Fairness in Auto Insurance

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. 

Hyundai_Elantra

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. 

Sigo_Seguros

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.

Nestor_Solari
Nestor Solari

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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  1. 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.

Adventures in Auto insurance

I conducted an experiment a few months back to test a long-held theory. The ubiquitous funny advertisements with the green lizard have led me to believe I could save money by calling up my automobile insurance provider and asking them to reduce my costs. (FWIW I don’t use that company. I have a different one, and I’m loyal to mine.)

Gecko

Long story short, it worked. At the end of my phone conversation with my provider I’ll pay $20.07 less per month. To state some obvious math, that’s $240.84 per year. 

I think my choices are prudent for me, but they are not free-lunch choices. I made a series of calculated gambles based on what I know about insurance in general, my particular car, and my personal financial situation.

This all started from a conversation over coffee with a reader two weeks ago. He mentioned that since the 1980s he’d declined to pay for collision insurance on his car, and that he calculates having saved at least $30,000 since then as a result. That got my attention. I realized I haven’t deeply studied the different components of auto insurance. Maybe you haven’t either. Now’s your chance to get a little nerdy with me.

For starters, auto insurance is required by law in every state. The required part of auto insurance is liability insurance. That’s for when you damage someone else’s body, car, or property. In Texas you’re allowed to buy a minimum of $25,000 in coverage per person or car, and $60,000 per incident. I pay to insure well over the minimum amounts and I didn’t mess with this liability part of my auto insurance policy. 

The second part of auto insurance – which turns out to be optional in some cases – is collision insurance. That’s the amount you’ll receive if your car gets damaged.

Here’s where insurance theory and two other personal finance theories came into play. I’ll hit you with all three theories. First, insurance is expensive, so buy the least you can while still avoiding catastrophic financial risk. Second, don’t buy too much car. Third, try to buy so little car that you can avoid having a car loan. This third part is admittedly rarely achieved, but something to strive for. Because if you can eliminate your car loan, you have more options with collision insurance.

If you have a car loan, your lender makes you buy collision insurance, naturally, because the car acts as collateral for your loan. A smashed up car makes for poor collateral. If you don’t have a car loan, however, you can decline collision insurance. 

I don’t have a car loan. I also don’t have a valuable car. In combination, that means I’m not terribly worried about losing many thousands of dollars in value if I wreck it. During this process I looked up trade-in value for my 11 year-old Hyundai Elantra with 95,000 miles and learned it’s worth $1,800 to $2,500. I don’t expect my insurance company to shower me with much more than that amount, in the event of a total wreck. And I’m not dropping $7,000 in repairs into this automotive beauty in that event either. Both of these factors mean I should keep my collision insurance to a minimum. I declined to pay for any collision insurance this week, because that suits my particular circumstance. 

A fourth rule of personal finance came into play on the issue of comprehensive coverage. The rule is that it helps to have money in order to save money.

collision

I saved a small amount when I upped my comprehensive coverage deductible from $500 to $1000. A few definitions might be helpful to explain what this means. Comprehensive coverage protects me if something other than another motorist hits me, such as hail damage, a tree falling, or flooding. The deductible is the amount I’m on the hook for, in the event of needed repairs. My upping the deductible is really a result of being able to handle the financial hit if a bad thing happens. If I didn’t have either savings or decent lines of credit, I wouldn’t be able to responsibly increase my deductible. But I do, so it’s cool. That’s the “it takes money to save money” thing.

A few other fine-print things I considered during my auto insurance conversation.

I continue to pay for vehicle damage if I’m hit by an uninsured motorist, although I lowered my coverage to the Texas state minimum of $25,000. As I mentioned, my car ain’t worth $25,000, so I’m probably over-covered there.

I continue to pay $1.65 per month for towing and labor. Between a history of dead batteries and flat tires, it feels like I need a tow or jump start more than once a year. So I’m getting my full money’s worth there, if history is any guide.

I also learned that our household auto insurance premiums won’t jump in six months when my eldest gets her learner’s permit. But they will jump in 1.5 years – quite a bit – when she gets her full license. I could hear the empathetic pain over the phone in the auto insurer representative’s voice when I told her my daughter’s age.

So that will be a future auto insurance cost increase. In the meantime, I was happy to squeeze out a bit in savings while I could.

A version of this ran in the San Antonio Express-News and Houston Chronicle.

See related posts:

Book Review My Vast Fortune by Andrew Tobias

Buying a Car Part I – Not Getting Fleeced


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Savings on Auto Insurance

I conducted an experiment last week to test a long-held theory. The ubiquitous funny advertisements with the green lizard have led me to believe I could save money by calling up my automobile insurance provider and asking them to reduce my costs. (FWIW I don’t use that company. I have a different one, and I’m loyal to mine.)

Long story short, it worked. At the end of my phone conversation with my provider I’ll pay $20.07 less per month. To state some obvious math, that’s $240.84 per year. 

