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ONE DAY, AS I WAS walking through the mathematics building at the community college I attended, I saw a poster that screamed, “Math Majors?”
That got my attention. The poster introduced me to a career possibility: becoming an actuary. My job path was set. Or so I thought.
The actuarial career path consists of passing either five or 10 standardized tests. Complete five, and you become an associate. Complete 10, and you’re a fellow. Unfortunately, I flunked the first test I took.
Still, I didn’t give up on insurance as a career. Five years after graduating, I began as an underwriter trainee. I continued in the insurance field for 42 years, until I neared my 70th birthday.
I want to share some things I learned that could help you to be adequately insured. This may sound pretty straightforward. But insurance coverage is often a guessing game—both for insurers and customers.
Actuaries decide what premium to charge and how much money should be kept in reserve to pay the claims that’ll occur over the life of an insurance policy. Life insurance actuaries are very good at this. You rarely hear of life insurance companies declaring bankruptcy. Life insurance losses are predictable—unless something unforeseen like AIDS or COVID-19 comes along, and suddenly younger people are dying in large numbers.
The same certainty isn’t always found with other sorts of coverage, and sometimes insurers get the pricing badly wrong. For instance, the insurance industry didn’t know how to properly price long-term-care coverage. Pricing was based on the historical length of stays in nursing homes. But people were beginning to live longer and nursing-home stays lengthened—sometimes dramatically. In desperation, insurers began canceling losing policies or raising premiums drastically.
Meanwhile, in property-and-casualty insurance, actuaries aren’t used consistently. Instead, pricing is often a guessing game undertaken by the underwriters, who try to size up how likely customers are to file claims.
It can also be difficult to figure out how much coverge a customer should buy. Take homeowners’ insurance. I wish I could assure you that your insurance agent, broker or salesperson knows exactly how much coverage you need, but I can’t. They also guess.
That’s because the insurance company can’t take the time to decide exactly what your house or its furnishings are worth. To do such a painstaking survey would be too costly given the slim profit margins on most homeowners’ policies.
Many policyholders discover they’re underinsured only after a loss. To prevent this from happening, make a full inventory of what you own, and then get a professional appraiser to evaluate what it would cost to rebuild your house and replace your belongings.
These appraisals can be costly and won’t be paid for by your insurance company. Nor is it guaranteed that the insurance company will accept the appraised value that you present to them. But at least you’ll have a better idea of how much coverage you should buy.
You might discover that your insurance company doesn’t value your belongings as highly as you do. That’s because of an insurance principle called “like kind and quality.” Let’s say you have imported Italian marble that’s damaged by a tornado. Unless you presented the insurance company with an appraisal of this marble at the time your policy was first written, you’ll likely get covered for the cost of replacement marble from Vermont. It will look and perform similarly to Italian marble, but cost a lot less.
Many people intentionally underinsure to save money. When they file a claim, they may learn that’s a costly mistake. To understand why, let’s say it would cost $100,000 to rebuild your house if a fire destroys it. Yes, I know that’s a low figure today, but I’ve chosen it for simplicity’s sake.
You might think, “What’s the chance the house will burn to the ground? I think the average loss will only be $20,000, so I’ll insure for $20,000.”
Now, let’s assume you did have a $20,000 loss down the road. You won’t get $20,000 from your insurance policy. Instead, you’ll get far, far less. Why?
First, there’s your deductible, which you’re required to pay out of pocket. Let’s say that knocks $1,000 from the $20,000.
Second, there’s the coinsurance clause, which looks at the ratio of what you insured the house for versus what you should have insured it for. In this case, you’d insured a $100,000 house for $20,000—a 20% coverage ratio.
That means you’d only get 20% of the $20,000 loss covered—and that’s after the deductible. In this example, insurance would cover only $3,800 of the $20,000 loss. You’d have to pay $16,200 toward the repairs yourself. Painful, I know, but it pays to understand how insurance works.
Insurance is not a racket. But it is a for-profit industry. Insurers are only required to pay based on the terms and conditions of your insurance policy. Knowing what is—and isn’t—covered can save you heartache and money, regardless of what kind of insurance you buy. Be sure to read your policy.
David Gartland was born and raised on Long Island, New York, and has lived in central New Jersey since 1987. He earned a bachelor’s degree in math from the State University of New York at Cortland and holds various professional insurance designations. Dave’s property and casualty insurance career with different companies lasted 42 years. He’s been married 36 years, and has a son with special needs. Dave has identified three areas of interest that he focuses on to enjoy retirement: exploring, learning and accomplishing. Pursuing any one of these leads to contentment. Check out Dave’s earlier articles.
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My insured value of my home is well more than the market value (which includes land). Per my agent the reasons are:
-building to current code is more expensive
-replacing my home is a custom, one off, build even if it is straightforward construction (no economies of scale)
-clearing the lot
-building in an existing neighborhood has many additional expenses
-everything about building is more expensive (one area of our economy that we seemingly can’t make more efficient)
I am skeptical of the preceding comment (by stelea99), although it could be true for that state (or maybe I just didn’t understand what was written). For sure, all states have insurance regulations and oversight, and there must be differences. From my experiences, the author’s (David) version is more likely to represent what we will find applicable for our coinsurance. I guess that most states provide a 20% margin of error for coverage – so we receive 100% of loss if we have insured at least 80%. Otherwise,the claim will be reduced per David’s example. An issue not mentioned but folks should know (and I believe this is true in all states) is that if there is a mortgagee named, there can be no diminution for underinsurance.
