Car Insurance Claims Cost & Retention - What It Means To You

If you are like most folks, when you think about filing a car insurance claim and the costs associated with covering the damages, you likely are not too concerned with how much it costs your insurance company to pay for the damages since you have been paying your premium each month. Clearly, insurance companies are in business to make money and most of us think they make a lot of it, money that is. Although car insurance companies do pull in a great deal of money from premiums and investments, I think it is helpful for people to understand the other side of the coin as well. In this article I am going to provide some insight into the inner workings of insurance companies so that you will have a deeper understanding of what variables go into your rates, to include the cost of claims and the need for car insurance companies to retain you as a customer.

Let's Begin With The Facts

In 2010 alone, insurers in the United States paid out over $36 billion in physical damage claims, which would be for damages falling under comprehensive and collision first party coverage. Another $64 billion was paid out for liability damages, which would include damage caused to someone else's property and injuries resulting from the corresponding accidents.

I know what you may be thinking: "that is a lot of money but those insurance companies are still making a killing." Though I am certainly not going to argue that many insurance companies are pulling in healthy profits, there are some things that many folks don't understand in terms of how insurance companies operate and some of the "behind the scenes" facts. I thought it might be helpful to share some information with you that you would likely only know if you either did your own extensive research or have or do work for an insurance company. You may not view your insurance company as a necessary evil after reading this article, at least not as much!

Combined Ratio

All insurance companies know the term "combined ratio" as it indicates whether an insurance company is profitable or not. Let me first begin with a definition: a combined ratio is calculated by dividing an insurance company's claims payments plus operating expenses by the premium earned in a given year. Although we could go deeper into loss expenses, such as ULAE (unallocated loss adjustment expenses) and ALAE (allocated loss adjustment expenses), the bottom line is whether an insurance company generated more in earned premiums than it paid out in claims payments and operating expenses.

An example of a good combined ratio would be a 94% CR, or combined ratio. In general terms, this would indicate a 4% profit margin for the insurance company. Having said that, it would not be abnormal for an insurance company to have a 104% CR in a given year and still be profitable. How, you ask? Insurance companies are financial institutions and often have vast investments from funds invested from profitable times. I have personally worked for 2 insurance companies in which they both had years in which the combined ratio was in excess of 100%. It is in those times that insurance companies rely on their investments to get them through difficult times.

How Does a 100% or Higher CR Even Happen?

Every insurance company is required to maintain adequate reserves, or to put it simply, enough cash on hand to pay for estimated losses or claims payments in a given year. There is a lot of math that goes into determining how much those reserves should be, however, for simplicity, the number crunchers look at how much was paid out in losses or claims in recent years and also considers things like the chances of certain natural disasters occurring in the future or even that have happened recently in which all anticipated claims have yet to be paid. Again, this is oversimplifying the process a bit, but it gives you a general idea of how reserves are calculated.

Claims Frequency & Severity

Claims Frequency and Severity are two key factors that are considered when the number crunchers consider reserve needs and also for product managers that are responsible for pricing the different auto insurance coverage's. Although it may be obvious, let me clarify these two terms before we continue: claims frequency refers to how many times an insured is likely to file a claim and claims severity is a measurement of how much is paid out for those claims.

Clearly, if claims frequency and claims severity are trending upward, it is likely that an insurance company will file for rate increases eventually to be sure they can maintain adequate reserves to payout for claims that are filed.

Average Policy Profitability

Here is a fact that I am almost certain will surprise many people: on average, it takes over 2 years for an insurance company to realize a profit on an insurance policy. I know what you are asking: how can that be? When you consider the cost associated with writing a new policy, to include agent commissions and just keeping a website live for those buy online, and couple that with the likelihood of an accident (that severity and frequency thing we discussed), and compare that against the average annual car insurance premium of approximately $1,200, it is not hard to see how it can take time for a policy to be profitable for an insurance company.

Retention - Use It To Your Benefit

So, what can we decipher from all of this information as it relates to you and your own car insurance policy? Answer - Retention is king! Just like the saying that "content is king" on the web, the same holds true for customer retention and car insurance companies. In order for an insurer to be profitable on your policy, they must retain you or, in other words, they need you to renew your policy term every 6 months or year for at least 2 ½ years to be profitable on your policy.

The "how" of you can benefit from this information is to make your insurance company for your business each time your policy comes up for renewal. I suggest using a free online quoting site to secure competitive quotes 30 days prior to the end of your current policy term. You can then use the rates you receive as a negotiating factor with your current company. If your current company isn't willing to go that extra mile to retain your business, simply change insurance companies. There is no cost associated with changing insurance companies. Just be sure that when you do go online and get competitive quotes to use the exact same coverage amounts you now have so that you get a true comparison.

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