Saturday, May 28, 2011

Quote of the Week-For Aspiring Entrepreneurs

" In order to succeed in business a man does not need a degree from a school of business administration. These schools train the subalterns for routine jobs. They certainly do not train entrepreneurs. An entrepreneur cannot be trained. A man becomes an entrepreneur in seizing an opportunity and filling the gap. No special education is required for such a display of keen judgement, foresight, and energy. The most successful businessmen were often uneducated when measured by the scholastic standards of the teaching profession. But they were equal to their social function of adjusting production to the most urgent demand. Because of these merits the consumers chose them for business leadership." ~Ludwig von Mises

Saturday, May 21, 2011

Profiling can save you money?

Many of us have seen the commercials: "You can save $422 per year with switching your Auto Insurance to company (fill in the blank company) or "We can provide you the cheapest rates" etc etc.

As we go into this analysis, here are some Economic Axioms to consider:
1. All of us are seeking to pay the lowest price possible for the product or service.
2.Companies are seeking to sell their service at the highest price possible.

After further analysis of these two axioms, something has to give. Companies must compete for the prospects' business against other competitors, but maintain proper profitability to stay competitive in the marketplace. This leads to this question: How are Insurance Companies able to provide and advertise for low rates? Is it a scam? Before we entertain this "scam" or "rip off" rhetoric, let us explore how auto insurance is priced and underwritten. Let's also see how profiling can save money for certain drivers.

How does Auto Insurance work?

Auto Insurance like all insurance contracts is based on several principles: Law of Large Numbers and the Law of Averages. Insurance companies compile a large amount of drivers in a certain market, and analyze certain characteristics to use in the calculation of the cost of premium: e.g. driving record, mode of living, insurance score(credit), Type of vehicle, Age of drivers, Garaging Address, admin costs, loss ratios, Fire District, and other factors. Of course some variables have a higher "weighting" in the calculation of the premium. When a prospective customer is placed into the risk pool, his/her auto premium is based on all those factors. The better the driver, his/her rates will reflect this, and so forth with the other factors. Some factors count more into the pricing than others.

What is a risk class or Rate Pool?

The risk class or rate pool consists of thousands or millions of drivers in a particular market that is insured by the insurance company. The process is this: as drivers are entered into the pool, the risk from the drivers in that marketplace is shared amongst the drivers. The drivers pay premiums, which may vary based on some of the factors of calculation of the premium. There are administration costs associated with this insurance program. Cost to maintain the policy regulation, billing, accounting, etc. Also, there is a cost to administer claims. Of course the insurance company maintains cash reserves to insure financial stability. The insurance company also invests some of these reserves into secure investments.

What really happens if a Claim occurs?

If insured drivers have accidents, resources from the risk pool are re-allocated to cover the cost of this claim: Claim adjusters must spend more time on this claim rather than on other duties, increased customer service contact is required for more inquires about the claim, Special investigation unit may have more time being allocated for a claim to investigate possible fraud, accounting must process checks, legal council must review and ensure claims process is done properly, and of course the individuals in the claim must be compensated. If this happens to an unsatisfactory financial level on an annual basis(this level is relative to each company), then the insurance company will look at the prospect of increasing premiums. The increase may be not equally be distributed within the same rate pool.

That is unfair! I have not had a ticket or accident in 10+ years!

That is the trade off for transferring the risk to an insurance company. If you are "self insured" you can control the rates! But, most folks are not in a position to be "self insured". How does one deal with paying higher rates, but they have an excellent driving record? Profiling...

Profiling can save you money!

Insurance companies are in a competitive marketplace. Their job is to retain as many customers as possible so they can receive premium(revenue) to stay in business. But, if their rates are increasing, its obvious that attrition of the customers will happen. What do the insurance companies do to prevent this? Profiling is the key.

Here is the underlying assumption: If the Insurance company can pool in insureds that have similar characteristics, then the rates will reflect the characteristics of the group. If the insurance company has a risk pool of excellent drivers, then the rates for that risk pool will be lower than the rates of than a rate pool with sub standard drivers. Another note: since this is a preferred risk pool, the odds are that the amount of claims will be lower. Why? The risk pool has excellent drivers.

The set up

Insurance companies will "profile" by segmenting the risk pools. This allows the safer drivers that share similar characteristics to be in a certain rate pool(rate segment) and the sub standard drivers in another. This is a strong attempt to reward excellent driving. Rate increases will still happen in both segments, but if the safer pool of drivers are segmented, the rate increases based on poor driving will be mitigated do to the characteristics of the over all risk pool. Keep in mind, this action benefits the customer, and the insurance company. Their retention figures for customers increase simply because they are making an effort to profile for safe drivers and discriminate against sub standard drivers in the preferred rate segment.

How can I save money knowing this info?

The first step is to contact your local Insurance Agent, and discuss an annual review. Make sure that all he available discounts are available. In that review, see if you are eligible for preferred rates. This may help you be placed in a preferred rate segment, thus providing greater savings.


In summary, profiling CAN save you money. If your driving record fits the profile that the insurance company sets for their standards in their preferred risk pool, it can save you money! Segmenting the risks benefit the customer and the insurance company. Meet with your local agent, and asked to be profiled!