What is the role of interest rates in determining your premium?

interest rates

This question has always been in the insurance industry, but given the recent history of the Federal Reserve to keep interest rates low as a stimulus to borrowing, uh, the economy, it is now more important than ever. They have a limited set of investment options and are required by laws in every state to maintain certain minimum reserves in cash and equivalents. You’re getting no return, but it’s not there for the return, it’s there for the margin of safety it provides your family.

Well, the no down payment car insurance companies out there have considerably more than $1,000 set side in these reserve funds, and their funds are so large, the yields they should be getting from keeping money in the bank are factored into their premium models. Now, when the yields aren’t there, they can’t do what and investment guy or gal might do for you; turn to blue chip companies, like power and communications companies, as well as commercial real estate companies that are not quite as safe as U.S. bonds, but get much better yield. These reserves are more regulated by far, than your 401k and because the yields aren’t there, and haven’t been there for 10 years, something or someone, has to make up the difference. That someone is you.

This is why the financial solvency of a company, and its debt to income ratio have never mattered more than they do right now. In fact, it matters more now, than it will a year from now, because the Fed is slowly weaning the markets and the economy off of “cheap” interest, and back to nominal levels of 6 to 8 percent. In the last ten years we have seen some staggering premium increases, a lot of merger and acquisition and those tides have just begun to reverse.

Remember, under major violations, we spoke of ticket sensitivity? There is no force, other than distracted driving, that is making insurers more sensitive to tickets, accidents and driving history than these low interest rates. The return they needed to pad the blows of claims just isn’t there anymore. And those companies with the most debt are the quickest to pass along the increased sensitivity in claims to consumers.

The answer to this question is probably the least important answer the representative will give you. In fact, they may not be able to explain it so you can understand it, or even be aware of it themselves. They and their underwriters have zero control of it, but it is important for you to know it is real and it is impacting your rates and claims experience across the board. There is a high cost to “cheap” interest.

Is there coverage for drivers who I allow to infrequently borrow my car?

This is a concept called “permissive use”, and it can be explicit, as in a friend says, hey, can I borrow your ride?” and you say “Uh, OK”. It can also be implicit, as in you say to the babysitter, “there’s a spare set of keys here, in case you need to move the car when I am out of town on business”, then the babysitter’s boyfriend totals the car while you’re on a business trip trying to sell mukluks to Tahitians. That is exactly the reason why you need to ask this question, but also to identify if any drivers other than yourself are eligible for coverage. Some companies like goodtogoinsurance.org will cover anybody under the sun, but require you to ‘rate’ or explicitly list each household driver who lives under your roof. If those drivers are youthful, under 25, then this will cost you (more on that later). Other companies will cover only you and your spouse. But you have to have the answer to this question before you show the babysitter where the extra set of car keys are, because if the babysitter’s boyfriend totals your car while you’re on that business trip, you will have bigger problems than a large inventory of unsold thermal, Canada-made mukluks. You will have to find a new ride on your own, if your insurance company doesn’t pay. Also, you will need to do a better job of background checking your babysitter!

At this point, the conversation should to turn to the nitty gritty of what you’re actually buying from the insurance company, the promise to pay when something happens, or in the case of car insurance promises to pay. That’s right, multiple independent promises to pay. The first promise is the most important, it is the liability promise or clause, the industry’s lawyers really prefer the term “clause” over “promise”, it sounds more official and legally binding. The industry’s lawyers also strongly prefer to be called attorneys as that term provides some insulation from lawyer jokes. (Take a moment to remember the funniest lawyer joke you’ve ever heard, then continue reading). The liability clause is required by every State to legally drive down the street. Liability covers you for the things you’d get sued for, lost wages, medical bills, pain and suffering and property damage. So, in addition to replacing your totaled car, you’d have defend yourself in the lawsuits caused by the babysitter’s boyfriend if there is no permissive use coverage in your auto insurance. So, buy a permissive use policy, or don’t let the babysitter have the keys.

Full coverage insurance with no down payment is required if you borrowed money to buy the car. “Full coverage” from the lender’s point of view, is usually comprehensive and collision coverage with no more than a $1,000 deductible on each one. Full coverage is an imprecise term, because it doesn’t include medical payments for people in your car or rental replacement coverage. Be sure ask about what it costs to add these as well. Comprehensive and collision coverage are additional, separate promises, that states don’t require drivers to buy, lenders usually do. So, if you haven’t dropped the note, you can’t drop the optional coverage.

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