If your annual home insurance premium has been rising each policy year, you might want to understand the forces behind it because your personal behavior has a significant impact on what you pay for insurance. For example, if you have lots of claims, your insurance company may increase your premium upon renewal regardless of what city you live in – Chicago, Houston, Seattle, Omaha. Phoenix, etc. However, if you have not had any claims and the exposure you present to the insurance company has not changed, it may be more difficult to understand the increases. For better or worse, you are part of an overall insurance market and are therefore subject to its changes.
According a recent study by the Insurance Research Council, the cost of homeowners insurance claims has been steadily rising in the past 15 years. The increase during this period was 173%, with a 27% increase solely in 2011. With these significant costs, insurance companies have no alternative but to increase their premiums to make up for the claims, so even though you may not personally be responsible for any claims on your policy, as part of the insurance purchasing population, you may still face insurance premium increases.
The study explains that the claims cost increase is a function of both frequency and severity. Frequency means there are more claims and severity means the claims are more expensive. While it’s not uncommon to see an increase in one or the other, an increase in both means that there now more claims and they are each costing the insurance company more than previous claims. With this one-two punch, insurers have to find ways to cover their costs and that usually means passing it along to policyholders.
As you may know, the basic principle of insurance is that of pooling risk. While individuals are not able to independently incur an expensive claim, they can reduce the impact by combining their risk. For example, if 100 homeowners could each afford an annual loss of up to $1,000, they could combine their funds into one pool of $100,000. If the probability of all claims to be paid among the homeowners totals $100,000 or less, they have effectively pooled their risk. The few homeowners who had claims could still recover the full cost (up to $100,000) and the homeowners who did not have claims paid for the peace of mind and security of knowing there was financial protection in place for claims in excess of $1,000.
Insurance companies function in the same way, but on a very large scale. To effectively pool their policyholders’ risk, they have to carefully underwrite and evaluate the possibility of claims and the ultimate cost of those claims. They don’t want to lose money or, even worse, become insolvent and unable to pay claims. As the overall frequency and severity of claims increases, it likely means premium increases for all policyholders to help insurance companies stay in business with a reasonable amount of profit.
Therefore, you should always consider your insurance as something of a group effort. While individual behavior and results will have a degree of impact, the aggregated result of all policyholders will also have an effect on your premiums and costs. When dealing with claims, it’s never really just the insurance company’s expense, as your claims (and those of others) will ultimately have some bearing on what you pay for insurance.