Did you know that the global financial markets have a significant impact on your home insurance rates? If not, you’re not alone! On its surface, the insurance might seem fairly straightforward. You pay your insurance company premium and lots of other people do the same thing. The insurance company hopes that not all of you will have claims. It then uses the pooled money to pay claims and, hopefully, has enough money or even a little extra as profit. While that concept is pretty much the basic insurance principle, it doesn’t actually work out that way in real life. You’ll see that many other factors actually affect how much you pay for insurance.
When insurance companies consider nothing but the premium they take in and the claims they pay out, they create a measurement known as the loss ratio. A loss ratio of 1.00 means that for every dollar the insurance collects in premium, it has paid a dollar out in claims. Insurance companies also generate other ratios that take into account their expenses. After all, someone actually has to collect that $1.00 in premium and someone needs to write a check to pay the claim. All of those expenses mean the insurance company actually needs to collect a little more than a dollar just to break even!
Now that we’ve established how the loss ratios work, would you be surprised to know that it’s pretty common for insurance companies to regularly operate with ratios greater than 1.00? That means they are actually spending more on claims and expenses than they are collecting in premium. If you’re wondering how they can do this and stay in business, your instincts are correct. The saving grace of most insurance companies is this little thing known as investment income!
Think about how often it is that someone pays premium to their insurance company on day one of their policy’s effective date. Then think about how often the insurance company actually pays a claim on that day. Probably not a lot, right? The insurance companies rely on a delay in the time they collect your premium to the time they need to pay a claim. During this interim period, the insurance company invests your premium money and hopes to earn some interest and investment returns. This is how they can manage an underwriting loss on your business but still come out ahead.
Certain types of insurance take longer than others to pay out. Those lines of coverage allow the insurance company to earn even more investment income. Unfortunately, the overall business climate right now is one of low interest rates. As a result, insurance companies have to charge higher premiums to make up the investment income they would otherwise have earned on your premium dollars.
If you’re a savvy investor, you might be wondering why the insurance company doesn’t just invest in higher-yielding options, such as stocks. They do invest in them to a certain degree, but because those investments are more volatile, the state insurance regulators limit how much risk the insurance companies can take with your money. After all, you’d really hate to find out that your insurance company invested your premiums in a bad stock when you need them to pay a claim!
As you can see, external forces such as the global financial markets can actually have a direct impact on something as personal as your home insurance policy. The next time you either enjoy a premium decrease or are frustrated by an increase, consider that there may be larger factors out there driving the change.