How Insurance Prices are Determined
Every parent has had that moment when a child of theirs has asked that ever-important question. The one that leads to uncomfortable looks and a feeling of angst. When your child takes you by the hand and asks "Mommy/Daddy, where do insurance premiums come from?"
If that's not really what you remember as a child or from your own children, you are not alone. Insurance is not an issue that is discussed much among family and friends unless it is to complain about how expensive it is or gloat that you're getting a lower rate with a new provider. The truth is that very few people have any real awareness of how insurance prices are determined so that when they receive their insurance offers, they know which factors played a hand in setting the premium.
Factors Vary By Insurance Type
Of course, the primary considerations for auto insurance are going to be different than those considerations for health insurance, but the principles are the same no matter what type of insurance we're talking about - profit and risk. If you hadn't already guessed, insurance companies are in business to make a profit and you are their primary source of income. They can offer you a hundred thousand dollars of insurance for a few hundred dollars a month (and the likelihood that you'll never actually pay them a hundred thousand in premiums) based on the fact that you and millions of other people like you, are paying that money every month and not having an accident. A successful insurance company will make a lot of money in premiums every month and pay out far less in actual claims. To set the price of insurance, balancing a price point with profit means that an insurance company must be looking at a customer from a statistical and actuarial point of view. The more risk that the statistics say you present to a company, the more they have to charge you in premiums to offset that risk.
A Day In the Life of an Actuary
Actuaries are actually real people with families, joys and sorrows just like you. Contrary to popular opinion they are not cold-blooded, money-grubbing pirates sitting in the back of an insurance office just itching for the chance to find an excuse for raising your premiums. Their lives consist of staying abreast of legal issues in their industry that may affect rates, news stories that may change behaviors or state laws, and studies and reports that show relevant trends in behavior. As all of this changes, the behavior of a populace of people (say automobile drivers), can be seen to change as well in slight ways, sometimes for the better, sometimes for worse. For example: after September 11th, driver safety in the United States increased significantly for awhile and accidents were down. This information, and other bits like it, help actuaries determine the likely risk that any given person poses to their company's bottom line. They will use complicated computer models to forecast events and behaviors and when all is said and done, must hope to collect a certain amount of premium from a customer before a claim is filed.
When an insurance underwriter or actuary receives a request for policy, they evaluate everything about the policy and the person requesting it based on the assumption that the client told the absolute truth on their application. They must then come up with a number based on several standards in their company, that represents that client's risk to the company. If the number is too high, the premiums set for that policy will reflect the risk.