Insurance Rates by Zip Code

As I'm sitting around waiting for business school, I ran across an interesting article on sfgate.com. Basically, there is a debate among lawmakers, consumer groups, and insurance companies about what factors insurance companies should use when determining their rates. The part that really caught my eye was whether insurance companies should use zip codes as a factor to calculate rates.

Obviously, if you live in a poorer area of Oakland, there is statistically more crime than a rich area in Marin County like Tiburon. Therefore, insurance companies charge higher premiums in Oakland than Tiburon based on the risk of crime. I'm no actuary, but it seems that it costs more (insurance rates) to drive if you live in a poor zip code, versus if you live in a rich zip code. I may be oversimplifying the issue, but this just seems wrong. I understand insurance companies are businesses that need to make money to survive, but they do have a social responsibility to not exploit the poor. I'm not suggesting insurance companies should lead the way in redistributing wealth by overcharging the rich and giving discounts to the poor, but I believe they should give slightly better treatment to safe drivers in poor zip codes over safe drivers in rich zip codes.

My limited understanding of the insurance business is that they make money by taking out their "overhead" costs from the big pool of money they accumulate from charging premiums to every customer. Regardless if 10 poor customers pay $10 more or 1 rich customer pays $100 more, the insurance company still makes the same money from "overhead" costs. I believe if zip codes are used as a factor to determine insurance rates, the responsible thing to do is to charge the 1 rich customer $100 more so 10 poor customers can save $10 each (assuming all other factors besides zip codes are constant). This should apply to every insurance company so rich customers can not defect to cheaper alternatives. The insurance businesses make the same profit and the size of the pot of money to draw from to pay off claims remains the same. This post may sound really naive, but I do believe insurance companies can still make big profits while being socially responsible.