Behind the curtain

What’s Really Going On Behind The Curtain?

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I’m sure if I asked most policyholders what they thought “I.N.S.U.R.A.N.C.E.” really stood for I’d get some examples like:

















Responds (with)






In other words, it’s not surprising that the general majority assume insurance carriers;

– have no idea how to rate their products correctly,

– have poor customer service when you actually need them, and

– do not give enough relief when the situation arises.

The purpose of this blog post is to lift the veil of uncertainty regarding those issues.  I hope I can give you some further insight in how an insurance carrier operates.

1)      “I’m paying too much!  Where did you even come up with this number?”

I think the large majority of the population believes that insurance carriers have “no idea what they’re doing” when it comes to pricing a risk.  Well, it’s time we figured out where these rates come from.  You are probably not surprised to hear that the people in the field (adjusters and salesmen) do not set rate.  But I’m sure there may be a few readers out there that are surprised to hear that underwriters, whose job it is to assess risk and deviate price, do not set the rate either.  It is true underwriters sculpt the rate but they do not create the rating clay.

Every insurance company has a division called an Actuarial Department whose primary role is to assess multiple industry trends, corporate/policy changes, economic factors, internal and external claim analytics, and societal tendencies to develop base policy rates.  These employees rarely interact with the customers but they are the first step in deciding how much an insurance policy will cost a potential insured.  Think of insurance actuaries like the meteorologists in our society.  Both meteorologists and actuaries use historical data to create accurate predictive models.   As the need to “massage” or amend the base rate increases, the predictive model also changes.  Take for instance; as hurricanes become more prevalent on the east coast, the rates will change to reflect that pattern.  The actuaries are the ones who amend those base rates.  The strongest asset, and potentially biggest flaw, is that they are primarily concerned with the mathematical impact.  In other words, they look only on the numbers.  They do not care that you instilled the best and most intense training for your employees and they do not care that your home is located never floods even if you’re in the “flood zone”.  They research the numbers and create the rules to rate.

So now hopefully you know who is involved in your entire claim experience.

–          An actuary will spend long hours constantly amending that original base rate.

–          An underwriter decides how to manipulate that base rate from the actuary by assessing the potential risk of that individual insured

–          A salesman will sell you on the “benefits” of choosing their insurance policy over a competitor based on the rates per benefit from actuarial and underwriting.

–          A claims adjuster will determine the scope of damage and it’s worth based on policy guidelines from the combined efforts of sales, underwriting and actuarial.

What you may find amusing is that actuaries are not typically “loved” within their own insurance company because they are the principle voice for rate increases.  As you can imagine, this makes the conversation between a perspective policyholder and an underwriter, marketer, salesman or adjusters more frustrating when those actuaries change prices.

2)      “I felt so used.  The insurance company just showed up, gave me some money and then left.”

Insurance companies are notorious for having poor customer service.  When you look at annual customer service reports from JD Power and Associates, it’s typically just a handful of carriers that have “high” scores.  The old message from the carrier perceptive is “No news is good news.”  They believe that if carriers do not hear from their insured’s, all things are running smoothly.  Well, that has started to change with the invention of the internet.  People can now review competitor’s products regularly and have access to multiple resources of information.  Insurance carriers have become more proactive with their insured on the front end with mass amount of marketing dollars spend defining their brand.  But where carriers still seem to get poor customer service scores is when a claim occurs.

Remember the carrier’s responsibilities after a claim has occurred is creating a notice of loss (NOL), investigation into the claim itself and ultimately payment based on policy language and damage.  Carriers have begun to segment themselves away from being responsible from the actual repairs.  The jury is still out on whether this is a good thing or not.  The repair or replacement work is usually handled one of three ways, by a carriers preferred network of contractors, a recommended third party contractor network or a homeowner who chooses his or her own contractor.  The carriers very rarely make direct contractor recommendations because of a perceived legal connection between the carrier and contractor.  If something should happen during the repair (or after the repair), the carrier does not want that implied liability.  In almost all homeowner’s insurance policies, the carrier is not contractually obligated to handle who the homeowner decides to fix the problem.