Overall, this is a good article. There are a couple of things that I would like to mention which are not correct. I spent 30 years in the Property and Casualty side of the business, and at least in the auto and homeowners’ business, no rates are made without the actuaries creating them. Because of state regulation, rates generally must be approved before use by each state and these filed rates must be backed with actuarial evidence to justify the rates. The underwriters have no ability to alter the rates on an individual policy. On the commercial side of the business there is often not enough data and the underwriters can make adjustments because the rates are not filed.
The second and more important area was your mention of coinsurance. For commercial policies it works as you have described. However in homeowners’ policies, there is no coinsurance clause. There used to be, but because the biggest problem today during the settlement of claims in catastrophes is that there is not enough coverage to pay to rebuild a home, the contract language has changed.
For example my AZ USAA homeowner policy says that in the event of a loss greater that $5000 to the structure, it will pay the Actual Cost Value (replacement cost less depreciation) if the home is not rebuilt. If it is rebuilt it will pay the cost to rebuild with like kind and quality up to the policy limit. So what happens as is often the case when the home is a total loss and the cost to replace exceeds the coverage amount? Well, there is an additional section to deal with replacement cost. In this clause, the policyholder agrees to insure the home for enough coverage(as calculated by the company) to rebuild. It will then increase the amount of coverage each year to what IT thinks is necessary. If you have done this, and there isn’t enough coverage, it will increase the amount of coverage by up to 25%. These escalation clauses differ by company, so you should read the Loss Settlement section of your own policy. Some are more generous than others.
Most companies have a home replacement cost calculator on their website. These calculators take into account quality of construction and features and size of a home to come up with the cost to replace. For a really custom home, or an older home of high value with unique architectural values you will need an appraisal.
Read your policy. For many people their home is a large portion of their assets.
Or, it turns out, the company may overvalue your possessions. I used State Farm for over forty years. My one claim, for an accident (not my fault) was handled reasonably well, after I challenged their initial estimate. My agent then retired. I rejected the one the company chose for me and picked another that seemed well regarded.
When I moved from my house to an apartment I asked for a quote for renters insurance. The quote was nearly as high as my existing home owners insurance. When I looked at the fine print I saw that they were insuring the contents for $300,000. I had not asked for that. Further research revealed that the contents of my house were insured for $200,000. I had never asked for that either, and discovering that my contents had miraculously grown in value by so much was infuriating. I moved all my insurance to Erie, and insured my possessions for $100,000. This attempt at sharp practice cost State Farm a long time client.
I’ve had a house catastrophe in the back of my mind, ever since I took my first insurance course in college. One key to being fairly reimbursed is to be able to come up with the records needed to prove your loss(es). My Quicken detail, saved pdfs and pictures of receipts, room & cupboard/closet photos, and video have been stashed in the cloud.
This link gives advice, straight from the insurance industry’s horse’s mouth.
https://www.iii.org/article/how-create-home-inventory
That is really helpful, Stacey, thanks. I have on my to-do list for my upcoming sabbatical to call my insurance agent about a rider for some art and musical instruments we’ve acquired over the last few years, but I think I’m going to go further and do this home inventory.
Similarly, I can also state that keeping records of vehicle maintenance plus any physical add-in’s after purchases has helped us recover $800-$1,000 more from insurance companies on cars that they decided to total. You need not accept their “firm and final” first offer that a computer spits out somewhere from a general database. Newer items installed on cars, such as a set of new tires, engine components and the like that were not damaged in the accident are worth more. Remote vehicle starters added as an aftermarket accessory also added back a bit. Yes, you have to push back and play the game and show receipts, etc., but it was more money for us. Most important, of course, is that nobody was hurt or worse – priceless.
Thanks David. Very interesting article, with lots of good information. Insurance is a necessary but complicated product.
Very informative article, David… thanks!
Are there consequences to over-insuring? Having read so much about homeowners who lost everything and only then found out they had undervalued their replacement cost, I tend to go big on my policy.
Such a useful article, David. Thank you.
A non-profit I volunteer for hired an independent insurance advisor this year to review its policies. The review process was quite thorough and uncovered many gaps in coverage and troubling risk exposures. The advisor worked with the non-profit’s insurance agent and would sometimes need to (gently) educate the agent. Every cent of the advisor’s fee seemed to be money well spent.
This particular advisor only takes non-profit and corporate clients, and independent advisors in general seem few and far between. Do you know of any who advise individuals?
David, you explained complex principles in such a clear and succinct way. I briefly worked for a large life insurance company before becoming a nurse and took some classes for employees who were not in the actuarial division. About ten years later, I became a nurse just as AIDS hit. I well remember the anger of so many when people with that diagnosis couldn’t get life insurance. As you state, insurance is a for-profit business. Right now, we are painfully witnessing the anger directed towards the for-profit segment of the health insurance industry.
Great article David. Lots of good info here.
I had a tax client who had to give up their LTC policy due to increased premiums after paying into it for many years.
I only understood the math for under-insuring a property when I acquired a P&C license; most folks would not be aware of the consequence.