How insurance companies risk-assess you
In the second article in a series on short-term insurance, in association with Santam, we look at how an insurance company assesses the risk you pose, which, in turn, determines what you pay in premiums. Martin Hesse reports
Google the word “risk” and you will find a hundred definitions, but essentially risk is the potential for losing something of value. That “something of value” could be something you own that has monetary worth, or it could be priceless, such as your life.
The probability of something happening to cause you a loss may be very small. For example, the chances of your car being hit by a train are extremely slight, but if you are that unlucky one-in-a-million individual who happens to be in the wrong place at the wrong time, the outcome could be devastating.
This type of risk – where the probability of an event occurring is small, but the loss is great – is the reason insurance companies exist. They pool the small contributions of many to pay for the large losses of a few.
But not all people are the same, or are exposed to the same degree of risk, so should they be treated equally? If you were suicidal, you could drastically increase your chances of being struck by a train by parking on a railway line. If you were overly fearful, on the other hand, you could reduce your chances almost to zero by avoiding level crossings altogether. In this respect, you have a degree of control over your fate. But external factors can also increase your risk: you may live near a dangerous, unguarded level crossing and need to cross it several times a day.
In the past, on their personal lines policies, such as vehicle cover, home contents cover and buildings cover, insurers tended to treat everyone equally, and they all paid similar premiums. Marius Neethling, manager of personal lines insurance at Santam, says that in his early years in the industry, one of the only criteria an insurer took into consideration when you applied for cover was your claims history. But, for various reasons, including increased competition, insurance companies have moved to risk-based pricing models where each individual is priced according to his or her own risk. In other words, people are not treated equally; their premiums are based on the probability that they will submit a claim.
Neethling says the model involves the segmentation of clients into different risk categories, from low risk, through average risk, to high risk. To determine into which segment you fall, and hence what premium you pay, many more factors must be taken into consideration when you get a quote, he says. In the past, for car insurance, say, you could get a quote within 10 seconds from a rating manual. Now, the process is entirely automated, and it involves the insurer gleaning a lot more information about you.
This process of assessing your risk according to the information the insurance company obtains about you and your circumstances is known as underwriting, and it has become increasingly scientific. The more accurately an insurer assesses your risk, the more economically it can insure you and the fairer the system is on lower-risk policyholders, who would typically form the majority.
However, the insurer must reach a balance. The more strict it is in its underwriting requirements, the more likely it is that prospective clients will be turned away. The more lenient it is, the greater the chance of outpricing the competition but gaining undesirable business.
“Any company looks for profitable growth, and there’s a fine balance between profitability and growth. It’s easy to grow your client base by having relaxed under- writing or pricing the product too low, or to make a profit by pricing the product too high or being too strict in your underwriting criteria at the expense of losing business. So, in budgeting for profit and growth, insurers look at trends, both those directly affecting the insurance industry, such as weather patterns, and macroeconomic trends. Growth and profitability must be realistic in terms of the economy,” Neethling says.
QUESTION TIME
So how do insurers obtain information about you? The obvious way is by asking you directly, in the form of a questionnaire that accompanies your application, or by asking you a number of questions over the phone, while you envisage the call centre operator on the other end ticking a series of boxes. But they have other sources of information, including their own statistics and data shared by the industry, as well as your credit report, which they get from one of the credit bureaus.
Neethling says that insurers are obliged to ask for your consent before obtaining information such as your credit record; if you don’t give your consent, they are unable to provide a quotation.
Depending on the type of product, insurance companies use automated underwriting systems to reduce the amount of manual work in processing quotations and issuing policies. This is especially true for less complex personal lines insurance. And for these products, there is less and less paperwork generally, Neethling says.
Most insurance companies are going the telephonic route in soliciting and processing applications. All the information you provide over the telephone is recorded and, if you accept the quote, a written schedule is sent to you for verification and approval.
This means you need to have on hand all the information the insurer requires when you phone for a quote. And if you get it wrong, and don’t correct it when the schedule is sent to you, you may lose out when it comes to claiming for a loss. If your insurer covered you based on the wrong information, it is within its rights to repudiate your claim or not pay you out in full. Neethling says insurers will usually take you at your word when you provide them with information upfront, but at claims stage may seek to verify it.
Also, don’t think that once you have provided the correct information upfront you are off the hook. If anything changes during the life of your policy that, in the words of the industry, is of “material” importance to how your insurer assesses your risk, you need to let your insurer know – for example, if you change address, or turn your home into
a B&B. If you are truthful about yourself upfront, and happen to fall into a high-risk category, the insurance company can either decline to offer you cover, which is unusual, Neethling says, or it can load your premiums and/or include certain conditions in your policy contract.
The advantage to you of the latter? Well, it’s preferable to having no cover at all, and at least when you are honest, your insurer is unlikely to repudiate any of your claims as a result of non-disclosure or incorrect information.
Because so much more is required of you when you apply for cover than in the past, and although there is a higher degree of automation, a broker can be a great help, acting as a middle man, giving you advice, assessing your risks, gathering information, obtaining quotes, and acting on your behalf when you need to claim, Neethling says.