Expenses in Insurance:
There are many factors for an insurer, that drive the cost across it’s value chain. Economic climate, it’s business complexity, performance management, operations, IT, support functions, geography – just some of them perhaps. At their core operational model, these expenses fall under similar groups and patterns.
An insurance carrier’s expenses split into two main groups (as per it’s activities): expenses generated by underwriting activities and expenses generated by the investment activities.
The underwriting activity expenses.
- Loss payments arising from claims – this constitutes the major expense category for most insurers.
For P&C insurers, loss payments often represent 70 percent to 80 percent of their total costs. [1]
- Loss adjustment expenses. Expenses represented by the amount needed to investigate a certain loss under a claim: e.g. for property insurance claims, a claim representative must identify the cause of loss and decide whether the loss is covered by the policy or not. If the loss is covered, a claim representative must determine the covered amount. Same applies for earthquake insurance for instance.
*loss payments and lae divided by the earned premium will give an insight into an insurance carrier loss ratio. This varies strongly with the line of business we’re referring too. For P&C this can add up to 60%. For health insurance this varied between 60% and 110% in US in the late 1990s [2] and as of 2007 the average loss ratio was 81% [3].
- Costs of providing insurance acquisition expenses; general expenses; and premium taxes, licenses, and fees.
o Acquisition expenses - generated by new business. There are generated by the marketing system and marketing operations including agents, brokers, producers, or sales representatives and the administrative staff who manage and support a new business effort.
o General expenses - generated by maintaining and supporting departments like accounting, legal, statistical and data management, actuarial, customer service, information technology, and building maintenance.
o Premium taxes, licenses, and fees - depending a different government regulation an insurer must pay certain taxes that can take the form of a percentage, or fixed fees for it’s running operations.
Investment Activity Expenses.
An insurer's investment department is composed of staff which oversees it’s investment program. This generates expenses related to salaries and all other dependencies for such a department to run it’s activities.
Fraud.
With time fraud became an important area where insurers can save money on claims. I’m not sure if this is visible these day because this is a new practice or because we have the means to see it.
“According to more than 80% of the respondents, insurance fraud can increase costs for the insurer by at least 1% and can go up by more than 5% in certain cases.” [4]
“The total cost of insurance fraud (non-health insurance) is estimated to be more than $40 billion per year. That means Insurance Fraud costs the average U.S. family between $400 and $700 per year in the form of increased premiums.” [5]
“Detected and undetected fraud is estimated to represent up to 10% of all claims expenditure in Europe” [6]
Depending on the line of business and country, fraud varies due to a number of factors such as market or prevalence of insurance type.
Fraud creates an increase in the loss payment amount arising from claims, hence this increases the claim value, which will in the end reflect on the insurance premium; in turn, fraud impacts both insurer and consumer.
In US the insurance industry estimates to put fraud at about 10% of the property and casualty insurance industry’s incurred losses and loss adjustment expenses each year. [7]
References:
[1] ANNUAL STATISTICAL REVIEW SEPTEMBER 2014 GUY CARPENTER STRATEGIC ADVISORY OLIVER WYMAN ACTUARIAL CONSULTING
[2] James C. Robinson, "Use And Abuse Of The Medical Loss Ratio To Measure Health Plan Performance", Health Affairs, vol 16, No. 4, pp 176 - 187, 1997
[3] "Beyond the Sound Bite: November 2007 Review of Presidential Candidates’ Proposals for Health Reform", PricewaterhouseCoopers' Health Research Institute
[4] “Fraud in insurance on rise Survey 2010–11” Ernst&Young
[5] “www.naic.org”; and “fbi.org”
[6] “The impact of insurance fraud, Insurance Europe, 2013”
[7] “Estimate based on research conducted by the Battelle Seattle Research Center for the Insurance Information Institute in 1992 (Fighting the Hidden Crime: A National Agenda to Combat Insurance Fraud. Insurance Information Institute, March 1992) and other industry reports (including Insurance Fraud, Renewing the Crusade, Conning, 2001).”
