Consumers beware
Theoretically, it is because insurance companies are paying consumers losses.
Unfortunately, that isn't always the case. As discussed here, some
extra costs often push up insurance rates. Rarely are these expenditures
required and benefiting policyholders. Many other expenses incurred (i.e.,
slick television ads and lobbying state officials) do not significantly
add consumers value. Unfortunately, policyholders cannot select which
expenditures they will finance. Insurance is a take-it-or-leave-it proposal.
Policyholders can manage expenses by shopping. Each insurance carrier
has a different expense ratio, the dollar cost of all fees other than
the premium (revenue) ratio.
Loss ratio
The percentages of loss and cost are grouped into a combined balance or
number of all losses and expenses divided by the overall premium. Lower
numbers are better: if a carrier has a combined ratio of less than 100,
that means they make a profit on their operations (known as profit underwriting).
A loss ratio above 100 indicates the carrier loses money on its operations.
The net loss cost plus costs are not entirely compensated by the premiums
it receives. Premiums are invested before they need to pay claims. This
investment gain will cover the company's underwriting losses. (This
is the standard for longer-tailed lines, such as workers' compensation,
where the final resolution of lawsuits can take years.)
Insurance firms operate to make profits. Due to a collection of losses
and costs, their actuaries conduct extensive statistical analysis to decide
what premium to charge. In the long run, they usually get it right more
frequently than they get it wrong, and insurance firms continue to work,
often for decades. It's good news. However, policyholders only want
to pay the premium they need to cover their losses and expenses. As a
consumer, you select which insurance carrier you want to do business with.
If you are sufficiently entrepreneurial, you can also compare various
carriers' cost ratios as part of your overall selection criteria.
Carriers with higher expense ratios can provide extra value worth paying
for - or not. As a customer, you can buy cover from which insurance providers.
You can't, however, pick which carrier senses you'll pay. High
insurance rates, driven in part by higher expenses, create opportunities
for nimble conventional insurers, reinsurers, technology companies, insurance
entrepreneurs, and non-traditional rivals. Using state-of-the-art technology,
process changes, and cost efficiencies can be gained to reduce insurer
costs. Beyond incremental changes, a new model could emerge to provide
a similar risk transfer degree (downside protection) without the waste
currently plaguing the insurance ecosystem.
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