Is Your Insurance Product Worth It?

When considering whether or not to buy insurance, many people start by trying to figure out how likely they are to need it. A common question that pops up is: What’s the insurance company’s target loss ratio?

 

At first glance, this seems like a smart question. A high loss ratio might make insurance seem like a good value, while a low one might lead you to think it’s not worth it. But here’s the catch: that number doesn’t actually tell you what you really need to know. If insurance companies were completely candid, their ideal target loss ratio would be 0%. After all, they’re businesses designed to make money. If they paid out more in claims than they took in with premiums, they wouldn’t be around for long. So when you buy insurance, odds are that you won’t come out ahead financially.

 

With that in mind, self-insuring tends to work out better, most of the time. Insurance companies stay in business because most activities involving the purchase of an insurance product don’t result in claims that are greater than premiums. If we were gambling, which is really the best description for an insurance transaction, you’d essentially be placing a bet. And like in any casino, the house (or in this case, the insurance company) has the edge. You may win a few hands, but ultimately over time, consumers pay more premiums than they get back in claims.

So rather than asking what the insurance company’s target loss ratio is, prospective insurance purchasers should instead focus on quantifying their own risk tolerance is in the event of an unexpected, catastrophic loss.

Insurers know unexpected losses have a chance of occurring across a large pool of people. It is for those risks that they actually charge risk premium. Everything else is inefficient dollar swapping. For example, health insurance companies anticipate and charge premium for expected physician appointments, chronic disease medications, and more. For this reason, a single, healthy young man with no known health conditions might think self-insuring is a great option. Why pay an insurance company for administrative expenses, broker commissions and medical services you—as a healthy, young, single man—almost certainly won’t need or use?

 

Paying for an annual checkup is undoubtedly less expensive than what you would have to pay in annual premiums to an insurance company. But an honest insurance company would not define expected and encouraged annual physicals as “actual risk.” Actual risk is something that is possible, but unlikely, in any given scenario. A few examples could include a cancer diagnosis, a car accident, or something slightly more extreme like getting knifed in a bar fight (for most people).

All of this is a long-winded way to say that insurance is a rip off—until you need it. Of course, you can ask what the insurer’s target loss ratio is, but if they tell you something other than zero, they’re giving you a number that contemplates actuarially expected claims over a statistically significant population. That alone won’t help you determine what your own specific risk tolerance is. In fact, you could argue that it’s not truly helpful information at all, especially when deciding whether or not to buy insurance.

 

As we’ve covered earlier, self-insurance is usually the best option, unless you experience one of those catastrophic losses. But due to the sudden, unexpected nature of those losses, by then, it’s too late.

 

So how should we approach decisions about purchasing insurance?

 

One way is to minimize that risk of potential catastrophe, and secure what stability you can. As a nationwide managing general underwriter, we’ve seen our fair share of risk at RMTS—and we’ve worked to build a reputation for reducing that risk for you. Our stop-loss policies offer you a way to self-insure without losing sleep over your potential risk. And ultimately, that’s what insurance coverage is for.