How Auto Insurance Rates Works
While it may seem complex, insurance is really quite simple: The payments of the many pay for the losses of a few. Your premiums go into a large pool, if you will, at your insurance company. The claims of the few are paid from that pool. Because there are more people contributing to the pool than there are making claims, there is always enough to pay the claims – even large single claims like when someone is permanently disabled as a result of a car collision, or many smaller claims like those resulting from a natural disaster. (The 1998 ice storm that hit parts of Ontario, Quebec and New Brunswick resulted in an estimated 700,000 claims for damage totalling $1.4 billion.)
Your insurance is an annual contract, so the pool operates for only one year at a time. Your premiums and the premiums of others are based on how much money the insurance companies think they will need to pay the coming year’s claims. Your premiums do not build up over the years – unlike the premiums for some types of life insurance.
How premiums are calculated
Within reasonable limits, some of which are prescribed by law, your premium is calculated to reflect the probability that you will make a claim – that is, that you will draw funds from the insurance pool. Those who are unlikely to draw from the pool pay less than those who are more likely to draw from it.
Insurers take many factors into consideration to determine the likelihood that you will make a claim. A common misconception is that a policyholder who has never made a claim should pay less, little or nothing for insurance. While it is true that past claims history is important, a more reliable indicator of how likely a person or business is to make a claim is the statistical group to which he/she/it belongs.
Your Insurance Dollar
Here is a breakdown of where your insurance premium dollars go.
For every dollar of premiums gathered from policyholders, 53.1¢ go back to policyholders in the form of claims, 15.9¢ go back to communities in the form of various government taxes on insurance, 20.5¢ go to industry operating and regulatory costs and 10.5¢ go to industry profit.
These percentages are based on a 7-year national average from 2004 to 2010.
Insurance pays for …
Insurance pays for only those types of losses described in your contract. It is very important that you read your policy and/or talk to your insurance representative about what you are covered for and what you’re not. Insurance will not pay for every problem that you may encounter, nor is it a maintenance contract. Insurance is generally intended – and priced accordingly – to help policyholders cope with the financial consequences of unpredictable events that are "sudden and accidental." If, for example, you live on a floodplain by a river, flooding of your property in the spring is not sudden or accidental; it is inevitable and, therefore, uninsurable.
How Car Insurance Premiums are Calculated
Car insurance premiums, like all insurance premiums, are determined based on risk. That is, how likely it is that a customer – and a group of customers with the same set of circumstances – will make a claim, and how much those claims will likely cost. Actuaries (those with mathematical training in the principle of large numbers and the theory of probability) must also predict how much it will cost to settle these claims, the company’s overhead, selling costs, industry taxes and the amount that must go into reserve funds to cope with catastrophes.
What My Insurance Company Does With My Premiums
There are some common and persistent misconceptions about what insurance companies do with the money they collect from you and every other policyholder. Some people think it sits in the bank until someone makes a claim. Not true. Others believe that premiums go to pay for claims that have already happened. Not true either.
Your premium dollar travels a long and winding road, but, in the end, most of it goes to assist consumers in one way or another. For example, if you suffer a loss, a portion of your premium dollar and those of several other policyholders finds its way back to you, to help you recover.
For the record, this is what happens to your premiums:
In the insurance system, money is always moving. On a daily basis, there are claims to be settled, taxes to be paid and other costs related to running a business (paying salaries, buying equipment, paying rent, etc.). Some money is always set aside so that the company can respond quickly to catastrophes, when a large number of claims will have to be paid in a short period of time. This is called a reserve.
Any money that is not needed for day-to-day expenses or reserves is usually invested by insurers.
Here are a few things you should know about insurers’ investments:
- Contrary to what some people think, insurers have never had a year when they lost money on investments. Some years are better than others, but the industry has always generated positive investment returns.
- Insurers are among the most careful investors in the country. On average, approximately three quarters of their investments are in government bonds.
- In order to make sure that insurers are able to pay claims, the federal government monitors the industry’s investments to make certain that they are low-risk.
- Insurers strive to maintain a portfolio that allows for quick liquidation of investments to pay claims.
Why do insurance companies invest the money?
The nature of insurance is such that your insurance company holds your premium until it is needed to pay claims. By investing the money in the interim and making a return, your insurance company is able to offset the cost of claims and charge you less than you would otherwise pay.
In fact, there have been years when returns on investments were so good (10% or higher) that insurers only had to collect enough premium to pay for claims and expenses, and made all of their profit from investments. Even when investment returns are much more modest, this is an excellent way to keep premiums as low as possible for consumers.
These factors affect what you pay for automobile insurance:
- Where you live: If you live in a bustling city, for example, accidents and vehicle theft are more likely, which may translate into higher premiums.
- The type of vehicle you drive: Insurers consider the make and model of your vehicle in terms of what the risk factors associated with it might be. For example, some makes and models fare better in collisions than others, meaning injury to the occupants and damage to the car end up being less severe. Also, newer, more expensive vehicles cost more to replace, so they are more expensive to insure. In determining your vehicle’s risk and expected claim severity, your insurance company may rely to some degree on IBC’s Canadian Loss Experience Automobile Rating clear.
- How you use your car: The more time a car spends on the road, the higher the chance of an accident. That means higher premiums if you drive a lot, you drive long distances or you drive to work every day.
- Your driving record: Your driving record has a big impact on the premiums you pay. For example, a long driving history with no accidents can help keep your premiums down, and every accident where you're at fault may push your premiums up. Speeding tickets and other moving violations may also increase your premiums, but parking tickets will not.
