Opacity and complexity
Probability, the branch of mathematics on which insurance is based, is relatively young and widely misunderstood. Unfortunately, insurers generally make little effort to explain their calculations to their customers. Insurance buyers who do not work in insurance will normally have no idea what a loss ratio or a combined ratio is. What most people can grasp, however, is that their financial interests are usually diametrically opposed to those of their insurers. In other words, the larger the share of premiums that is paid out in claims, the better the deal will be for the policyholder and the worse for the insurer. This fuels suspicion that insurers will always look for ways to refuse or limit claims payments.
Key features of the insurance market that may also have a major impact on the price of insurance are also largely unknown to most policyholders. Two of the most important of these are the financial demands of distributors and of reinsurers. Distribution and administrative costs typically consume close to 30% of insurance premiums, leaving only around 60 cents in the premium dollar to pay claims if the insurer budgets for an underwriting profit of 10%. And the cost of reinsurance, particularly for property catastrophe risks impacted by climate change, has soared in recent years, forcing the primary market to raise premium rates steeply.
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