Ok class... please turn your text book to page 101.... yes today we will be taking an in-depth look at the principles of risk management and how it impacts the insurance industry. This past week you could not have made it through the week without the knowledge of the pending doom that hurricane Irene was about to inflict upon the eastern sea board of the United States. I am not saying that the media every "over blows" a good story about a pending natural disaster... I'm just say in....
This story usually starts with an advance yet small mention of some type of "tropical depression" way out in the eastern Atlantic.... typically pummels a series of islands first, then threatens some resorts in the Caribbean and then either continues in a north westerly direction OR a more direct north route along the east coast. More times than not... it will clip the south reach of Florida and then pick up steam over the Gulf of Mexico and ultimately make land fall in the gulf coast as was the case with Katrina a few short years ago. It seems that southern Florida and the Gulf have been the path of choice over the past decade and the east coast has been spared from the massive amounts of devastation and property damage. Not this time.
So... lets go to the first section of chapter one and discuss the principles of spreading the risk through the law of large numbers. Simply put.... If we are a class of kindergartners who want to protect our favorite toy from damage caused by say fire, theft, or water damage... AND we all agree by contract to spread the risk of the $25 toy.... we all need to "pool" our resources in the form a a smaller "share or premium" to protect our toy. So... we all pony up say.... $.25 to put into the pool and now we have basically started an insurance pool.
Now... no doubt I have oversimplified the entire scenario... but even a cave man could understand this. ( I mean no harm or disrespect to cave men here... please forgive?) From here with a pool of funding to protect the toy's we should be comfortable in knowing that we can play all day in the sun shine with little concern over what may happen to our toy's... right?
Not exactly. When the clouds gather and the wind picks up and the rain begins to fall... we have long since put that contract away. Some of us are more organized than others. Some have a system in place to keep their papers and records in a sequenced system. Others... well they just have a pile of debris to plow through in hope that they might somehow find what they are looking for.
Enter the storm.
Now... this is no time to be worrying about the contract... or worse yet... trying to get a contract (policy).
You don't get fire insurance when the smoke has already started AND you can't get wind and water coverage when the warnings are already posted. Yet... time and time again... after the storm passes the media loves to get that sound bite of the person suffering from a loss with the inevitable statement of loss of everything... with no coverage.
So... back to our simple example... when the creek is rising... should the simple example of toys at the playground covered in our simple pool feel secure? Well.... that depends.
Huhhh?
Yes... it depends on the cause of the loss. Remember... the contract stated that coverage extends to the following perils:
"damage caused by say fire, theft, or water damage..."
And... the contract states it covers the following property....
"our favorite toy..."
Now the dust has settled and the sun has come out again. It is time to settle up... turn in your claim... and get an education. Enter the claim adjustment process....
So the questions we need to know are straight, to the point and simple. Describe what happened? What was the cause of the loss? What is the damage to the property? Estimate the cost to repair or replace... and then apply this to the policy language.... adjust the loss.... and settle up.
Example A: John had damage to his favorite football caused by Ralph. Ralph is always doing things he's not supposed to do and pops the ball with a sharp stick. Let's review the contract... Fire? no.... theft? no... water damage? no... You make the call! NO COVERAGE... ILLEGAL USE OF SHARP OBJECT... NOT A COVERED PERIL... REPEAT DOWN!
Example B: Ralph decides to throw the ball into the fire pit (with fire burning brightly). You make the call! FIRE IS A COVERED PERIL... BALL DESTROYED BY FIRE... TOUCHDOWN!
The ball is covered and John receives payment for the loss of his football. You get the idea. Now... if how ever a large loss occurs to the play ground toys... say a rain storm caused water damage to 50% of all the insured toys in the insured group.... that would be considered a catastrophic event! Why?
We took in a small premium from a diverse group, however in this case the amount of loses will exceed the amount of premium we took in to cover the risk. What choice do we have? Either demand a higher premium from the group to cover the potential for future losses OR our small group will have to disband or in simple terms... we are broke!
This story is really an over simplification of what the insurance industry is faced with after dealing with any large loss of property. This year has been nothing more than "jaw dropping" when you go back and look a the volume of Catastrophic losses of property. Yes... you may live in a neighborhood that was untouched by a tornado, hurricane, or flood. The most common question we get is "why should I pay a higher premium for another guys losses"? OR "Why should my rate be effected by "their" loss" ?
Spreading the risk over the masses. His loss this year may be your loss next year. Insurance 101... spreading the risk.... sharing in the pain over the masses.
Not saying rates will go up soon... but... be prepared and educated if they do...
http://www.donshermanagency.com/
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