What is Risk Worth?
It has become normal for insurance prices to rise on every renewal. Before, whenever it rose, there seemed to be a real reason or cause. However, in todays ever complex world, there doesn’t seem to be a clear “why?” A topic like this can get complicated quickly, so it’s important to stick to the fundamentals as much as possible to tie this monthly cost to real life. Therefore, keep in mind what insurance is. At its core, insurance is a simple transfer of risk. But I would add to this simple definition. It’s more of an “exchange” of risk for money. The insurance carrier is the one taking on the risk, and you are the person paying for that. Accidents and negative things are part of life; I think everyone can agree with that. The risk of those accidents happening is the risk that is being traded. So, buying insurance is basically saying: “If negative events happen in my life, I do not have the financial ability to fix it. I don’t want that risk, so I will trade it for a monthly fee.”
Under that understanding of insurance, frankly, it is a good idea. Insurance is extremely helpful in many different ways. And throughout history, it has proved to be part of a successful society. There’s plenty of negative stories of insurance coming up short, but statistically, insurance does what it is designed to do. So the argument isn’t “is insurance necessary?”. in a advance soceity like America, insurance is absolutely necessary and fundamental to keeping things running smoothly. The question is, and should continually be: “What is risk worth?”
To simplify, we will be specifically looking at auto insurance in the great state of Texas. It may differ from property to property, state to state.
First of all, who comes up with the price of insurance?
And when we say the “price of insurance”, we mean insurance rates. Insurance rates and your monthly payment are a bit different. So if someone says “rates went up”, it doesn’t automatically mean your monthly payment went up too. Rates can rise for different types of cars, zip codes, and/or driver types.
In Texas, there is a private company + government regulatory relationship to decide insurance rates. This partnership is between the individual insurance carriers (think Progressive, Allstate, Farmers, GEICO, etc.) and TDI. TDI is the state governmental body that regulates insurance. This relationship is key because these groups are the ones controlling prices that directly affect you.
So how do they come up with the price?
In general, this is what is being added up:
characteristics of insured driver, vehicle, and location + claims frequency in that area + vehicle cost and repair + Texas weather events + dollar inflation + reinsurance cost + market loss…. easy, right?
Not really, but we will sit here and define each piece while having zero control over it.
The first bit is easy. The vehicle age and characteristics. Your age, your sex, whether you rent or own your housing. All that and a little more is being calculated in your price. But you already knew that.
Your housing ZIP code is also important in that it gives a geolocation of accident frequency. With insurance covering car accidents and more, this is key data in determining price. If you live in Harris County, where we are, congratulations, you are in one of the most accident-prone counties in the country. Meaning we have high insurance rates.
Next is the base price of the vehicle and repair parts. This varies from car to car, so it’s an important one.
Texas is known for crazy weather, so this is always a variable. Whether it’s floods, tornadoes, or wildfires, all of these natural disasters are looked at and factored in.
Everything before, you might have known, but these next ones might be a little less familiar.
The US dollar has a natural inflation rate year over year. Lately, it’s been much more than usual, but this must be accounted for in the rate.
Reinsurance is also not talked about much, but it’s basically insurance for insurance companies. While this might seem redundant, it basically covers the insurance company from a huge catastrophe that renders them insolvent and unable to pay any claims. While rare, there are companies that have come and gone for this reason.
Now TDI and the insurance companies are in constant negotiation over this rate. A way to measure whether a company is charging a higher rate is the Loss Ratio. The loss ratio is the amount the insurance companies paid for claims over the total revenue collected. This number is healthy around 80%. This allows the companies to run operations while paying claims in a fair manner. Lately, it’s been closer to 70%, which does indicate that rates are higher than they need to be. Hopefully, in time, these rates can decrease, which would be beneficial not only to the drivers but to agents alike.
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