Thursday, November 17, 2011

The "Corrupted" Image of Insurance

I came across a rather interesting question on how come the insurance industry is often portrayed as corrupt. I was indeed compelled to try my hand on writing a sensible explanation to this commonly perceived "curse" on insurance business. I had to make a top-of-mind justification and I was hoping my exposure and experience to both the major fields of the financial industry (i.e., banking and insurance), would prove helpful in my attempt to do a "pseudo-trance writing" session.

The business model of insurance is based on a promise to indemnify someone for a contingent loss on a future date. The product itself is merely a piece of paper, which is basically a contract. The "utility" or satisfaction from the consumption, i.e. payment of premium for the insurance policy, can either be attributed to the "peace of mind" acquired by the Assured when he thinks he is covered upon the purchase of the policy or the relief that the policy grants upon the filing and payment of the insurance claim. The business is also based on proper pricing for statistical events. Ultimately, it is a "bet" by the insurer (with his money/capital) that after pooling all the premiums, the company will reap a profit margin after netting expenses including claims payments. Rates increase as the shareholders/capitalists demand a higher return for the money they are "betting" with against the possibility that premiums AND capital will be wiped out. If the return on investments aren't enough, the owners of the money would simply pull-out and invest in another business (a Starbucks or a McDonald's, whatever would make money). On the other side of the fence, stiff competition among different insurance companies for the premiums of consumers pull down the rates charged. Underwriters make final decisions on the pricing and the offer for cover. Underwriters evaluate whether or not the coverage would in the end be a loss or if the price (fractional portion of the entire pool of premiums) is enough in view of the risks involved. During claims processing, insurers are stringent about paying-out because there have been agreed-upon rules and stipulations on the "contract"/the insurance policy (even the fine print, so always read EVERYTHING on the policy - prepositions in, on, at among other terms in the wordings of the policy can make or break your case for a claim). The insurer will naturally try to find a way to say that the claim cannot be granted and the Assured meanwhile would naturally insist that the claim can be made. Questionable claims may be presented upon the regulators and the Courts and it would be a waste of resources, time, and effort for insurance companies to deny claims through formal legal proceedings if in the end they knew all along that the Assured would be favored by the Commissioner/Judge. Insurers will often grant claims payments to airtight claims cases since this also adds to their company's image and industry reputation as reasonable organizations. When it comes to a point when an insurer always tries to deny all claims by Assureds, the industry and customers would get word of this and ultimately no matter how low the premium/rate quotation is, people will not simply buy the coverage/policy because it will be tantamount to just throwing away money. Premiums are a fractional amount of what could be a large monetary claim so Insurers are careful about easily granting claims because it will also attract mafia-type insurance claims fraud. It is of course hard to pinpoint and prove who is lying and who is telling the truth. The process of granting relief isn't easy, just as forensics and detective work for law enforcement means having to sift through a lot of dirt, noise, and evidences. Unlike the banking industry, where pricing and the cashflow are influenced by interest rates and economic factors (that are mostly interdependent anyway), insurance business is anchored on "events based probability", which is practically saying insurers have to contend with the universal confluence of natural phenomena (i.e., anything and everything possible under the sun). The insurance policy sets the parameters by which the coverage shall operate and it shall be the reference point for insurance claims adjusters/investigators in order to establish indemnity obligations and liabilities to the Assured. The insurance company is also a fiduciary trust, answerable to all policyholders who paid the premium that make-up the pool. The expectation is basically a fractional loss (e.g. 10 out of 100 people will experience a loss) and it's the truly and authentically unfortunate ones who should be indemnified. The insurance company can't just give away other people's premiums to claimants who say they should be paid, when in fact based on the agreed upon contract (which ALL policyholders agreed to) he shouldn't be deserving of a single dime.

All compositions, statements and opinions of the author are copyright © Earl T. Malvar 2009-2011. All rights reserved. There is no honor, respect, admiration, intellectual and academic dignity garnered through plagiarism.

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