- Your statistical group: Depending on what province you live in, your insurer may consider the claims history of the group to which you belong as a driver – for example, the group of drivers of the same age and in the same geographic location. If you belong to a group that is more likely to make claims, your premiums may be higher.
- Other factors: In the highly competitive field of insurance, prices are also affected by the interplay of market forces, government regulations, taxes at many levels, discounts and unpredictable catastrophic events.
Because insurers consider a policyholder’s individual history in combination with that of his/her group, there is no one-size-fits-all method of determining premiums. Therefore, it is not the case that all 30-year-olds driving Fords and living in downtown Calgary pay the same amount for their car insurance. If the factors listed above weren’t considered, lower-risk policyholders would be subsidizing the higher-risk ones.
These factors DO NOT affect what you pay for automobile insurance:
- The colour of your car: The colour of your car does not affect your automobile insurance premium. You will not be asked to specify the colour of your vehicle on your auto insurance application.
- Whether your car is foreign or domestic: Insurance premiums will not necessarily be higher for a foreign vehicle than they will be for a domestic automobile. See “The type of vehicle you drive” in the list above for more information.
Who is insured through Facility Association?
Facility Association (FA) and its member companies ensure that car insurance is available to anyone who is entitled to it or is required to have it. FA is not an insurance company; rather, it is a not-for-profit organization made up of all car insurance providers operating in every province and territory in Canada except British Columbia, Manitoba, Saskatchewan and Quebec.FA ensures that any driver who can’t get car insurance in the regular market can ultimately get insurance. That being said, only a very small percentage of drivers is insured through FA.
Generally, you may have to buy insurance through FA because:
- you have one or more moving violations on your record;
- you have a poor, or no, driving record;
- of something in your claims history;
- of the type of car you drive; and/or
- of how you use your car.
These are some of the reasons you might be considered a higher-risk driver – that is, at higher risk of having an accident. Insurance premiums are based on risk so, higher-risk drivers insured through FA pay more for car insurance.
Getting out of FA
There’s good news: You are not destined to pay the higher FA insurance rates forever. If you are currently insured through Facility Association, you should be shopping around for insurance. Facility Association exists to make sure coverage is available for those unable to obtain it anywhere else. As the insurance marketplace improves, or if your situation changes, there is more chance you can find insurance in the regular market – at a lower price. Talk to your insurance representative.
There are other things you can do to make your insurance business more attractive to insurers and lower your premiums.
Borrowing or Lending a Car?
Under certain circumstances, you can borrow a car without worrying about whether or not the car’s insurance names you as an occasional driver, or lend your car without worrying about whether or not the guest driver’s name is on your insurance policy.
If you are borrowing a car
- The person whose car you are borrowing must give you permission to use it.
- The use of the car cannot be part of a regular pattern, such as driving to school every day. (If you regularly borrow the same car as part of a routine, you must be listed on the owner’s insurance policy as an occasional driver.)
- You must be a licensed driver who is legally allowed to drive in the province.
If you have an accident while driving a borrowed car, the accident goes on the record of the person who has the insurance policy on the borrowed car.
If you are lending your car
- You must consent to its use by the other driver.
- The person who borrows your car cannot be using it as part of a regular routine. If your friend uses your car every Friday to go grocery shopping, then he/she must be named on your insurance policy as an occasional driver.
- The person to whom you lend your car must be a licensed driver who is legally allowed to drive in the province.
If the person borrowing your car has an accident while driving your car, it goes on your insurance record. When you lend your car, you are also lending your good driving record.
What You Can Do to Control the Cost of Insurance
To lower your premium, ask your insurance representative about the following:
- increasing your deductible (i.e., your share of the cost of a claim) – by increasing the amount you are willing to pay, you will decrease your premium;
- dropping collision coverage on an older car;
- getting package deals for insuring your car and home, or more than one car, with the same insurance company;
- installing an approved theft deterrent system in your vehicle;
- buying a car with a lower-cost insurance rating.
Addition to shopping around and considering the options above, you can:
- build a consistent accident- and conviction-free track record;
- adjust how your car is used – for example, to keep annual kilometres down, take public transit to work if it is available;
- check with your insurance representative about excluding high-risk drivers from your policy so that if you are a good driver, you are not penalized with a higher premium;
- Ensuring that the insurance company has an accurate VIN on record for the car. The VIN is your car’s identity – what insurers use to confirm the kind of car you drive. Some cars are more expensive to insure. You could be paying the premiums for a different – more expensive make or model – car.
What to Do if You're in a Collision
Always call the police if:
- someone is hurt;
- you think any other driver may be guilty of a Criminal Code offence, such as drunk driving; and/or
- there is significant property damage.
If no one is hurt:
Safety first: If it is safe, try to move your car to the side of the road, out of traffic. If you can’t drive your car, turn on your hazard lights or use cones, warning triangles or flares.
Just the facts ma’am:
- Jot down details about the accident, including how it happened, the time, date and location, the speed of all cars and the road conditions.
- Get the contact information (names, addresses, phone numbers) of the registered owners of all cars involved, other passengers and other witnesses.
- Get insurance information from all drivers involved in the accident, including the driver’s licence and plate numbers, and the names of their insurance companies and brokers.
Picasso you don’t have to be: A sketch of the accident scene noting the position and direction of the cars is also helpful. (You may want to keep a disposable camera in your glove box to use instead.)
Preventing further loss: If you are involved in a collision, you are responsible for protecting your car from further loss or damage. Your insurance company will, however, pay for this if you have purchased collision or all perils coverage.