Questions often arise from board members on how insurance companies operate as it relates to claims against the homeowner association’s insurance policy. Especially when large claims are paid out by insurance companies as compared to the relatively low premiums paid by the homeowners association. Considering the objective of an insurance company is to collect more in premiums and investment income than is paid out in claims.
Insurance companies have two methods of profit making:
- Underwriting and risk management is the process by which insurance companies select the risks to insure and decide how much in premiums to charge for accepting those risks.
- Investing the premiums received from policyholders.
It is said that the most difficult aspect of the insurance industry is the actuarial science of ratemaking or price-setting of policies. Actuarial science is the use of statistics and probabilities to estimate future claims based on a given risk. After developing policy rates, insurance companies will utilize discretion to accept or not accept risks through the underwriting process.
To summarize how insurance rates are determined, actuaries, professionals of actuarial science, look at the frequency and magnitude of claims and the payout resulting from these claims. Then the insurance company will analysis historical loss data and bring the claim data to present value and then compare these prior losses to the premiums collected to assess rate adequacy.
Loss ratios and expense loads are also used. Loss ratios are losses divided by premiums as one of the tools with which to gauge an association’s suitability for coverage or continued coverage. An expense load is the amount of acquisition and other costs included in the premium in addition to the pure premium.
Insurance companies earn investment profits on their available reserves. Reserves are the amount of funds on hand at any given moment that an insurance company has collected in premiums and has not paid out in claims. Insurance companies invest premiums in a multitude of investment vehicles until claims are paid. Investing reserves during economically challenging periods can be difficult for insurance companies to realize investment returns, so they will shift away from investments and tighten up their underwriting standards. As a result, a poor economy can generally result in higher insurance premiums.
Insurance companies employ claims adjusters to investigate and resolve claims. When claims are filed, a claims adjuster begins an investigation to determine if the claim will be covered under the policy and, if so, the monetary value of the claim. Many times, especially on major claims such as fires, the homeowner association will retain their own public adjuster to help negotiate a claim settlement with the insurance company on the policyholder’s behalf. WDPM
Copyright – William Douglas Management, Inc. 2016