On Mon, 6 Sep 2004 17:57:59 -0500, chuck wrote:

>Insurance and scam go together real well in most states.  Just a question of
>the scam du jour.  Seems to me, that insurance is legalized gambling.  You
>are betting something will happen and the insurance company is betting it
>wont. ....There is something fundamentally flawed about the whole insurance
>system in this country.

I'm not in the insurance business, but I've taken the trouble to learn
a bit about it.  What you've said here is half right.  You probably are
betting that something (i.e., a bad hurricane) will happen, but the
insurance company isn't really betting the other way.   Over time, the
question isn't whether Florida will have another "Andrew" type
hurricane (or California a mega-earthquake, or another forest and brush
fires that destroy billions worth of homes built in dry brush canyons).
There will be another "Andrew" in Florida, and California will have
more fires and eventually a mega-earthquake. It's just a matter of how
many and when.

What most people don't realize is that most insurance companies don't
even try to make money on the underwriting business itself.  When it
all works right, the amount paid out on claims (over time) more or less
equals the sum of premiums paid in.  All the insurance companies are
betting is that they can make enough money reinvesting the premium you
pay before they have to pay it out on a claim to make the whole thing
worthwhile.

In effect, insurance premiums are a loan from policy-holders to the
company. If the underwriting business is well run (all premium income
is eventually paid back, but no more), then that loan is, in effect,
interest-free.   From the insurance company's point of view, this
premium income is called "float" and, at least in theory, all of it
will eventually have to be paid to (some) policy-holders.  In the
meantime, the insurance company invests that money and the income
earned from investing the float is actually where the insurance
company's profits (if any) come in.

It never feels this way to us at the premium-paying end, but the real
scam in insurance comes when insurance companies, in order to capture a
larger flow of premiums, price insurance products too low. That's fine
in "normal" years when the flow of premiums is always bigger than
outgoing claims payments.  But when an "Andrew" comes along, if there
isn't enough money in the "float" bucket to cover claims, the insurance
company will be forced to dip into its capital.  If there isn't enough
of that (and often there isn't), then the insurance company will go
bankrupt, and policy holders with valid claims who still haven't yet
been paid will be left holding the bag, receiving at most a partial
payment from the insurance company's own insurers, or else emergency
disaster assistance from the government - itself a kind of insurance
too, since in effect this is really covered by "premiums" paid by all
taxpayers.

This is all a gross over-simplification, of course, and it leaves out
the important role of reinsurance. That is basically when the insurance
company lays off the risk represented by your policy by bundling it
with other policies and on-selling them to another company.  When an
Andrew happens, it's really the big specialist reinsurance companies
(like Munich Re and Berkshire Hathaway) that end up paying out most of
the claims.  But the same process still works at this level.
Ultimately, it is the financial health and underwriting skill of the
reinsurance companies - whether they've priced the premium they charge
your insurance company correctly - that determines whether you and
other policy-holders will actually get paid when your home is damaged
or destroyed.

As a policy holder, rather than thinking about your policy as a "bet"
that a hurricane will happen, it probably makes more sense to think
about it in the inverse of the way the insurance company thinks about
it (or should).  You both know a hurricane will eventually happen.  The
calculation you are making is that the cost  to you of paying premiums
(even if the next Andrew doesn't actually happen in your lifetime, or
while you're still living in Florida) is worth the protection against
being financially wiped out by an event which destroys your home during
that same window of time.  If it isn't, then you're better off staying
"self-insured" and keeping the premium payments in your bank account,
or using them to pay for more dive trips.

Robert Delfs




Tabula International Ltd.
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