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What is Insurance? Why is it such a Profitable Industry?

Written by Tom Crosley
Catastrophic Personal Injury

Photo credit: PaperScraps / Foter / CC BY-NC

Insurance, today, is an enormous industry. Back in 2006, non-life insurance claims averaged almost a billion dollars – every day. In 2013 in the United States, the net premiums written for all types of insurance totaled $1 trillion dollars (that’s over $2.7 billion a day). And despite the recession and new legislation such as the Affordable Care Act, insurance companies are still posting profits. State Farm, the largest home and auto insurer in the United States, posted profits of over $5 billion in 2013, and UnitedHealth, the largest health insurance provider in the U.S., posted profits of over $5.6 billion in 2013 and has been posting higher-than-expected profits in 2014 and 2015. So what, really, is insurance, and how has insurance become such a profitable venture?

Insurance, on the most basic level, is a way to redistribute risk. For example, you may have your digital photos backed up in several places: they’re on your personal computer’s hard drive, they’re posted online on a social media site, and perhaps some of them are even printed out as hard copies in photo albums or picture frames in your home. All things being equal, it’s probably more likely that your personal computer’s hard drive will crash than a popular social media site will stop providing services or that the pictures in your home will be destroyed by some sort of disaster. So, by storing your photos in several locations and in several different formats, you spread out the risk of losing all your pictures. That common-sense approach to saving your photos is a basic form of insurance.

When an insurance agency offers you a policy, they are doing the same thing with a slightly more complex problem. To provide you with something like fire insurance, they would research how often fires occur, determine the value of your home and belongings, and then charge you a certain amount that reflects how much of a risk there is for losing everything in your home due to a fire. They can do this because they have a lot of customers paying for that same service.

For example, if the cost to rebuild a house after a fire is $100,000, you would have to pay that whole amount to rebuild your own home after it was lost in a fire if you did not have insurance; however, if the risk of a fire happening was 10%, an insurance company could come talk to you and 9 of your neighbors to get each of you to pay $10,000 – as an insurance policy; the insurance company could set that $100,000 aside in case someone did lose their home to a fire, and everyone would only pay an amount equal to their risk instead of having to pay the full amount.

Of course, the problem with only 10 people contributing is that if those 10 people have a string of bad luck and 2 houses burn down (or 3 or 4), then they’re in big trouble. This is why insurance companies sell policies to a lot of people: the bigger their pool of paying customers is, the more accurate their risk assessments are going to be and the more people they’ll have to distribute that risk among. This is also why insurance companies need to make some profit: no matter how good their research is, there is no way to know if or when an accident or disaster could strike and cause more damage than anyone could have calculated.

In fact, this is what happened when the World Trade Center collapsed; it was the largest insurance loss in history – a $45 billion loss. The insurance policy for most skyscrapers, such as the World Trade Center, assumes that a skyscraper will never completely collapse. Things like fires, flooding, and other disasters that can occur in large buildings usually affect a few floors before they are contained, so the “total loss” of a skyscraper in the World Trade Center’s policy was estimated to be damage to the interior of 10 floors. All the research suggested that was the worst a fire could do before firefighters put it out, but no one could have predicted the true and total loss that occurred on September 11.

So, it’s understandable that insurance companies need to make a profit to essentially have their own insurance policy against the risk of making inaccurate calculations or estimates, but that risk is very small, and the assets of insurance companies are very large. For example, the net worth of State Farm, whose primary source of premium income is auto insurance, is over $70 billion. The average auto claim for property damage is a little over $3,000, and the average auto liability claim for bodily injury is approximately $15,000. That means if State Farm stopped collecting money from customers today, they could still pay approximately 3,888,888 auto claims before going broke, which feels like a pretty solid insurance policy.

At Crosley Law Firm, many of our clients seek us out because they have been in a vehicle collision and they are struggling to deal with insurance companies. Whether it’s another driver’s or their own, every insurance company has an incentive not to pay – every unpaid claim means more profit for them. Insurance companies will use multiple tactics to try and deny your claim or even discredit you before you’ve even had a chance to consider filing a claim! They do these things to maximize their profits, even if someone has been hurt and needs the financial compensation they’re entitled to as a paying customer.

If it isn’t clear from the discussion above, insurance is all about numbers. Often, victims in crashes who have suffered injury get stuck between insurance companies who are just crunching the numbers and trying to pay as little as possible to make as much as possible, regardless of who is affected by those calculations. If you’ve been injured in a vehicle collision, Crosley Law Firm wants to help you. During a free consultation, we can review the details of your situation and give you expert legal advice to help you decide what your best course of action is. And if we think we can help you – our service to you extends well beyond the conclusion of your case to make sure you keep the settlement money you do receive. Call (877) 535-4529 today to schedule your free consultation or browse our website to learn more about what Crosley Law Firm has to offer.

Reference:

Kaplan, M., & Kaplan, E. (2006). Chances are… Adventures in probability. New York, NY: Penguin.

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