The Client’s Risk Premium

The questions asked here are:

How likely it is for your ‘risk’ to become a reality?

And.

How severely will it affect the firm’s bank account?

Insurance firms assess you as a risk factor so they can quantify whether you’ll be an expensive client or not. In other words, if you are accident prone, the firm’s fee (your insurance premium) will be higher, because they will most likely go bankrupt handing out checks to as your house catches fire each time you bake cookies.

Similarly, the auto insurance premium for brand new cars is higher than for old car (because they are more likely to get stolen) and a brand new car’s replacement value will be a lot higher than that of an old car.

We can apply the same logic to health insurance. Suppose you have a family history of chronic heart disease, unfortunately, the chances you may develop such a condition are high. Even if you have not yet contracted any heart-related problems, your insurance firm will charge a high premium simply for the great likelihood you will suffer from a heart condition in the future.

Moreover, if you already suffer from a chronic heart or liver disease, your premium will be even higher because treatment for such conditions is rather expensive.

The Insurance Firm’s Expenses (Expense Loading)

Companies have their own share of expenses which they have to cover by charging clients. Businesses have to pay their electricity bills (for all the Jacuzzis and air conditioners), the building’s rent, salaries (for all the frightfully-dull insurance agents), all the paperwork, and office equipment, and so on.

A Teeny Tiny Profit (Profit Loading)

Insurance firms are in the industry for the money and they have to report positive earnings to their shareholders, unless they have an excellent reason for running into losses. As a result, the firm ends up drawing a bit of profit from each client’s insurance premium. Insurance firms can also bump this figure along if the general economic situation is faltering, to cover for the economic risk.

Of course, sometimes they still go ahead and make lousy investments and that is when the government graciously steps in.

Read more light-hearted articles about finance at Management Mafia. The best way to learn management is the fun way! You can also find articles about marketing on the site.