“Price is what you pay. Value is what you get.”
– Warren Buffet
Can cheap life insurance be good quality?
Like any for-profit organisation, life insurance companies want to earn more money than they spend. Doing so keeps their shareholders happy, and also provides peace of mind to their customers, who are relying on the life insurance company to be there in the event of a claim.
Personal Insurance policies are a contract between two parties; the policy owner and the insurance company. The policy owner pays premiums (the cost) to the insurance company who, upon an insured event occurring, will pay the policy owner the amount specified in the contract (the benefit).
While a detailed discussion of the actuarial science behind insurance premiums is well beyond the scope of this article, in general, the premium charged for bearing this risk depends on the following key factors.
.
Group Risk
Insurance companies rely on the fact that risk is spread over a large number of people. Consider the simple example of an insurance company issuing 1000 life insurance policies each with a death benefit of $500,000. Assume statistics show that 1 out of the 1000 policy holders will die in any given year. To cover the $500,000 they expect to pay, the insurance company needs to charge each policy holder at least $500 for their policy.
Note: Insurance Companies are required by law to maintain a pool of (statutory) funds to ensure they can meet payment obligations.
.
Individual Risk
In the example above, every policy holder pays the same premium (shared the same risk) as everyone else in the pool. In reality, the probability of someone dying is not exactly the same for everyone. Age, gender, occupation, medical history and lifestyle choices are just a few of the variables that impact the likelihood that an individual will suffer an insurable event. When setting premiums, insurance companies usually take some of these variables into consideration in a process known as underwriting. The more underwriting the insurance company conducts, the more accurately they can determine individual risk and, therefore, require those at greater risk to take on a greater share of the cost.
.
Operating Costs
All businesses incur costs in the production and distribution of their products and these costs must be passed on to customers in the prices charged for the products. All things being equal, a company with higher overheads will need to charge more for their product than a competitor who operates more efficiently.
What the above demonstrates is that Warren Buffet was only half right. In the case of Life Insurance, there are in fact three things that impact price:
.
Quality of the Product (Warren Buffet’s Value)
If the insurer’s product provides you greater benefit they need to charge higher premiums.
.
Amount of underwriting
Insurers that conduct more underwriting, generally charge lower premiums for their products. The reason for this is that they only offer their standard prices to low risk customers. Any customers who are perceived to be a greater risk will either be declined or will pay more to get cover. Therefore, if an insurer asks very few underwriting questions, you can generally expect to pay more for their product.
.
Operational overheads
If the insurer operates inefficiently (i.e. they spend more than their competitors to generate the same revenue) they must pass on these inefficiencies in the form of higher costs
.
Saving Money on Personal Insurance
Traditionally products offered directly to consumers have been more expensive, because:
- It is more difficult to conduct quality underwriting quickly
- Attracting customers usually requires large advertising spend
To help offset these higher costs, many direct insurance products are lower quality than those available through financial planners.
But we plan to change all that. Utilising the power of the Internet, miPlan has is able to offer quality insurance products, direct to consumers, at affordable prices. This is possible because:
- Our underwriting engine has the intelligence to differentiate between low risk and high risk candidates
- Our operational expenses are much lower than other insurers because we don’t rely on large call centres and advertising budgets to distribute our products