Large Losses, Natural Disasters and Your Insurance Premium
At its simplest, the premise of insurance is that you pay a monthly or annual fee (premium) for protecting you in case you suffer a loss resulting in significant financial strain that would be challenging or impossible to manage on your own. Essentially you pass off that risk, and its potential cost, to your insurer.
Insurance companies, in turn, are able to operate by taking on the risk and collecting premiums, from many, anticipating that the cost of significant losses that occur will not exceed the volume of premiums collected.
For policyholders, there are a few new factors that can drive up the cost of premiums:
1. Increase of claims frequency and average cost per claim
Home insurance: For example, the frequency of water damage is increasing year after year, and the average cost per claim is rising too. In the last couple of year, the costs of water damage has increased so much that it now represents 50% of the total cost of claim!
Auto insurance: From 2006 to 2016, auto thefts have decreased but we saw that change in 2017 with more vehicles stolen and the trend is on the rise. And now, instead of stealing small vehicles, thieves target luxury vehicle and SUVs. As a result, the average cost of auto theft has increased.
2. Large losses
Large losses refer to major losses resulting in expensive insurance payouts. For example, an electrical fire that destroys a factory, including specialized equipment and merchandise or a fire that consumes an entire apartment block or a high value home. Large losses can be alleviated to an extent. In this case, regular factory inspections may be a condition of the insurance policy and public education about fire safety and mandatory fire alarms can reduce the risk of fires at home.
3. Natural disasters
Natural disasters are, of course, impossible to control and their frequency across Canada, and the world is increasing. And, their severity is greater than ever. Recent examples include the windstorm in Ontario and Quebec, the wildfires in Alberta and British Columbia and the Ottawa-Gatineau tornadoes. All in all, there have been 100 natural disasters in Canada in the last ten years, resulting in insured losses of over $17 billion.
Insurance companies can employ a variety of solutions to deal with these realities.
Risk sharing may be employed to ensure large commercial properties or apartment buildings through multiple insurance companies so that if a catastrophic event occurs, it’s not just one insurance company on the hook for the damage.
The other method is reinsurance - insurance for insurance companies. Just as you pass off risk by paying a premium to your insurer, insurance companies pass off risk to their reinsurer for a share of the premiums. For example, the first $50,000 loss may be paid out by the insurer and the rest by the reinsurer, up to the maximum amount of coverage provided for in the contract. Reinsurance provides access to more funds and ensures a company stays solvent after particularly large claims.
All insurance companies use risk sharing and reinsurance as good practices of the insurance. They avoid the standard deviations. They help stabilize the insurance premiums for the consumers. Without that, insurance premiums could be very high a year there was an increase of large losses or natural disasters.
Understandably, the increasing frequency and severity of natural disasters is putting unprecedented financial pressure on the insurance industry which can result in higher premiums for policyholders. To learn more, connect with your broker.
Catastrophe Indices and Quantification Inc. (CatIQ)
The content in this article is for information purposes only and is not intended to be relied upon as professional or expert advice. Aviva and the Aviva logo are trademarks of Aviva plc. and are used under licence by Aviva Canada Inc. and its subsidiary companies.