For such a rational business, driven by cold numbers and actuarial equations, the auto insurance industry has always had a hard time explaining its pricing. The most curious wrinkle is why two people with similar driving records can pay drastically different rates depending upon which ZIP code they live in.

The industry calls this practice "territorial pricing." Consumer advocates call it unfair. Some also say it discriminates against minority populations who live in urban ZIP codes where rates are often the highest. "Take an excellent driver with 22 years' driving experience, no penalties and who drives the same number of miles as someone else," says Mark Savage, a senior attorney with Consumers Union. "Change that person's ZIP code, and she pays dramatically more in a low-income area or a community of color than in a suburban area."

While territorial pricing is a common practice in most states, California Insurance Commissioner John Garamendi approved new regulations this summer that prohibit insurers there from using ZIP codes as a leading determinant of how much to charge drivers. Insurers fought the regulations in court, arguing that the change would lower rates for urban drivers by raising them for rural drivers. But a Superior Court judge upheld the new rules. Most insurers will begin writing policies according to the new rules starting in January.

In California, the ZIP code issue goes back to 1988, when voters approved Proposition 103. That initiative said that when setting rates, auto insurers must first consider a driver's safety record, annual mileage and years of driving experience--in that order. After insurers went to court on that measure, California adopted rules that allowed territorial factors to remain at the top of the list. What Garamendi's new regulations do is essentially return to the original language of Prop 103. ZIP codes can still be a factor in rate setting, but they have to be a minor factor in the overall actuarial equation.

Insurers have defended the use of ZIP codes, arguing that there's a strong correlation between where people live and the number of claims they file. But even the trade publication Insurance Journal wrote recently that ZIP codes don't always do the best job at calculating risk. ZIP codes are, after all, designed for the purpose of delivering mail not setting insurance rates. The California regulations also relegate other common actuarial factors, such as sex and marital status, to the back of the pack.

Insurers may not be happy with California's new regulations, but their rate filings with the state Insurance Commission show they are complying with it. And the situation seems less gloomy than the insurers had predicted it would be. For example, the Automobile Club of Southern California, the state's fourth-largest insurer, decreased its rates by 7 percent overall. "The bottom line is that since the reforms went in place, rates have fallen," says Garamendi spokesman Norman Williams. "It's difficult for them to make the argument that we'll be penalizing rural drivers when their rates are set up now in a way that's so nonsensical."