Understand how the insurance industry works and the challenge of protecting your customers from unpredictable events by turning this into a profitable activity
The insurance market constitutes a multi-million dollar industry worldwide, made up of companies and people who develop insurance policies and work in the sale, administration, and regulation of these services.
Today, there are very few items of value that cannot be insured, although the most common types of insurance involve business, vehicles, real estate, rent, and health problems.
What is behind the success of this industry is the risk management activity. This is because insurance is nothing more than a risk transfer service, in which the insurance company protects people and companies against the risk of unpredictable events occurring and which would represent great financial losses for them.
To offer this guarantee, the company receives a fee from all its customers, charged from time to time. In industry jargon, this fee is called a ‘premium’, while the customer is treated as a ‘policyholder’ (the document that formalizes the contract between the insurer and insured). If the event specified in the policy occurs, the customer receives compensation from the insurer.
To be successful, the insurer must make sure that it has earned enough money from the premiums to offset the expenses it will have to reimburse customers for damages and losses while maintaining a profit. It may seem like a simple procedure, but it is an extremely sophisticated analysis and calculation mechanism.
Calculation of risks The final account only closes when the risk that each individual or company represents is calculated with great precision. A banal example: wooden houses, for example, have a greater risk of fire than those made of bricks, in the same way, that a customer’s history of fines says a lot about the chances of him getting involved in an automobile accident.
This process of analyzing whether the risk is worth it or not is called underwriting and is one of the most crucial activities within an insurance company. This is an in-depth study, which takes into account several factors to try to establish what are the chances of this client needing to call the insurance company to reimburse losses in a certain type of insurance.
It is the analysis made by the underwriting team that will determine whether or not the insurance company will close the contract, and under what price plan. The lower the risk, the lower the premium.
If the risks are poorly calculated, the value of the premiums will not be sufficient to cover the company’s expenses. In other words, if underwriters (also called underwriters) assume that the probability of an event happening is very low, the fee charged to each customer will also below. If the event, contrary to what was predicted, occurs for many customers, the insurer comes out at a loss.
Crisis situations: scenario that took insurers by surprise occurred during the 2008 financial crisis. The American International Group (AIG), the largest insurance company in the United States, recorded a loss of more than $ 99 billion in the year and needed financial support from the Federal Reserve (FED – kind of central bank of the United States) to not go bankrupt.
To understand what happened, an initial explanation is worth: AIG’s main business is selling insurance, but not just the more traditional types, such as real estate or health insurance. The company also provides more complex services to meet the demand for large companies, especially banks.
To protect their large operations, banks often hire insurance companies to help them in case their business goes wrong, and they pay a high price for it. In this way, AIG insures financial institutions worldwide against risks.
Virtually no insurance company was able to predict the risks behind subprime real estate loans, a type of loan practiced by several banks that were AIG customers. When this type of credit triggered the financial crisis, the banks lost a lot of money and started to activate the contracts they had signed with AIG, forcing the insurance company to pay huge refunds. The account, in this case, clearly did not close, leading the company to a state of technical bankruptcy that was only overcome through government aid through the FED.
Industry workers, It’s not just underwriters who deal with risk management within an insurance company. In the company, professionals are known as actuaries also play an important role in this activity.
It is up to them to look at the latest trends and statistics for a specific occurrence (be it fire, theft, death, car accidents, etc.) and use this information to build probability and risk prediction tables. These professionals, who constantly calculate risks, are involved in several processes in the insurance company, including the subscription itself, but also the definition of pricing policies, product development, investments, and customer claims.
Professionals in the actuarial field must appreciate solving problems through data analysis and modeling and are often motivated by working with computers and formulas.
The truth is that, in an industry built around the idea of risk, all professionals must have an affinity with this theme. From executives in managerial positions, such as directors and presidents, to the other end of the organization chart, where sales agents are located – the objective, in the latter case, is to sell insurance policies, and these professionals must know how to assess risk associated with each customer and recommend a product that adapts to their needs, while at the same time not making the insurer take unnecessary risks.