Have you recently seen your renewal on your car insurance policy only to be surprised by how much it's gone up?
So, you stop to think about why a rate increase might have occurred and you think to yourself…. “hmm wait a minute, I’ve never filed a claim on my insurance, I couldn’t tell you the last time I got a ticket, and I’m darn near the safest driver I know! Why did my rates go up?!?”
To understand this question, we must know how insurance works. Insurance is something that works on the law of large numbers. This means that an insurance company insures a large group of risks to spread out the chance of loss. It would be the same as an investor looking to diversify his or her portfolio to help alleviate the loss of any one investment. By operating on the law of large numbers, the premium of the many, helps pay for the losses of the few. If a few people do experience a wreck, or “claim”, the insurance company can use the money that comes from the entire group, to help pay for those losses.
What do insurance companies do with my premium that I pay?
You might be thinking that insurance companies are big evil corporations out to drain you of your bank account and leave you penniless and on the streets. That’s usually not the case, and more importantly that’s not a very good business model in this day and age. Insurance companies use your premium for a few things such as;
To Make a Profit
- This has actually become pretty difficult for insurance companies to do. With increased competition in the market place, the demand to keep premiums down, has increased. Over the past decade or more, insurers have usually paid out $107-$115 for every $100 of premium earned. This is called the combined ratio, or the amount of money the insurer spends on both losses and its expenses.
- The premium you pay, as we uncovered earlier, goes towards paying claims for those folks that are insured with the same company and are on contract to receive money in the event of a covered loss. Let’s say ABC company invests the $100 you have paid for premium, and earns 15% on that investment. They now have $115, which they in turn use to pay claims.
- Like any other company out there, insurance companies have expenses in the day to day operation of their business. Expenses include; salaries, rent, office supplies etc. A portion of your premium, along with any interest earned on it, will go towards the company expenses.
Over 2500 companies offer car insurance in the United States. With that much competition all selling one product, the competition in the market place definitely exists. A lot of companies are operating in a loss column, or perhaps a razor thin profit margin when it comes to their car insurance product offering. State Farm for example experience the largest loss since the start of the company in 1922.
Understanding how an insurance company operates is important to understand the question of why your insurance costs have gone up, especially with your car insurance. State Farm is not the only company that has experienced losses in their auto program, it has joined Geico, Allstate, The Hartford and others who are looking for ways to counter the rising auto insurance costs. Industry wide it has become more and more difficult for insurance companies to remain profitable with their car insurance program.
Why Are Companies Not Profitable Anymore Their Car Insurance Program?
The reason why we have seen a trend in companies becoming less and less profitable with their car insurance program, is because companies are having to pay out more in claims now, than they ever have before. The industry has seen an increase in the average cost of bodily injury claims of 32% between 2005 and 2013. Part of the increased cost is due to accident severity, the cost to repair cars and costs of medical expenses. All of which aren’t getting any cheaper.
Why Are Their More Claims Paid Out Now?
The real reason behind this is due to the increased number of accidents that have occurred and continue to occur more now than they have in the past. The total number of miles driven, for all drivers on the road in the U.S, in 2015 was up 3.5% from 2014. That was the largest increase in 25 years. With more miles driven, it means there are more cars spending more time on the road, increasing the chance for accidents. 1 in 4 car crashed involve cell phone use, and 87% of drivers say they engage in risky behavior while driving, which of course only leads to a greater chance for an accident.
1. Insurance companies operate on the “law of large numbers” to spread out the risk of loss among several risks.
2. The premium of the many pay for the losses of the few.
3. Claims are rising across the country due to distracted driving, increased cost in repairs for newer more technologically advanced vehicles, and medical costs increasing.
Cause and Effect
The Cause: More people are getting into more expensive wrecks, and insurance companies are paying out more money for claims.
The Effect: Insurance companies are forced to charge more for their car insurance premium.