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Why Are Some Car Insurance Companies Cheaper Than Others?

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Shuman Roy is an entrepreneur, business owner, and musician. He started RoysNoys, LLC in 2013 as a music production and education service company. He also offers small business consulting and advisory services to help businesses get from start-up mode to turn-key operations. Shuman earned his M.B.A from the Stern School of Business in 2001...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency...

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Reviewed byJoel Ohman
Founder, CFP®https://res.cloudinary.com/quotellc/image/upload/insurance-site-images/truthaboutins-live/2020/03/joel-ohman.jpg

UPDATED: Mar 13, 2020

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With the constant barrage of insurance advertising centered on how much lower everyone else’s rates are compared to the next company, you might be wondering how one particular company can offer lower insurance premiums than everyone else.

It’s a valid question, and the explanation is simple…kind of.

Timing Matters

The reality is that no car insurance company will be the cheapest for everyone all of the time…it’s just not possible.

Each company decides exactly what type of driver they want to attract to purchase their product. And if you happen to find the company that’s “looking for you,” you’ll get the cheapest rate available.

Make no mistake though. Just because you aren’t the insurer’s ideal driver doesn’t mean they won’t try to sell you a policy. They’ll just sell you a much more expensive policy.

So if you don’t shop enough, or simply believe a television commercial spokesperson wouldn’t steer you wrong to earn his three-million-dollar endorsement check, you might be paying too much.

If you’re not matched up with the right company, you’re not getting the best deal. This is why you should work with an independent insurance agent who will shop your rate with multiple companies and find the right match.

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Too Good to Last

Every once in a while, a company will come along and decide to sell a ton of cheap car insurance to just about anyone. Perhaps the company is new to a particular state and wants to make a splash by attracting customers with low rates.

But sometimes this is done by accident. Insurance companies won’t know how much money they made in a prior year for quite some time, so they may “release” a product before realizing it was too cheap.

Just think, every lawsuit from insurance policies sold in 2011 must be settled in court and all insurance claims paid – perhaps in 2013, before the insurer finds out they weren’t charging enough money.

And after a long enough time of selling insurance too cheap, the insurer will finally notice they’re losing money by paying out more in claims than they’re bringing in. This is when you will see your previously cheap insurance policy take a huge jump at renewal time… assuming you’re paying attention.

[How are car insurance rates determined?]

Just Like Every Other Business

Insurance companies are no different than any other type of company…except you legally have to purchase their product. Either way, every type of business is subject to basic principles that guide how much money they can make and what they can charge for their product.

Basically, how many customers they have, how much it costs to generate the “product,” how much it costs to attract customers, and how much they can charge before their customers think they’re being ripped off and purchase from the next guy.

All said, a company that operates efficiently on each front will be able to offer a less expensive final product, in our case a car insurance policy.

Wait…Not Just Like Every Other Business

Insurance can be significantly more complicated because insurers don’t just sell you a vacuum and never speak to you again. They sell you a promise to keep you from being bankrupt in the event you hurt a person or damage their property, by paying the costs to “fix” everything if anything goes wrong.

An insurer can make a ton of money off of a person if they pay premiums and don’t have accidents, but lose their shirt on a person who gets into accidents and files claims for tens-of-thousands of dollars.

Additionally, insurers can experience “bad luck” that costs them hundreds of millions to billions of dollars. When Hurricane Katrina struck the Gulf Coast, thousands of cars were totaled and insurers had to cough up a ton of money to policyholders.

In the end, no matter how well you execute a business plan, an unexpected billion-dollar loss makes things difficult. This explains why insurers must set aside cash or easily convertible equities.

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But Why Are the Big Guys So Expensive?!

Remember how we talked about being efficient so you can offer a product at a lower cost?  Well, the big guys that you see advertised on TV every single day aren’t as efficient as the smaller guys.

The Allstates and State Farms of the world spend millions on celebrity spokespeople to “sell” their insurance product to you, and thus must charge a premium for the car insurance they offer.

Ultimately, they can try to charge as much as they want, but it’s up to the state department of insurance to determine what they will allow.

Some car insurance companies make every effort to charge the maximum amount possible.  And these companies are typically the ones that advertise the most, because they’ve “sold” you on their product, and can validate charging more.

Meanwhile, the smaller (yet reliable) insurers who want to gain more customers without hiring LeBron James will be able to offer you the same product for considerably less. But they may not have gained your trust over the years with multi-million dollar ad budgets. Hence the “discount.”

Read more: 10 ways to lower your car insurance costs.

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