What are the economics of insurance?

Economics of Insurance 101

Let's face it from a customer viewpoint, property and casualty insurance coverage are costly relative to benefits received. Just 6.1 percent of car owners filed a lawsuit, and 5.3 percent of homeowners filed a claim in 2016. For the remaining policyholders, their insurance policy worth is mainly intangible. This intangible value is often called "peace of mind" in industry.

A means for an end

Insurance is typically an end-user. People buy insurance because they want. It would help if you had motor vehicle insurance to run a vehicle. (At least, data shows that 1 in 8 drivers in the U.S. is uninsured.)

To buy a house, the lender demands the home be insured before closing. Landlords may require tenants to obtain insurance. Insurance isn't a volunteered product. Instead, mandated. Since insurance is not a commodity most people want to buy, the expense is substantial. From one angle, P&C insurance premiums fit comparably priced products.

Profit margins

Wholesale profit margin is the equivalent to profit margins, agent fees, and insurance procurement expenditures. A typical way of calculating the relative cost of insurance is to look at the portion of the premium dedicated to paying claims, referred to as damages, and related loss adjustment expenses or LAE. LAEs are the costs of collecting, prosecuting, and settling cases. Also, claims resulting in no award include loss-adjustment fees.

Both non-claim expenses are referred to as underwriting expenses and include all other costs associated with operating an insurance policy. A loss ratio is a standard industry measure of total losses, and LAE is paid as a percentage versus premiums. According to NAIC, based on data from the National Association of Insurance Commissioners (NAIC), here is a summary of rates, losses, expenditures, and (operational) income from the latest 2016 data.

Some business lines, such as homeowners and numerous commercial hazards, are more vulnerable to disaster losses and experience broader profitability fluctuations than other cables. Although losses can vary from year to year and affect loss adjustment expenses, the remaining broad cost categories are more predictable. General prices include running expenses such as staffing, IT, office space, and appliances.

Expenses

Sales expenses include advertisement and marketing, and fees of agents and brokers, the primary source of underwriting expenses for most carriers. Agents and brokers usually receive commissions to buy a new policy and another package of policy-renewing commissions. Based on the details for these four business lines, note that the loss ratio—the number of premium dollars spent on paying claims—varies significantly from product to product. For private passengers and commercial vehicles, loss ratios indicate that about 70 cents are used for each premium dollar to cover losses.

In contrast, only 40 cents was expended (leading to a loss of about 10 cents per dollar in 2016). While 61 percent of Americans think car insurance is too costly, the recent challenges for auto insurance profitability come. For homeowners and various commercial risks, loss ratios indicate that about 50 cents of each premium dollar are used to pay damages. The majority, however, is used to cover costs and provide a benefit. The portion of premiums not used to cover losses allows carriers to reduce costs, whether lowering loss adjustment expenses or underwriting expenses.

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