Why insurance companies are cautious about risk: In defence of risk averse insurers

Some persons complain about insurers not accepting risk or denying payment for certain claims. While a few insurers really push the limit on good business practice, there is another side to it. Insurers must avoid substandard risks or those that are deemed uninsurable.

It may seem as though that defeats the purpose of insurance, but companies must remain viable – as going concerns. Therefore, they need to balance providing coverage with remaining profitable. As such, insurers have good reasons to avoid certain risks.

Underwriting losses

An underwriting loss refers to when insurers pay out more money than they received from particular policies. Aversion to high risks or uninsurable risks is a way of reducing underwriting losses – especially catastrophic ones – that could cause the company to collapse. Underwriting losses on too many policies would not be healthy for any insurance company.

For instance, if a medical insurer collected $3,000 in premiums from you, but had to pay a claim of $20,000 on your behalf, that represent an underwriting loss of $17,000. It is, therefore, imperative that insurance avoid very high risks, since the stability of the company is at stake.

Anti-selection

It is natural for those who face more risks to seek insurance coverage; this tendency is referred to as anti-selection. A person who has medical problems is even likelier to seek coverage against future problems than a healthy individual with a good medical history Insurers need to be aware of this because such information is critical to assessing the level of risk.

As a result, applications are more rigorously reviewed – especially when high coverage levels are involved. Insurance concepts like deductibles, excess and policy exclusions are also used to prevent or manage the possibility of anti-selection.

Moral hazard

A “moral hazard” is a terms that refers to the risk of dishonesty occurring in an insurance transaction. If there seems to be willful misrepresentation or non-disclosure, insurers would be unwilling to accept the risk. Using policy exclusions, denying claims and voiding policies are just some of the methods of reducing moral hazard.

Preventing speculation

Insurance seeks to indemnify, not to allow persons to profit from losses. In fact, one of the principles of insurance declares that no one must profit from it. Even with life insurance, coverage should be comparable with a person’s economic value. Insurers who suspect speculation or illegal wagering in an application would be inclined to deny the risk or deny a claim.

Lower premiums

Proper risk management facilitates lower premiums as well. Certain risks are too high for insurers to cover comfortably. Assigning risks to categories ensure that the actuaries can determine premiums according to risk and eliminate risks that are way too costly. For instance, if a terminally ill patient seeks $500,000.00 in coverage, what premium could cover that without guaranteeing an underwriting loss? Whatever premium that is would not be worthwhile for the insured or the insurer.

Profitability

It is no secret that insurers want to make a profit – and significant profits as well. This is not confirmation that insurance is a “rip-off.” Insurers merely take calculated chances in order to achieve their objectives. Most times it works out for them; a few times they do not. Being too liberal with risk would reverse that truth and negatively affect profit margins.

Remaining a 'going concern'

Significant or frequent underwriting losses can make an insurer insolvent or illiquid. Risk-selection is the critical to sustaining long-term viability of an insurance company. Being somewhat risk-averse protects the insurer and their policyholders. If something affects the company’s viability, many more persons would be affected.

Adherence to insurance principles and policies

Insurers use a very robust risk-management system to analyze and select risk. These are based on a network of insurance principles (indemnity, subrogation and contribution for example) and policies outlined by insurance underwriting departments. Therefore, rejection of applications or denials of claims are not usually random, whimsical events.

Conclusion

Insurers must discriminate among risks for mere survival; as such, they would only accept insurable risks and stipulate premiums based on the extent of risk. Sometimes, the discretionary nature of underwriting or claims processes can fuel the perception that insurance is a “rip-off,” when that is the exception instead of the norm.