Most people understand that an insurance premium is the price paid to secure insurance coverage as outlined in a policy document, but according to Richard Deakin, Head of Insurance Sales at CoreLogic NZ: “the perception that you have around those insurance premiums will be heavily influenced by whether you’ve ever had to claim on your policy, and if you have - what that experience was like”.
As Deakin notes: “Many consumers who have paid premiums for many years without making a single claim, buy into the theory that insurers (like banks and other financial institutions) are just part of a greed-driven grab for the available consumer wallet: demanding high premiums for the privilege of insurance whilst simultaneously paying out as little as possible in claims. I think they imagine insurers happily counting mountains of cash in some enormous safe, à la Scrooge McDuck”.
Deakin looked into the data reality behind premium components recently and discovered that Scrooge would definitely have his work cut out for him.
Deakin analysed a typical home insurance premium example of $1,502. Contributing to that figure is the Fire Service Levy ($106) and the Earthquake Commission (EQC) Levy ($200). “As the name suggests, the residential Fire Service Levy pays for the fire service, whereas the EQC Levy goes into the Natural Disaster Fund. Both are collected by law via insurance premiums, then you’ve got GST too ($196). So $502 of that premium immediately leaves the insurer’s coffers, destined for payment to other parties”.
The insurer is then left with a $1,000 net premium but it’s very far from pure profit.
For starters, New Zealand isn’t called the Shaky Isles for nothing - the ground beneath our feet has a tendency to move on a regular basis. Most of those shakes go unnoticed, a few are big enough to prompt people to question whether others in the same room felt what they did - or if it’s at night, for Geonet to start appearing on everyone’s news feeds. But as NZ knows all too well: when a ‘big one’ hits, the impact is massive. The many affected homeowners then make a claim on their insurance policies.
Deakin explains: “to guarantee they can pay out on these claims, insurers model both their typical average annual loss scenarios and their worst case probable maximum loss scenario. Insurers couldn’t afford to cover these losses themselves - our premiums would need to be far higher, probably even unaffordable. So instead, insurers share this risk with other insurers around the world, through the ‘risk transfer’ process known as reinsurance”.
Reinsurance is best described as ‘insurance for insurers’. “Reinsurance gets triggered for significant events and just like a standard insurance policy, there’s a threshold before reinsurance will pay out (just as an excess on a standard premium applies)” Deakin comments.
“For significant events like Christchurch or Kaikoura, reinsurance has provided critically important rebuild funding, but increased global natural hazards are increasing the cost of that reinsurance”. Deakin’s analysis indicates that out of a typical $1,000 net premium, reinsurance cost might account for an average of $375 per policy.
“Insurers are moving towards a future that involves allocating the actual cost of reinsurance and risk at an individual property level, rather than an average across the insurer’s entire portfolio: the end of cross-subsidisation of premiums, as signalled already by NZ’s major insurers”.
So, after taking into account three key tax components and the reinsurance cost, the $1,000 in net premium is whittled down to $625, and it doesn’t end there.
“The whole concept of insurance is risk transfer and risk sharing. Home owners transfer their risk to insurers by paying a premium and then Insurers consider their total cost of their risk (claims exposure) and spread that across the risk pool”. And as Deakin’s analysis discovered, insurers pay out a lot in claims.
In 2017, insurers received approx. $1.6bn in gross written premiums for home and contents cover, against which they paid out $716m in claims*. “Spread across all premiums, the total cost of paying and administering claims might equate to some $500 of that $1,000 net premium in our analysis being allocated into the risk pool”.
Which would leave $125.
“Operating costs (staff, computers, offices etc) still have to be factored in. You could be saying goodbye to a further say $70, leaving maybe $55 (or about 6%) in pre-tax profit from that example net premium. Then of course, there’s corporate tax, share dividends and reinvestment of capital to consider”.
Deakin’s verdict on the premium analysis compared to general consensus? “All in all, those insurers could really think about downgrading to a much smaller safe”.
CoreLogic offers solutions to support the insurance industry improve the customer journey during underwriting and renewals phases and minimise claims costs whilst improving the claim experience. Contact us to discuss how we can help you.