I think my choices are prudent for me, but they are not free-lunch choices. I made a series of calculated gambles based on what I know about insurance in general, my particular car, and my personal financial situation.

This all started from a conversation over coffee with a reader two weeks ago. He mentioned that since the 1980s he’d declined to pay for collision insurance on his car, and that he calculates having saved at least $30,000 since then as a result. That got my attention. I realized I haven’t deeply studied the different components of auto insurance. Maybe you haven’t either. Now’s your chance to get a little nerdy with me.

For starters, auto insurance is required by law in every state. The required part of auto insurance is liability insurance. That’s for when you damage someone else’s body, car, or property. In Texas you’re allowed to buy a minimum of $25,000 in coverage per person or car, and $60,000 per incident. I pay to insure well over the minimum amounts and I didn’t mess with this liability part of my auto insurance policy. 

The second part of auto insurance – which turns out to be optional in some cases – is collision insurance. That’s the amount you’ll receive if your car gets damaged.

Here’s where insurance theory and two other personal finance theories came into play. I’ll hit you with all three theories. First, insurance is expensive, so buy the least you can while still avoiding catastrophic financial risk. Second, don’t buy too much car. Third, try to buy so little car that you can avoid having a car loan. This third part is admittedly rarely achieved, but something to strive for. Because if you can eliminate your car loan, you have more options with collision insurance.

(Not meant as an advertisement. Just the pictures was BIG!)

If you have a car loan, your lender makes you buy collision insurance, naturally, because the car acts as collateral for your loan. A smashed up car makes for poor collateral. If you don’t have a car loan, however, you can decline collision insurance. 

I don’t have a car loan. I also don’t have a valuable car. In combination, that means I’m not terribly worried about losing many thousands of dollars in value if I wreck it. During this process I looked up trade-in value [LINK to Kelly Blue Book https://www.kbb.com]  for my 11 year-old Hyundai Elantra with 95,000 miles and learned it’s worth $1,800 to $2,5000. I don’t expect my insurance company to shower me with much more than that amount, in the event of a total wreck. And I’m not dropping $7,000 in repairs into this automotive beauty in that event either. Both of these factors mean I should keep my collision insurance to a minimum. I declined to pay for any collision insurance this week, because that suits my particular circumstance. 

A fourth rule of personal finance came into play on the issue of comprehensive coverage. The rule is that it helps to have money in order to save money.

I saved a small amount when I upped my comprehensive coverage deductible from $500 to $1000. A few definitions might be helpful to explain what this means. Comprehensive coverage protects me if something other than another motorist hits me, such as hail damage, a tree falling, or flooding. The deductible is the amount I’m on the hook for, in the event of needed repairs. My upping the deductible is really a result of being able to handle the financial hit if a bad thing happens. If I didn’t have either savings or decent lines of credit, I wouldn’t be able to responsibly increase my deductible. But I do, so it’s cool. That’s the “it takes money to save money” thing.

A few other fine-print things I considered during my auto insurance conversation.

I continue to pay for vehicle damage if I’m hit by an uninsured motorist, although I lowered my coverage to the Texas state minimum of $25,000. As I mentioned, my car ain’t worth $25,000, so I’m probably over-covered there.

I continue to pay $1.65 per month for towing and labor. Between a history of dead batteries and flat tires, it feels like I need a tow or jump start more than once a year. So I’m getting my full money’s worth there, if history is any guide.

I also learned that our household auto insurance premiums won’t jump in six months when my eldest gets her learner’s permit. But they will jump in 1.5 years – quite a bit – when she gets her full license. I could hear the empathetic pain over the phone in the auto insurer representative’s voice when I told her my daughter’s age.

So that will be a future auto insurance cost increase. In the meantime, I was happy to squeeze out a bit in savings while I could.

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Guest Post: Don’t Buy Too Much Insurance!

Editor’s Note:  Lars Kroijer, semi-regular contributor here and author of Investing Demystified, offers one of the two most important principles of Insurance: Namely, don’t buy too much of it. In this post he uses the simple example of auto insurance – which because of state laws in the US we must buy – to argue that less insurance is generally better. Even though we cannot avoid auto insurance altogether, we can apply this same principal to other types of insurance. Take it away, Lars…

lars_kroijer

In very rough terms the world of insurance is divided into life and non-life insurance.  Non-life insurance is for things like your car, house, travel, company, and other non-life things.  We all know how it works.  You pay $500 to insure your car against a number of things, including for example theft.  Let’s say it is a $10,000 value car.  In simple terms, the probability of making a claim against the full value of the car in any one year has to be 5%.  Without necessarily doing it in those terms, most buyers of insurance probably consider that about right and therefore worth it.

The reason I would not prefer to buy the $500 insurance on my $10,000 car – other than the insurance that is required by law – has to do with my knowledge of the insurance company’s combined ratio.  The combined ratio is the sum of the claims and expense ratio.  The claims ratio is exactly that – what the company pays out in claims to people whose cars were stolen or damaged.  And the expense ratio is all the other costs of the insurance company; marketing, administration, overhead, etc.  Insurance companies can have combined ratios over 100%; if claims don’t come due for a while the insurers earn an interest on the premiums they collected until the claim falls due.  But since car insurance is typically a one year policy the combined ratio for this policy should be below 100%, in order for the insurance policy to be profitable for the insurance company.