In short, the insurance carrier views the claim as resolved when their insured receives compensation or payment.  The Insured, on the other hand, believes that repairs are a part of the entire claim process.  Understanding the responsibilities of an insurance carrier and how they operate will typically improve an insured’s expectation.

3)      “How can my insurance carrier only pay me “$X,XXX” when my roof clearly is worth more?”

When a claim occurs, we all want the maximum for our loss.  Unfortunately the agreement or insurance contract that was made between the insurance carrier and insured does not reflect the same philosophy.  Most insurance contracts are “replacement” contracts which mean that should something be lost, stolen or damaged, the carrier will “replace” that with a “like-for-like” type of product.  The accepted language in insurance policies is “like kind and quality”.  In this instance, if all the shingles are damaged by a covered peril, the insurance company is obligated to replace the damaged material with the same type of shingles.  If those same shingles cannot be found or are no longer manufactured, the next closest type of material based on performance should be used.  The material should never be inferior to what is being replaced.  Like in the auto industry, when a 2014 Mercedes is totaled, you don’t receive the comparable 2014 Ford price but a comparable 2014 Mercedes price.  Both cars can get you from A to B, but because of market value, performance, and quality the Mercedes should return a higher insurance payment. (By the way, I have a Ford, so no judging!).  But the point is, if you have a GAF Premium Roof, I believe, you should receive a GAF premium roof, because of those same standards of value, performance and quality.

Now, in some insurance policies, there is specific language called “actual cash value” which replaces the “replacement cash value” benefit.  In this case, the insurance carrier will pay what your item is worth without including depreciation cost.  Policy language usually stipulates a depreciation rate is about 4-5% per year.  The maximum amount of depreciation that can be calculated is normally 50% of the value of that item.

Let’s try a very generic example so you can see what happens regarding an ACV policy.  Let’s say you put on a new roof 15 years ago, the policy says it will pay actual cash value of that roof.  A storm has completely damaged the roof and it needs to be fully replaced.  The total value of that roof is $15,000.  With a replacement value policy the insurance carrier will pay $15,000 to replace the roof.  With an actual cash value policy the cost will be depreciated 4-5% each year.  All things being equal the below is not exactly how ACV is calculated but the philosophy is similar.  The below example is very simplified, but the purpose is to show the allocated amount to the insured is reduced annually.

Year 1 = $15,000.00 – 5% ($750.00) = $14,250.00,

Year 2 = $14,250.00 – 5% ($712.50) = $13,537.50,

Year 3 = $13,537.50 – 5% ($676.88) = $12,860.62,

Year 4 = $12,860.62 – 5% ($643.03) = $12,217.59,

Year 5 = $12,217.59 – 5% ($610.88) = $11,606.71,

Year 6 = $11,606.71 – 5% ($580.34) = $11,026.37,

Year 7 = $11,026.37 – 5% ($551.32) = $10,475.05,

Year 8 = $10,475.05 – 5% ($523.75) = $9,951.30,

Year 9 = $9,951.30 – 5% ($497.56) = $9,453.74,

Year 10 = $9,453.74 – 5% ($472.69) = $8,981.05,

Year 11 = $8,981.05 – 5% ($449.05) = $8,532.00,

Year 12 = $8,532.00 – 5% ($426.60) = $8,105.40,

Year 13 = $8,105.40 – 5% ($405.27) = $7,700.13,

Year 14 = $7,700.13 – 2.6% ($200.13) = $7,500.00,

Year 15 = $7,500.00 – 0% ($0.00) = $7,500.00,


Even though the value of the roof is $15,000, the coverage will only allow payment of $7,500 because it reached the 50% max of the value of the roof.  Ultimately it means the homeowner has to pay more out of pocket to replace what was on the roof (or worse have a homeowner or contractor not follow best practices and make the roof less secure than it was by installing less quality products).  I did not even mention that $7,500 out of pocket does not include the deductible.  The ACV language is a subtle policy variation but has a substantial impact on paid benefit amounts.

Overall I think the issues most people have around insurance companies is the lack of visibility.  I assume if carriers showed how rates were created, what analytics actuaries use, why one type of policy is priced differently than another, then the masses would know that it’s more than just throwing darts at a dart board.

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