Insurance - The Most Misunderstood Industry

Ruth Harper - Friday, June 21, 2013

Insurance - The Most Misunderstood Industry

A new look at the insurance industry was recently introduced in a book written by Howard Kunreuther and Mark Pauly, Behavior Economics: Improving Decisions in the Most Misunderstood Industry. The following essay borrows heavily from the concepts introduced in this book and from a related article written in the January 2013 edition of Business Insurance magazine.

We are all very familiar with insurance in our daily lives. One would think that the familiarity would translate into wise insurance purchase decisions: trading a relatively small premium for protection against a large loss when the price is right. Similarly, one would expect insurers to use data on the likelihood and consequences of specific events to determine a risk-based premium. Finally, one would expect regulators to allow insurers to change premiums that reflected the risk being insured.

Why then is such reasonable behavior by these parties so often the exception?

Many consumers simply do not appreciate insurance. They often view insurance as something required by their mortgage lender or the DMV and not necessarily the prudent exchange of risk. There is often a long interval between the time one pays a premium for protection and the occurrence of an insured loss. This is especially true in catastrophe prone areas like ours. Low probability events like natural disasters are so far and few between, a consumer may never experience a loss but still be required to pay inflated premiums year after year.

When we buy an insurance policy we benefit only when and if a loss has been incurred and we have successfully navigated the claims filing and settlement processes.  There is thus a tendency to view insurance as a bad investment when you have not collected after paying premiums for years. It is difficult to convince people that the best return on an insurance policy is no return at all.

When insurers make decisions on what coverages to provide, their concern is on the impact that a catastrophic loss will have on their balance sheets. Insurers know that if many claims occur simultaneously, as in the case of wind damage from hurricanes, there could be a severe negative impact on their surplus, and in the extreme case could cause their insolvency. For events such as terrorism, floods and earthquakes, insurers have perceived those risks to be uninsurable without some backup by the public sector. This goes a long way toward explaining why so few companies willingly insure property risks in our community. It explains why some of the largest insurance companies require policyholders to accept the highest wind related deductibles. Many of our clients come to us in search of an affordable wind deductible more so than an affordable insurance premium.

Insurance probably is the most misunderstood industry, misunderstood by all impacted segments of our society. Consumers often lament over the payment of premiums but not getting benefits in return. Would this person prefer to have been the victim of a major weather event? Insurers act like occasional large losses are not to be expected. They often don't price the risk appropriately in advance to reflect this possibility and accumulate reserves to cover the catastrophic losses when they occur.  Their managers strive to increase market share and shareholder returns in hopes of achieving short-term personal rewards. Regulators often do not allow insurers to price their products to accurately reflect the risk. They believe some consumers require subsidies. But aren't there better ways to do this than restricting premiums to be artifically low? The National Flood Insurance Program provides an excellent example of property owners being in flood prone areas being subsidized by tax payers through artifically low flood insurance premiums.

One of the remedies for a misunderstood industry is increasing the general understanding of it

Hurricane Season

Ruth Harper - Thursday, June 20, 2013

Preparing for Hurricanes

June marks the beginning of the hurricane season on the Atlantic coast. A significant portion of the premiums we pay for homeowner's insurance relates to the risks associated with hurricanes and tropical storms. Much of the information used in this article has been provided by the Loss Control people at The Hartford Insurance Company. The Hartford and Belmont intend for this information to be general and advisory. Readers seeking to resolve specific safety, legal or business issues or concerns related to this information should consult with an appropriate safety, legal or business advisor.

What is a Hurricane?

A hurricane is a tropical storm that has rotating winds of at least 73 mph, but rarely exceeding 150 mph. Hurricanes are usually accompanied by rain, thunder and lightning. These severe storms, which are spawned by low-pressure depressions moving over warm, tropical waters, originate in the Atlantic Ocean from June to October. In an average year, approximately six Atlantic tropical storms mature into hurricanes. (Hurricanes that originate in the Pacific Ocean are referred to as typhoons.)

As the warming air rises and gains moisture, it begins to spin and gain speed near the calm center, known as the eye of the hurricane. Surrounding the eye is a towering wall of moisture laden clouds whirled by strong winds.

At the center of the hurricane, the low pressure allows the surface of the ocean to be drawn up into the eye, forming a mound of water one to three feet higher than the surrounding surface. Driven by winds, this mound of water becomes the storm surge; as the storm makes landfall, the storm surge can tower up to twenty feet higher than the normal high tide.

What Happens When a Hurricane Makes Landfall?

Once a hurricane hits land, it loses contact with its primary source of energy, the warm ocean waters, and begins to slow down. As the hurricane passes over land, increased friction contributes to the break-up of the storm. 

The greatest threat posed from a hurricane is from the heavy rainfall and from flooding caused by the storm surge. However, hurricane-force winds and flying debris can cause extensive damage until they dissipate. Hurricanes can also spawn tornadoes that are extremely dangerous and that contribute to the overall damage.

Hurricanes can cause catastrophic damage and potentially large losses of life. In recent years, the death toll from hurricanes has been greatly diminished by timely warnings of approaching storms and by improved programs of public awareness. At the same time, losses from hurricane-related property damage in the United States continue to climb; this is primarily due to an increase in population and construction.

Hurricane Forecasting

The National Oceanic and Atmospheric Administration's (NOAA) National Hurricane Center in Miami, Florida uses satellite imagery, radar and weather balloons to spot conditions that could trigger a hurricane.

As the storm nears land, NOAA and the Air Force use special aircraft to fly through the hurricane, measuring wind speed and barometric pressure and gathering other data. The information gathered is analyzed by computer models that estimate the storm's strength, rate of development, path, and estimated storm surge. Based on this information, NOAA issues a tropical storm warning, a hurricane watch, or a hurricane warning.

A tropical storm warning may be issued if winds of 39 to 73 mph are expected in an area. Such a warning will not be issued first if a hurricane is expected to strike. 

A hurricane watch is issued for coastal areas when a tropical storm or hurricane conditions threaten within 24 to 36 hours.

A hurricane warning is issued for specific coastal areas when hurricane-force winds are expected to strike within 24 hours or less.

Usually, warnings allow sufficient time to prepare against hurricane damage and to make decisions for evacuation of personnel, if proper preparation had been taken at the beginning of the hurricane season.