On 20 Aug 2004 12:54:11 -0700, jim rozen wrote:
In article , pyotr filipivich
says...

Maybe that's what your insurance company does, but the ones I'm dealing
with tend to try to not only cut costs, but put the "idle" cash to work
making some money for the company.

Define "putting to work" please.

In this case a casual inspection of the process reveals
the companies take the 'extra' money and invest it. If
the investments do well, they post extra profits and
everyone gets a bonus.

If the investments bomb then the companies say 'ooh,
we're "doing" poorly so we have to raise rates.'

IOW the 'making money for the company' paradigm means
heads they win, tails you lose.

The other issue is that for large companies, the outflow
*equals* the inflow. They rely on a steady stream of
premium dollars sure, but I'm certain that they pay out
at a steady rate as well.

Premium income is steady, payouts aren't. Insurance acturaries
set rates so that over the long term, on average, premium income
equals settlement payments, but payouts are spikey. For example,
weather related claims due to snow or ice storms, hurricanes,
etc don't occur on a precise schedule. Some days, weeks, months,
or years, payouts may be large, other times they are smaller. The
company has to maintain reserves to cover the spikes. These
reseves are called "float".

Obviously, if income and payouts precisely balanced daily, an
insurance company wouldn't make any money, not even cover
overhead. They make their money the same way a bank does on
money deposited in a checking account, by putting the premium
money to work until they have to pay it out. They put the float
to work via short or long term loans, investments, etc.

This income from investing the float covers their operating costs,
provides their profits, and in the case of mutual companies some
is applied back toward reducing premiums, or directly paid back
to policy holders in the form of refund checks by charter and law.

Like banks, insurance companies tend to be conservative investors.
But even a conservative investor can be hurt if the stock market
crashes, or a real estate market boom goes bust. You can call it
gambling if you like, but it is the way any financial institution
operates.

Now insurance companies assume additional risks beyond those
of ordinary investors. Things like hurricane Andrew (a "storm of
the century") can strongly affect the size of the float. Premiums
are sized primarily by loss history, average cost of claims, etc,
but if a company's reserves fall below a certain level due to a
catastrophic event, they are obligated to raise rates to cover that
too. Otherwise, they wouldn't have the money to pay claims
during the next spike event.

On the flip side, during periods when losses are relatively low,
and investments are doing well, companies can lower their
premiums. Mutual companies are required to do this by charter
and law, other companies do it in response to competitive
pressure.

Medical treatment costs, automobile repair costs, home repair
costs, etc have skyrocketed over the last 30 years. Premiums
have generally risen in response. But through the 90s, investment
income was generally strong, so that compensated to some
extent for higher claim costs and served to keep premiums below
the levels they would otherwise have reached.

The economic crash after 911 wiped out a lot of those investment
gains, so we've recently been seeing sharply rising premium rates
because there is no longer enough investment income to subsidize
rates, and because the reserves have to be rebuilt to cover future
spike events.

Gary