What Makes Insurance Expensive?

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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