How is the cost of insurance determined?

Answer

Actuarial risk. Insurance companies look at whatever factors they deem are relevant to the risk and statistically determine how many incidents they should expect to pay for and what that costs. They then add it costs and profit. They can be amazingly accurate when they have a large number of policies (the rule of large numbers).

Example for auto insurance: Age – very young and very old drivers tend to be in more accidents. Annual miles driven - the farther you drive the more likely you will be in an accident. Location – car owners in big cities tend to file more claims than in rural areas. Driving history – people with fewer or no incidents tend to have fewer in the future. Driving experience – new drivers of any age have more accidents than experienced drivers. Deductible – it costs them more if they have to pay for a repair after the first $100 than $500. Credit history (where allowed by law) – people with good credit have fewer accidents than people with poor credit.

They have it down to a science. The feed your data into a computer and it tells them what they have to charge to make a profit if they insure millions of people on this policy. They know they will have claims but can not tell which exact clients that will be, nor do they care. There objective is to have enough policy holders to be statistically accurate. They price then is based on the whole pool by this actuarial matrix.

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