Another very common myth about insurance is that it is very expensive. Let’s talk about this:
Myth: “Insurance is very expensive, insurers make a lot of money at the expense of their clients.”
Many people have this belief, however it is very far from reality. It is not an easy subject to explain, although I will try to do so.
If one looks at the statistics of the insurance market, one will realize that the accident rate that exists in automobile insurance and major medical expenses is very high. If we add the operating expenses of insurance companies and the commissions they pay to their agents, the profit margin is generally very low. Sometimes it is even negative (that is, losses are generated, which are sometimes offset by financial product generated by investing technical reserves, although given the low interest rates that operate in the world, this is increasingly difficult).
There are other lines of business in which the loss ratio is apparently quite good, but it is much more variable: there are very good years and others very bad. For example, damage insurance that includes coverage for natural catastrophes. As we well know in Mexico, there are some years in which earthquakes generate very strong damages in certain communities. Others where there is only minor damage. Insurers also have to protect themselves from these eventualities and buy coverage in the reinsurance market, to be able to meet their obligations in the worst years.
But in addition, sometimes there are eventualities that not even the insurance companies, experts in measuring risks, can incorporate into their models. This year, for example, the loss ratio of life insurance soared due to the large number of insured people who died as a result of the Covid-19 pandemic. Insurance premiums also have to have a margin of safety against these “statistical errors.”
So technically, premiums are calculated following statistical and actuarial methods to quantify risk. Based on experience (both their own and that of the market), actuaries develop models to determine a “pure risk premium” which is the amount necessary to meet the expected or average loss ratio of a portfolio. A volatility or uncertainty factor is usually incorporated into this calculation. To the “pure risk premium” later concepts such as: operating expenses of the insurer, acquisition expenses (commissions paid to intermediaries) and finally, a utility factor are added.
However, the size of the Mexican insurance market is still very small because people do not insure themselves, and there are many companies competing for the same clients, often by price.
That is the reason why some insurers, to stay competitive in price, make adjustments to the conditions of their products or impose certain operating conditions. That is why it is not uncommon to see that suddenly, when we have an accident, an insurer gives us a letter to go to the workshop of our choice (of those who have an agreement) to go directly the day we have time, while another requires us to go to your valuation center during business hours, which is an additional hassle.
Remember that the cost of insurance is a relationship between the premium and the coverage that it provides us (in addition to the conditions of the product itself). For this reason – I emphasize what I have pointed out many times – we must not only see the premium as a price parameter, but the cost-benefit ratio, as in everything. Many people lose sight of this.
In my experience, I have seen how companies contract very low limits on Civil Liability policies, leaving them very vulnerable in case something serious happens. Or people who took out life insurance only for accidental death, excluding natural causes. All to save money and not understand what they are buying or whether or not the product meets their needs. Another very common myth is that insurers are always looking for how not to pay. We will talk about this in the fourth and last part.
(third of four parts)
Coach in Personal Finance
Heritage
Senior executive in insurance and reinsurance with strategic business vision, high leadership, negotiation and management skills.
He is also a Personal Finance columnist at El Economista, Personal Finance Coach and creator of the page planeatusfinanzas.com
Reference-www.eleconomista.com.mx