Why Is Car Insurance So Confusing?

Winston Takeda
November 26, 2012

Have you ever made the mistake of asking your buddy how much they pay for car insurance? I say mistake because you'll never hear the same answer twice. It's like asking a politician some kind of complicated economic question. He'll give you a different answer depending on who he thinks is listening.

So why is car insurance so confusing? Well, consider how they determine the rates. First, we must consider what insurance is. It's a way to mitigate risk. Mathematically, it's about the same as wagering in Vegas. You take in a certain number of bets, and you make sure that whenever it's time to pay them out, you have a little bit left over to cover your costs.

Consider a thousand people who each drive ten miles every day. You study them for ten years. On average, there's one accident every month. And the average cost per accident is a thousand dollars. That means, if you're the insurance company, you've got to pay out a thousand dollars a month in claims. Also assume that in order to run your business, including paying your own salary, it's going to cost you another thousand dollars a month.

So in order to stay in business, you've got to collect two thousand dollars a month. That means every drive has to pay two dollars a month. So long as the statistics stay the same, everybody's happy. But if suddenly people started getting into more wrecks, or there were less drivers, then the amount of money you'd need to collect would be different.

So why are different people charged different amounts for their insurance? Because insurance companies like a minimum amount of uncertainty. They group people together as much as they can. If they've got a million people, some people are going to get into accidents more often than others. So in order to be fair, the people that tend to crash the most tend to pay the most.

And unfortunately, statistics don't are about being fair. Certain people tend to crash more than other people. People that drive further every day have a higher chance of crashing. Younger drivers have a higher chance of crashing. People with a lot of tickets have a higher chance of crashing. People who live in bad neighborhoods have a higher chance of crashing.

In reality, there are dozens of variables that go into deciding your insurance. And unless you meet somebody who is exactly like you, who drives the same distance as you every day, and has your exact same birthday, your insurance rates are going to be different.

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