Zip Code Mythology

By Author: Marcus Stalder
Total Articles: 491
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When people start talking about the fairness in how insurance rates are calculated, the one issue they always mention is the zip code. The argument always runs the same way. Insurance should be all about the driver and how safely he or she drives. Insurance should work on a carrot and stick basis, i.e. if you drive well and don't make a claim, the rates should fall, but if you drive badly and there are multiple claims, the premium rates should rise fast. But if the rates are set by where you live, this has nothing to do with how well you drive. It's punishing you for your address. Worse, it may also be racist because many of the zip codes with higher rates are occupied by African Americans or Latinos. Higher rates are a judgement on how these races live in a neighborhood.

Let's go back to the beginning. The insurance rates are actually an estimate of the risk you will make a claim. Remember there are three basic types of policy. The liability cover is to protect you from claims made against you. In the cheaper policies, the extent of the liability is capped, i.e. the mandatory minimum cover is set by law in most states. ...
... In an at-fault state, this is more directly tied to your own driving skills so, for most practical purposes, where you live would be less relevant. But with collision and comprehensive cover, we are looking at the risk someone will crash into you or steal your vehicle. So, if you live in an area where people more often ignore traffic laws, steal vehicles or vandalize them, this does directly affect the risk you will make a claim. It's the same as living in an area prone to flooding. You would not ask the insurer to ignore the reality that every time it rains heavily, your yard fills up with water. Well it's the same when it comes to the risk of your vehicle being stolen.

It's not a coincidence that the state with the highest rates of vehicle theft should have voted through a limit on the zip code weighting system. In 1988, California passed Proposition 103 which outlawed the practice of raising the premium rate just on the basis of your address. Some estimate this change has saved Californian drivers billions of dollars. Yet, interestingly, the insurance industry continues to be profitable. Even though we've just been through one of the worst recessions of all time, it continues to make money. The protests of the insurance industry that they would all be driven into bankruptcy have been shown false. What's interesting about the change is that, in 1996, Commissioner Chuck Quackenbush tried to compromise and limit the percentage of the weighting for a "bad" address. Commissioner Garamendi rejected this and insisted there be no weighting at all. So the higher losses from one area are subsidized by the money collected from those with "good" addresses, i.e. the only change is in who pays, not in the total amount collected. This is good for those in bad areas when the car insurance quotes come in. They have saved billions. But the car insurance rates for those in the good areas have risen to compensate.