Life is full of uncertainties, but with the power of personal insurance, you can weather unknowns more easily. Personal insurance is a valuable safety net that provides our homes, cars, health and loved ones with a powerful financial cushion should the unexpected happen. Most people understand the financial implications of personal insurance — such as funding the replacement or repair of a home destroyed by wildfires — but for many, the particulars of how this essential system works remain a mystery. In this article, we dive into the basics of personal insurance and how external factors, such as climate change and labor shortages, impact your rates.
Risky business: How insurance manages and transfers risk
At its core, insurance is a tool designed to manage and transfer risk. All policyholders pay a set premium to their carrier in exchange for coverage against specific risks. Depending on the type of coverage — home, auto and health being the most popular — these policies can protect your way of life against a wide range of disruptive events, such as accidents, illnesses, property damage or loss of life. The purpose of insurance is to share the hefty financial repercussions of these events across many insurance holders, something that's also known in the industry as a pool, so no single individual is overburdened by the full weight of an unexpected loss. In most cases, the majority of a carrier's policyholders will not experience a significant covered event at the same time; this risk-sharing methodology helps ensure all individuals can receive financial assistance in the event of a loss.
Diving into the insurance pool analogy
When you discuss insurance matters with your trusted risk advisor or insurance agent, they might reference the "personal insurance pool." They're not talking about your backyard pool's insurance coverage; they're describing a fundamental mechanism insurance companies use to pay claims.
When you pay your insurance premium, your money is funneled into a collective fund, referred to as a "pool," that is invested by insurance carriers and used to pay out claims when policy holders experience a covered event. According to the American Academy of Actuaries, larger risk pools are generally more stable, but that doesn't mean more people in your carrier's pool can reduce your premiums. Several factors can affect these costs, including environmental, societal and industry trends.
Premiums are essential in replenishing and sustaining the insurance pool, similar to how you top off your swimming pool or water feature after several months of hot weather. In your pool, natural factors, such as the splashing of an energetic child, can cause the water level to drop. The insurance pool is similar in that claim events — the splashing, to follow the pool analogy — result in the withdrawal of funds and premiums — and you need to refill it. In both instances, failing to refill this resource would drain the pool dry, and no one could enjoy its benefits.
The premiums you pay are determined by underwriters who assess the risk associated with each policyholder. Insurance companies use underwriters to ensure each contributor pays a proportionate amount based on their unique risk factors. They'll calculate your premium based on factors like the type and amount of coverage you're carrying, your insurance history and applicable personal factors like your age, health, driving record or property location. Ultimately, by paying these premiums, you're supporting your insurance community and contributing to the payout of future claim events.
Because insurance works on the principle of shared risk, your insurance premium can increase even if you've never filed a claim. Returning to the insurance pool analogy once more, it's important to remember the pool is open to all applicants, all of whom are paying premiums and — potentially — filing claims. Major events, such as natural disasters, can quickly empty the pool. In that event, your insurance carrier will increase the premiums of everyone in the pool — not just those affected — to reduce losses and replenish the pool faster, ensuring funds are available for future claims.
Claims and payouts
After a disaster, an accident or other covered event, you'll want to get back to normal as soon as possible. Luckily, your insurance advisor can help you identify how to proceed.
Filing an insurance claim is something that's becoming increasingly easy over the years as many companies now offer options to file online or through an app. This quick process lets your insurer know about the loss you've just experienced and your request for payment. Because insurers can draw the funds necessary to cover the claim directly from the collective pool of premiums, they can respond efficiently to policyholders' needs during challenging times.
However, not every loss event is the same. Depending on the severity of the incident and your unique risk profile, your insurance advisor might urge you to avoid filing a claim. In certain situations, claims can increase your risk profile, causing your premium to skyrocket — or the carrier might drop you completely. If you can weather the cost of the repairs on your own, it could be a sound financial decision not to involve your insurance company. Insurance advisors are trained to consider these situations so you can make positive financial decisions that won't impact your insurance rates.
The current state of the market
Now that we've discussed the basics of how personal insurance works and its value in protecting your life should the unthinkable become unavoidable, let's discuss some challenges affecting your coverage and rates. There are two main factors currently affecting market conditions, leading to higher premiums and non-renewals.
The first is the rise in extreme weather events affecting significant parts of the country. Catastrophic natural disasters, such as hurricanes, wildfires, hailstorms and floods, continue to increase in frequency and severity, spreading into regions not historically associated with these high-loss events, according to our 2023 Gallagher Private Client State of the Market Report. Because insurance is a shared risk pool, natural disasters in one area can impact the insurance rates of all policyholders, especially if they are likely to experience similar events in the future. As the risk exposures associated with natural disasters increase across most of the country, carriers who cover those regions will have to find ways to guard against catastrophic losses due to high claim payouts, likely resulting in increased coverage costs for insureds.
The second factor is a complex knot of inflation and material costs — an issue compounded by the extreme weather events described above — that is increasing the cost of repairs amid a demand for skilled labor that currently surpasses supply.
If your house were to burn down, an important step in filing a claim is to estimate the cost of repairs. To rebuild, this estimate must account for the current market cost of materials and labor. As the cost of these rises, so too does the total claim amount. Heightened payouts deplete the insurance pool at a faster rate, something that causes insurance companies to adjust their premiums to recoup their losses.
Personal insurance can be a vital safety net against the increasing challenges of modern life, from increased costs for goods and services to worsening severe weather events. Protecting your quality of life, loved ones and treasured personal items is paramount. Forward-thinking, risk-minded individuals should take steps to reduce their exposure by consulting with their personal risk advisor or insurance agent. These professionals can help you identify your risk, eliminate any gaps in coverage and even help you find the most appropriate insurance carrier.
For more insight on how to optimize your risk management plans, read our 2023 Gallagher Private Client State of the Market Report for a high-level view of the latest trends, market dynamics and strategies.