So what does all of this mean for the cost of catastrophe insurance? Will catastrophe insurance remain affordable? Will carriers remain viable? A lot of questions are being raised following such significant loss in 2017, and we urge consumers to keep asking those important questions. Policyholders should not be passive about their insurance costs. By understanding the factors that contribute to the price of insurance, they can take steps to proactively manage their risk management dollars.
Picking Apart Premiums
Premiums are typically determined by the same three elements for all types of insurance:
- Expected loss – the amounts allotted to pay claims;
- Various costs – miscellaneous costs incurred by the insurance company; and
- Profits – the amounts allocated to the insurance carriers.
Unlike many other types of expected loss, it is extremely difficult for insurance companies to accurately calculate the catastrophe component. Complex computer models are often used to mathematically simulate large catastrophes to arrive at an estimated loss total, but many factors can influence this number (i.e., construction characteristics such as roof anchors). For property insurance pricing in catastrophe-prone regions, there are several elements of particular significance:
- Reinsurance Costs – Most insurance companies don’t retain all of the risk assumed under the policies that they underwrite. Even some large insurance companies find it financially desirable to transfer a portion of their risk to the reinsurance market. Reinsurance is essentially insurance for insurers and helps guarantee that worse-than-expected claims will not financially impair the company. An important role of reinsurance is to absorb property insurance losses resulting from large natural catastrophes.
- Emergency Funds – Natural catastrophes are among the most unpredictable insurance exposures. In addition to reinsurance, it’s important for carriers to set aside some cash in order to pay claims when losses are worse than expected. This practice has a bigger impact on insurance pricing in catastrophe-prone regions.
Make Informed Decisions
Given all the unpredictable variables and potential for significant loss, it may seem like policyholders have little control over their catastrophe insurance pricing. However, understanding the cost components can help consumers make better decisions. Policyholders might find more desirable pricing with an insurance partner that is large and globally diversified. These providers are typically less reliant on reinsurance and enjoy a larger spread of risk. Smaller companies with heavy concentrations of policies in catastrophe-prone regions are often more reliant on reinsurance and maintain higher cash reserves, which directly impacts premiums.
Currently, the insurance industry is well capitalized and short-term volatility resulting from catastrophe losses isn’t preventing insurers from providing coverage and paying claims. However, to remain profitable and provide appropriate return on capital, insurance carriers need to plan for the future and continue to engage in disciplined underwriting based on data and analytics. It’s also important for policyholders to follow premium trends and understand the various cost components. Having this knowledge could lead to better pricing, as well as a more stable and secure risk management plan.
¹ “P/C Insurers Lost $5.1B on Underwriting in First Half of 2017.” Insurance Journal. September 4, 2017.
This article originally appeared in the 2017 | ISSUE THREE of the SilverLink magazine, under the title “The Winds Are a Blowin’ | Understanding the Cost of Catastrophe Insurance.” To receive a complimentary subscription to the SilverLink magazine, sign up here.