How Insurance Companies Measure Risk

By Chris Pentago posted 06-18-2019 06:35 PM


Risk assessment is one of the most vital activities for insurance companies, because calculating premium rates would be nearly impossible otherwise. While this was once done by hand, actuaries now use software that calculates rates for policyholders based on a time-tested algorithm. Underwriters generally gauge the risk of someone filing a claim based on accident or health statistics that match their demographic profile.

Key indicators, like a person's gender or age, are weighed against numerical data. Verified third-party sources of data can be used for quick decisions, but most companies now like to carefully balance the potential need of a customer to use the policy with their overall outlook.

How they do so depends on the exact industry they're in as well as the condition of any other investments they might hold. Perhaps the most obvious example is the corporate culture that's arisen in the world of automotive insurance.

Risk Assessment for Motorists

Since all drivers are required to carry at least some form of auto insurance policy, actuaries have been able to collect a massive amount of data that's the envy of companies that provide fire and health insurance polices. This is also why you now see so many examples of insurers rewarding low risk drivers with different bonuses. Companies are actually able to afford this because their risk assessment systems are sophisticated enough to foresee how much money they're going to pay out over the course of several fiscal years.

A driver's insurer generally only has to pay if law enforcement officials deem that they were at fault for an accident. While this doesn't necessarily reduce the overall burden of any specific insurance company, it does further lessen the chances of having to pay if all motorists insured by a particular brand drive safely.

The flow of additional data coupled with a highly competitive marketplace has made any number of accident forgiveness and safe driving bonuses a reality. More than likely, you often feel inundated yourself with a deluge of auto insurance advertising, and this is precisely the reason why. That being said, the industry also uses the same methods that all other insurers do in order to protect policyholders and their bottom line.

Criteria Used to Judge Long-term Policies

Underwriters use all of the following when they're setting a general rate schedule for an individual policy holder:

  • History: Health insurance companies in particular look at an individual's history to see how much of a risk they are. Around 25 percent of male smokers and over 18 percent of all female smokes who use tobacco products habitually will develop lung cancer, which is a huge risk for insurers. This is why smoker's policies tend to cost so much more than those for non-smokers. Auto insurance companies don't forget about this metric either, which is why they're so hard on people who have had an accident in the past. An average driver may deal with a collision once in around 19 years, but some motorists have a much higher rate of risk.
  • Credit Reporting: While it might seem unfair, underwriters also look to credit history when insuring people. This is based on the idea that people with bad credit may have made poor decisions in the past. On average, those who had so-called good credit ratings paid between $68-526 more per year for car insurance than those who have great ratings.
  • Age: Life insurance companies have long given discounts to young people who can be expected to pay their premiums for many years. They more than make up for this in how much more they'll have to pay for auto insurance, however. There's a stigma regarding young drivers, though it might not be true. Motorists between the ages of 15 and 19 who were involved in serious accidents weren't often as distracted as traditional wisdom might hold. Only around 10 percent were at fault for reasons of youthful indiscretion.
  • Location: Urban dwellers are always at higher risk of things like theft and accidents. In one study, the average American paid around $1,470 in insurance costs but those in Maine paid around half. Residents of the state of Michigan were paying around twice that much even if their driving history remains steady.

How Actuaries Determine Homeowner's Expenses

Approximately 98 percent of homeowners are covered by the basic insurance package that's required by mortgages. These prices are somewhat controlled, so actuaries don't have too much say in how rate schedules are published for them.

What people don't realize is that these plans are often exceptionally minimal. Those who spring for more sophisticated plans are charged at least in part based on location. Obviously, some areas are more prone to certain types of damage. Interestingly enough, however, few rate schedules include the kinds of disasters most common to specific regions without feeding customers an upcharge. This may explain why only around 1 in 10 homes in Southern California have policies against earthquakes.

Ways to Save Money

Fortunately, there are a few ways that homeowners can fight back against some of these charges. Federal authorities back some flood insurance programs, which can cover up to $250,000 of damages. This is particularly vital since so few people actually have access to these kinds of policies. Insurance underwriters look for things like home stability and location in relation to hydrants, so make sure to always point these out.

Most importantly of all, though, make sure that you shop around. Everyone has the right to do so.