Insurance prices may feel random when two neighbors with similar houses or cars get quoted very different premiums. At its simplest, the calculation starts by grouping you with customers who share your risk characteristics. From there, your individual details and the coverage you choose help determine what you pay.

Shopping around is the best way to lower your premiums. If you’re curious to see if you could get a better price, check now.

Insurance theory

Insurance assumes that although claims cannot be predicted for one person, they become predictable across a large group.

For example, no one knows which driver will crash next year, but claims from millions of drivers reveal a pattern in how often losses happen and how much the insurer pays out. The insurer prices against that pattern, and it reviews and adjusts it regularly as new claims come in. Those adjustments shape the price of new policies.

Pricing depends on most people not claiming. Everyone pays a premium, and the many who file nothing cover the few who suffer a loss. If everyone claimed at once, there would be no pool left to cover claims, and insurance would become impossible to finance. Your premium is not priced on the assumption that you will claim, but on the possibility that you might.

The premium must cover expected claims, the insurer’s costs and a margin for profit and bad years. Charge too little and the company cannot stay solvent. Charge too much and regulators step in, since state law requires that rates not be excessive, inadequate or unfairly discriminatory.

Setting that number is what actuaries call ratemaking, and it looks forward. Past claims are the evidence, but the goal is to estimate what the group of people who share your characteristics is likely to cost in claims, and to price accordingly.

A rating factor does not even have to cause a loss to earn its place. Actuarial standards say it needs only to be related to the expected outcome, whether or not anyone can explain why.

Some insurers have used price optimization, setting rates partly on how big an increase a customer will tolerate before switching, rather than on risk alone. Regulators in more than a dozen states and the District of Columbia have restricted it, arguing that pricing by willingness to pay makes rates unfairly discriminatory.

Personal factors

Your personal history and details influence your final premium. For example, the National Association of Insurance Commissioners says rating factors can include:

• Where you live
• Your age, gender and marital status
• Driving experience and driving record
• Previous claims
• Credit history, where state law permits its use
• The car you drive and how you use it
• Annual mileage
• Previous insurance coverage
• The coverages and deductibles you choose

Homeowners insurance uses a different set of clues: rebuilding cost, construction, the home’s age and condition, distance to fire protection, claims history, deductible, and features such as pools, security systems and even pets.

The credit-based insurance score is the clearest example of a factor that predicts claims without causing them. Where it is allowed, insurers use your credit history to estimate the odds of a loss. A balance does not make you crash the car. The score earns its place because it correlates with future claims.

Technology is making these classifications more individual. Where older methods leaned on age, ZIP code, mileage and record, telematics measures how far, when and where you actually drive, plus habits such as hard braking and sharp cornering.

Tilting the odds

Plenty of inputs are not fixed. Driving fewer miles cuts exposure, a clean record improves your profile over time, security features may earn discounts, and raising your deductible lowers the premium because you agree to absorb more of any loss.

Telematics goes further, letting some drivers trade assumptions about people like them for a record of how they actually drive, though the tradeoff is handing over data on where and how you drive.

A customer is not priced the same with every insurer, because each insurer weighs the rating factors its own way. A profile one company treats as high risk, another treats as low. For drivers, comparing identical coverage and deductibles across insurers is how to find the gap without weakening the policy.

The system is likely to get more granular. The more an insurer can measure, the more your price reflects you specifically. This cuts both ways: fairer for some, costlier for others. In the meantime, shopping around is the best way to get the cheapest deal.

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