For car insurance the risks are somewhat predictable and the insurance company are likely to have a good idea of the number of claims and expenses they will face (insurers can reinsure risks they don’t wish to hold fully themselves).  Using very rough numbers the insurance company might have a combined ratio of 95% for these policies made up of a 70% claims ratio and 25% expense ratio (my friends in insurance will bemoan this simplification).  So essentially if you are an average risk customer, for every time you pay $100 in premium on your car insurance you get $70 back in claims and it costs $25 for the insurance company to make it all happen, and they take a $5 profit.  Put in other words, you are paying $30 for the peace of mind of having the insurance.

When I describe it this way, I am simplifying the amounts and the process. You obviously don’t get $70 back.  Most of the time you get nothing back as you didn’t make a claim on the insurance company, and then when misfortune strikes you get your $10,000 back; on average you get $70 back.

So the reason I don’t buy extra insurance above what’s required by law is that I don’t want to pay the 30% in cases where I can afford the loss (25% expenses plus 5% profit to the insurance company).  Obviously it would really stink to have my car stolen or damaged to the tune of the full $10,000, but I see this as a risk I can afford to bear and don’t need to pay to protect against.  Importantly I don’t think that I save the full $500 in annual car insurance.  I think that I save the 30% difference between what I paid and the average claims.  In my view the insurance company knows as much about my risk as buyer of insurance as I do, and if they set the average pay-out for me at 70% of a $500 policy then that is probably about right.  So using this case of car insurance to extrapolate how I think about insurance in general, on average over all the insurance policies I don’t buy I would expect to have a loss of $350 (70% of $500) on my car in any one year, and have saved $150 by not buying insurance (30% of $500).

porsche_savings_from_low_cost_mutual_funds

Not buying insurance against things we can afford to replace or have happen does not mean that those things don’t happen.  It just means that instead of having the small bleed of constantly paying small premiums for lots of small things we will once in a while be paying out larger replacements amounts for things we did not insure against.  Personally I also think the whole hassle of keeping track of insurance policies is a pain I would rather avoid and I also seem to constantly hear stories about insurance companies that either fought claims or made claiming on a policy a huge headache.

Without being scientific about it including all insurance forms that I don’t buy (including life insurance) I think I save about $500 per year in expense ratio and insurance company profit.  Assuming that I took this money every year for the next 30 years and invested it in the broader equity markets and was able to return 5% on that money, my savings from not buying insurance over the period would amount to around $35,000 in present money.  This is money I have, instead of it being in the insurance company’s pockets in 30 years.  Importantly this saving does not assume that I do not have accidents or have my car stolen.  In fact it assumes that I am at risk of those things exactly with the same probability that the insurance companies assume.

Investment advice typically has an “always seek expert advice” or “don’t try this at home” disclaimer, but here it really applies.  You should not save on insurance premium payments in instances where you can’t afford the loss; and everyone is different in terms of what they can afford to lose.  Most people could not afford to lose their house in a fire so they should insure against this possibility (you probably couldn’t get a mortgage if you didn’t). Most people in countries without national health services couldn’t afford bad health reverses and should get health insurance.  Many can’t afford to have bad things happen to their car or their homes broken in to, so they should insure against that.

Try to save your money from all these nice folks
Try to save your money from all these nice folks

But, importantly, most people can afford to lose their mobile phone, having to cancel a flight or vacation, or an increase in the price of their electricity bill, and they should not insure against those things.  And even if there are things you need to buy insurance for you should always get a high deductible which in turn will lower the cost of the insurance policy.  Over time having no insurance or a high deductible when you do will save you quite a bit of money, and that should make you sleep better at night.

Similarly there are many instances where life insurance makes sense.  As with the case of annuities many life products have an investment component to them, but obviously also a life component.  If you are in a situation where your death or disability will cause unbearable financial stress on your descendants then the premium you pay on these policies make sense.  As with the example of car insurance, you should do so when you or your descendants can’t afford the loss.  Whether they can or not is obviously a highly individual thing, but bear in mind that as with all insurance products there is a tangible financial cost to the intangible peace of mind many people cherish in insurance.  Make sure it is worth it.

 

Please see related posts:

Insurance Part I – Risk Transfer Only

Insurance Part II – The Good, The Optional, The Bad

Insurance Part III – Life Insurance Calculations

Book Review: Investing Demystified by Lars Kroijer

Audio Interview with Lars Kroijer, Part I – Global Diversification

Audio Interview with Lars Kroijer, Part II – On Having an Edge in Investing

Guest Post by Lars Kroijer: You don’t have an investing edge

Also, see book review about an author obsessed with auto insurance, in My Vast Fortune by Andrew Tobias

 

 

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