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Insurance Dilemma

16-Jul / Insurance / 0 COMMENTS

The conventional insurance dilemma

Over the last several years the global financial market, despite making significant progress, has been unable to fully recover from the devastating financial crash of 2007. Experts cite several different catalysts for the downturn and while many do not share the same opinions, most if not all, cite the significant causal effects of corporate irresponsibility, which is rooted in the basic urge to maximize profits – a practice that was rampant during the years leading up to the crash. From over-leveraging to partaking in highly speculative financial ‘Russian Roulette’, many conventional financial institutions gambled with their customer’s financial security and hard earned savings.  Unfortunately, as we know, millions of people were negatively affected as a result. Corporate irresponsibility was not exclusive to any one sector of the financial services industry and was a product of the changing corporate dynamics, which now seem to value maximizing profits over everything else. The insurance industry is a prime example where this can be seen most acutely. Focusing our attention on homeowner’s insurance, we learn from a recently published study by the Insurance Research Council (IRC) that from 1997 to 2011, average claim payments per insured home (in the U.S.) rose by over 150% and in 2011 alone, by 27% (“Homeowners Insurance Claims Cost Rising Rapidly: Study”).  Though the average cost of homes in the United States has risen quite significantly over the past twenty years, home prices have dropped since “the bubble” burst recently. The question is: why are insurance premiums still going up?

 

While changing climatery conditions have led insurance companies to restrict policy coverage to protect themselves from increased risks by passing it on to the insured, we need to understand that the fundamental structure of conventional insurance itself causes premiums to perpetually rise. At the most basic level, conventional insurance contracts create an adversarial relationship between the insurance company and the insured. In this bi-lateral risk-transfer arrangement (in which the insured transfers 100% of their risk to the insurance company for a premium), both sides only can profit if the other loses just like what happens in gambling. In the event of a loss, the insured aims to receive a reward (claim settlement) from the insurance company to cover the full extent of their damage or loss. Accordingly, the insured, to maximize their return, may resort to fraud, misrepresentation, and concealment. This is the case because conventional insurance companies are constantly seeking to cut their costs and minimize their risk in order to maximize profits.

 

Besides reducing coverage and increasing premiums on their customers, insurance companies have become more willing to drop or cancel policies simply on the basis of profit maximization. The Insurance Journal reports that Allstate is dropping 10,000 South Carolina home insurance customers who don’t also carry Allstate auto coverage, have older homes, and have homes insured for less than $220,000 (“Allstate Dropping 10,000 South Carolina Homeowners Policies”). A company spokeswoman said that such actions would allow the company, the largest publicly traded U.S. auto and home insurer, to remain financially strong for its customer base of almost 300,000 policyholders.  Despite the fact that last year Allstate’s profitability rose by 4 cents on the the dollar in 2012, and that over the last 15 months the company’s stock gained approximately 50% (beating the sub-20% advance in the Standard & Poors 500 Insurance Index), the insurance giant still chose to drop 10,000 policyholders in South Carolina. This leads us to the question why Allstate, in lieu of its strong financial position decided to drop customers that don’t even have higher risk profiles.

 

The answer is simple: profits. Decisions based simply on profit maximization, a result of the inherently misaligned relationship between insurance companies and the insured, can lead to both parties doing whatever it takes to win against the other.  Until there is a drastic paradigm shift regarding this fundamentally flawed structuring, policyholders will be exposed to more and more gaps in coverage and cost.



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Author: Joseph Assante

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