tax policy.

One criticism I have of the proposal is that it doesn’t apply to the bottom 99% of earners. Since the point here is behavior modification of both investors and public company managers, I don’t see why the rules wouldn’t equally attempt to modify their behavior as well.

Everybody should have a six-year-or-greater time horizon with their investments, so everybody should be subject to the rule.

Please see related posts on taxes:

Can we have an adult conversation about income tax policy?

Real estate tax – Agriculture exemption rant

Carried interest tax rant #1

Carried interest tax rant #2

Estate taxes

[1] Think about it: Heavy taxes on income if you work to earn it, but a tax free $5.43 million if it comes from Daddy!

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