Most of the Time, Nothing Goes Wrong and This Is a Big Problem

In Ernest Hemingway’s “The Sun Also Rises,” a character, Mike, was asked how he went bankrupt. “Two ways,” Mike said, “Gradually and then suddenly.”

Every agency owner with whom I’ve worked and whose agency went insolvent described their demise similarly. Likewise, insurance company CEOs whose companies went south always say they thought they were OK until the last second. These are not uncommon responses.

While it may be great news for society, a decrease in insurance claims is a problem for the industry. The number of all claims filed runs about 52 million annually with considerable consistency. Some years the number is around 49 million and some cat years the number is around 54 million But basically the number of claims filed deviates less than 5 percent off average any given year per A.M. Best data. This means, given how much our economy has grown since 1998 when I began tracking this, on a per capita basis, including businesses, claims frequency has decreased materially.

On a GDP basis, claims have decreased materially as well. In 1999, claims frequency was at 0.424 claims per $100,000 GDP (using A.M. Best data for claims and the U.S. Governments Bureau of Economic Analysis chained, seasonal GDP data). In 2014, the last, most fully developed year of claim data, the frequency decreased all the way to 0.314 claims per $100,000 of GDP. That is a huge 25 percent decrease in claims frequency!

Because of this trend, selling insurance is likely to become more difficult since humans base decisions on the probability of events happening frequently. In our world, consumers/businesses make decisions based on the frequency of claims they have incurred or have seen others incur. If claims frequency decreases, as it has and will further with all the new technology that will reduce auto claims frequency, property water damage claims, and even workers’ comp claims, insurance buyers will have more difficulty processing the need for insurance. The human brain is not designed to anticipate and evaluate less frequent but more severe events. An example is the common belief that “this will never happen to me.”

Take life insurance. Death is the most severe event and is certain but usually distant, which is why people are sold life insurance rather than buying it. Property/casualty insurance, on the other hand, has historically been bought, not necessarily sold.

Convergence

This convergence of realities, the way the brain works versus the world becoming a safer place, will make P/C insurance more difficult to sell, especially the correct insurance versus a commodity solution. The attitude is, “What difference does quality make when I’ll never have a claim?”

For instance, when it comes to software service applications, a major question exists whether various “sharing” companies have the correct insurance in place for all parties involved. No one ever checks because the odds of it ever being important are minute (0.314 claims per $100,000 of GDP is minute). But when it is important, it is very important. We just can’t process the importance at that moment, so we are willing to take a chance.

Another example involves insurance applications and even certain insurance companies, that do not provide nearly the amount, kind or quality of coverage that I think insureds minimally need. Compare what they are getting versus what the consumer thinks they are getting and the difference is material.

In both these scenarios, a software licensing agreement is usually signed (clicked on). From various perspectives, the user agrees to become their own insurance company for any gaps and sometimes entire events. No one reads these agreements, and few people likely understand the potential severity of their consent.

Furthermore, what difference does it make if nothing goes wrong? Odds are extremely high nothing will go wrong, so why not self-insure, even if unknowingly, if hardly anything ever goes wrong? Think about it this way: most P/C insurance is forcibly purchased. The state and/or the bank forces people/businesses to purchase insurance. These “sharing” entities remove the force. No forced purchase, a tiny chance of something going wrong, and ignorance means people will buy less insurance.

These applications identify humans’ inability to process severity and create a cost savings (no insurance) immediately, which consumers can process quickly. This is an ingenuous way get wealthy. It is so easy because most of the time nothing goes wrong, making it easier to tell consumers not to worry, leaving out the issue of severity of when something does go wrong.

No Free Lunch

For those readers with a conscious and understanding of severity, you recognize the human and societal issues. You know that no free lunch exists. Those entities taking advantage of human decision making will win until, maybe, enough (frequency) severe events occur for which inadequate coverage is available, before this mismatch is adequately addressed. Save a few dollars but put your entire wealth on the line based on the improbable but not impossible possibility of a catastrophic event.

For those readers with a conscious and understanding of severity, you recognize the human and societal issues. You know that no free lunch exists.

For example, someone needs $1 million limits on a general liability policy for one year but the policy they purchase is a new forms that only lasts a day or a week or a month. The consumer does not understand they need the policy for a year, so the cost savings is enticing. Or they purchase a seven-day policy because the insured only thinks they have a seven-day exposure when their severity exposure is longer. Most of the time, nothing goes wrong so who cares? But the one time, and severity is about that one time, a tragedy occurs and the damage done that a non-existent insurance policy cannot fix may wreck lives forever.

Critics may say insurers have always taken advantage of the human mind knowing severity was rare. Insurance is based on this reality. That is true. However, pricing historically addressed the probability knowing severity would eventually occur — the big hail storm, the fire, the tornado or the awful wreck. Insurance was a collective good based on the law of large numbers.

The new model preaches the big claim will never happen, but if it does, it is someone else’s problem. For those concerned, find a way to help your clients understand the importance of severity.