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Demystifying Auto Insurance Pricing

How your auto insurance premium is (really) calculated and how you can save up to 50%

Published on : 
October 21, 2021
Updated on : 
February 28, 2022

This blog post was brought to you by Onur Gungor, CEO of Allegory, and actuary of more than ten years.

Before I founded Allegory, I had worked for insurance companies as an actuary for more than a decade. Two years ago, I decided the industry needed to take insurance back to its fair and inclusive roots, as my experience showed me that insurance can be so much better than what it is today. This is why Allegory was created.

Besides being an entrepreneur, as an actuary, I specialize in insurance pricing. In this blog post, I will share some of my experiences with you to make the insurance business a little bit easier to understand. But first, what does an actuary do?

What does an actuary do?

In simple terms, an actuary makes financial sense of the future on behalf of insurance companies. Actuaries collect and analyze data in order to calculate insurance premiums and pension contributions, guide insurers on how much of the premium they’ve collected should be reserved for bad days, and how they can stay solvent so that they can keep their promises to their customers and the public (i.e. paying your claims and retirement).

Since calculating insurance premiums is essential for an insurer to keep its business running, we need to review how this calculation works. However, before we do this, it's helpful to briefly look at the history of the insurance industry as it will help explain today's current state--including premium calculations.

How long have insurance companies been around?

When you think about how the first American insurance company was organized by Benjamin Franklin in 1752 as the Philadelphia Contributionship, it’s not surprising to hear that most insurance companies have been around for decades. It means that they also have decades of historical data about their customers and their claims that they can use to optimize their business. However, not all insurance companies have the same customer demographics in their portfolio, meaning every company has access to slightly different data. For example, some insurance companies focus on auto insurance for young drivers only. However, another might target specific geography, such as drivers in Texas.

One of the major reasons why different companies will offer you a different premium is the differences in the data they have access to. Every company’s experience is just different with different segments of driving. For example, in auto insurance, even if you can prove you've been a safe driver for over seven years, different companies can offer you wildly different premiums simply because they have different kinds of data on people with similar profiles to you (e.g. age, sex, marital status).

The last thing to know about before we get into pricing directly are the ground rules all insurers must play by.

Insurance regulations and the "ground rules"

In a given jurisdiction, all insurance companies must play by the same ground rules. Regulators in different states or Canadian provinces regulate what types of data insurance companies can and cannot use when calculating auto insurance. For example, insurance companies cannot use your driving behavior in California, while insurers in Ontario, Canada, are prohibited from using your credit score.

Regulations help protect consumers, and in another blog post, I will write about my personal experience with regulators and how they help the industry progress.

How is auto insurance calculated?

Once insurers know the ground rules in their jurisdiction, their actuaries take a historical look at the available data in order to find patterns in it.

I don't want to sugar-coat the reality, but ultimately their goal as a business is to see what factors affect the number of claims they receive based on their past five to seven years of financial data.

For example, if in one insurer's data set, young drivers have gotten into more accidents than middle-aged drivers on average in the last five to seven years, young drivers are going to be given higher premiums, and have to pay more. Similarly, if consumers with low credit scores had to use their insurance more than people with higher scores, people with low credit scores will be offered higher premiums.

Below is the complete list of factors that most insurance companies use while calculating auto insurance premiums:

  1. Demographics: Age, gender, marital status (single, married, divorced), zip code or postal code, number of drivers in the household, number of drivers below 25 years old,
  2. Vehicle Information: Make/Brand, model and model year, previous damages to the vehicle, safety features,
  3. Driving Distance and Usage: Annual driving distance, one-way driving distance to work, percentage of the business, personal or farm use,
  4. Preferred Coverage and Policy Limits: The type of coverage you need, e.g. third-party, collision, comprehensive, how much you will need to be covered, and what types of value-added services you need as a driver, for example, assistance or rental services after an accident.
  5. Previous Insurance: Overall driving record (e.g. from the DMV in the US or MTO in Canada), number of at-fault accidents in up to the past 15 years, number and type of traffic violations in the past three years,
  6. Credit-Related: Credit score, insurance payment default, and if your insurance has been cancelled by the insurer in the past three years.

How is Allegory different?

The short answer is we don't use the factors listed above. It means we don't use your age, gender, zip code, marital status, credit score, or how many accidents you have gotten into. This is because Allegory is not about trying to understand who you are but is about understanding how you drive. As a result, our approach can differentiate between good and risky drivers 27 times better than any traditional insurance company in business today.

The model we have developed over the years consists of four components:

  1. How you drive,
  2. How much you drive,
  3. What you drive,
  4. Where you drive.

An image depicting the components of the Allegory Driving Score for telematics insurance

These are the primary risk indicators, not secondary or tertiary. It means that these factors do not include any demographical information such as your gender or marital status. And they still tell you more about how safely you drive.

That’s why the Allegory Driving Score is a true reflection of your risk of getting into an accident, and that’s also what we use to help you and your family prevent accidents. This model has been tested with over 300,000 drivers and more than a million location-based accident data across North America, so we can confidently say that it is possible that good drivers can save up to 50% on their auto insurance.

I hope this blog post has genuinely helped you understand how it works and how Allegory makes it more innovative, transparent, and fair for you.

Credits to images:

Blog main image by Marek Piwnicki

Second image by Tim Umphreys

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