How the Insurance Market Works

by on February 20, 2013

Ever wondered what makes your insurance prices rise and fall?  Quite simply, there are two forces at work in determining insurance prices – 1) risk and 2) supply and demand.  Let’s touch on how these two factors influence the insurance market and in turn the individual insurance policies that affect you.

Risk and Insurance

Risk is probably the easiest market factor to understand.  In essence, the more likely you are to need a payout, the higher your insurance policy will be.  This risk is determined by the insurance provider.  Typically, employees called actuaries study millions and millions of factors and past behavior to make assumptions about the risk profiles of their customers.

For example, if you buying health insurance your age is a primary factor in the cost of your insurance.  That’s because as you get older, you typically require more medical care.  This is a pretty obvious factor, but insurance companies don’t stop with just a few factors.  In most cases, they analyze hundreds of factors.  Things like your zip code, whether you rent or own, your sex, education level, employment and often other lifestyle choices that you make.

Sometimes insurance quotes from two different providers can be very different.  That’s typically because the two providers are measuring your risk differently.  For example, if you are applying for car insurance, one provider may place more weight on where you live (the risk of the area) rather than your age or past driving experience.  Every insurance company uses slightly different factors to assess your risk.  Finding a company that views your risk profile appropriately can often reduce your insurance rates.

Supply and Demand

Behind most insurance companies is a larger market that also affects insurance prices.  This is the supply and demand of insurance in general.  For example, if a specific market is found to be profitable and has laws established that make it profitable for insurance companies to write policies, then these areas will have many insurers competing for business and hence the prices will go down.  The supply of insurance will increase and the demand will remain the same or go up slightly – that is economics 101 for a decrease in prices.

The opposite can happen in markets that become troubled with crime or other negatives like increased regulation or consumer-focused laws.  In these areas, the insurers will often back away from underwriting and cause insurance prices to rise.

Furthermore, behind these insurance companies there is another market that helps insurers stay liquid and make the market more efficient.  In fact, there are insurance markets similar to the stock market, where insurers and investors come together to buy, sell, write and trade insurance policies.  Sometimes this is done by re-insurers and sometimes in a secondary insurance marketplace.  If you are interested in reading more about how this part of the insurance market works you can visit an insurance news website, which can give you more insight into this type of market.

Overall, the insurance market is a very complicated market.  Using simple concepts like this to describe the whole market is a good place to start, but if you want to really learn more, you may need to study statistics and economics.

{ 6 comments… read them below or add one }

Donald Quixote August 23, 2013 at 10:30 am

Hmmm, interesting article…good start on an interesting topic. I may end up searching for more articles to learn more about the secondary market for insurance

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DW September 4, 2013 at 7:30 pm

I can agree with the whole supply and demand thing when it comes to insurance. And I think in a lot of ways that can work to your advantage. Whenever I need the best price on insurance, I always make sure to get at least 3 to 5 quote from quality companies. That way I can compare and determine what the market rate is for what I want to pay.
DW recently posted..A Step-by-Step Guide to Getting Life Insurance Without a Medical ExamMy Profile

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frank October 30, 2013 at 3:13 pm

Don’t forget that insurance companies also use a prospects credit score as a ranking factor in calculating insurance premiums.

They feel that a persons credit score will be indicative of how risky of a client they will be.

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Diane December 9, 2013 at 6:13 pm

Interesting article. Thank you for this great post. I believe you are right about the risk and supply and demand. And insurance rate is affected by these two factors. Car insurance company for example will give you higher rate if your parking place is not safe or not well lighted. So these risks factors are really affecting the rate of the insurance.

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Matthew Colonna February 28, 2014 at 12:53 pm

Great article.
One of the things people do not realize is that if the insurance company lets people at higher risk in and they do not decline them, this will raise premiums.
Companies that generally have stricter underwriting guidelines have lower premiums.
Very informative post. Thank you!

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Scott Miller March 21, 2014 at 6:50 pm

Great post on the insurance market. Actuaries are very needed resource for risk assessment. It’s also interesting that the place you live can greatly impact insurance prices, not just age.

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