My last blog post explained why insurance is needed to protect people from large financial losses. A wise insurance customer is selective when filing claims, and uses their insurance only for large claims.

But why do insurance companies punish you with cancellation or much higher rates when you file claims? You pay for the coverage, and if the claim is covered, isn’t that what you pay for? Insurance agents & companies brag about what is covered by their insurance policies, but then they advise you to not file a claim when a small claim occurs. Isn’t that a rip off?

The contradiction lies between selling you on why you should buy their insurance, and properly advising you on the use of your policy, to avoid cancellation from being deemed a “higher-risk” customer, once you have purchased the policy.

Insurance companies pay claims. Insurance companies don’t sell insurance expecting to never pay any claims. Insurance companies insure hundreds of thousands of customers, if not millions, and some of them will have claims.

Insurance companies determine their rates based on the average claims costs of a certain risk class of customers. If you are considered a preferred risk or average risk, you don’t have a problem getting insurance or paying reasonable rates.

When you are considered a “high risk” customer you pay higher rates, or your insurance policy is canceled, and many insurance companies may decline to insure you.

Frequents claims, even if they are small claims, are a major expense for insurance companies to process, and are an indicator you are more likely to have claims in the future than the average customer.

Say you live in a bad neighborhood and park your convertible on the street. You have an alarm, and you never leave anything in your car, but every couple of years, someone cuts your convertible top to break into your car. You can carry a low Comprehensive deductible, and you place a claim each time it happens.

What if it happened every year? What if it happened every month? Every time it happens, you have coverage.

Your annual Comprehensive premium cost $100. Your insurance company has paid you $24,000 to replace your convertible top 10 times in the last year, plus the insurance company had the cost of adjusting the claim.

The cost of the average Comprehensive claim may be $6,000, and the average customer has one Comprehensive claim every 5 years.

Because you have Comprehensive claims more often than the average customer, you are considered too high a risk to insure. The insurance company does not have a rating plan to adjust the cost of your Comprehensive premium to reflect your greater risk, so your insurance company may no longer offer Comprehensive coverage for you at your next renewal.

Customers with an average risk or preferred risk of having a claim do not want to pay higher rates to cover people with a much greater risk of having a claim. Insurance companies, not wanting to lose low risk customers because of higher rates, cancel the insurance of high risk customers.
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The above example was exaggerated to explain the concept. In reality, to qualify for preferred auto insurance, you want to have no Comprehensive claims in 5 years, other than glass claims. You can often get by with one Comprehensive claim, but two claims in 3 or 5 years (depending on the state you live in) may mean some insurance companies will not quote you when you shop your insurance.

People should not use their insurance unless the cost of not using it is too high for them.

Couldn’t insurance companies avoid small claims by changing their insurance policies to not cover them? Some insurance companies do this, particularly when claims expenses keep rising, by such things as no longer offering lower deductibles.

However, competition between insurance companies has them offering broader and broader coverage to make their insurance company stand out in the market.

For example, some insurance companies offer broader coverage for personal property on their homeowners insurance policy.

A selling point from an agent might go like this, “Say you are moving your big screen TV and you accidentally drop it. We’ll cover damage above the deductible and many insurance companies don’t offer this coverage!”

In this situation, if you fall for the sales pitch, you pay more for your home insurance to cover small claims. But if you drop your TV and call to place the claim, your agent may advise against it, and if you do put in the claim, and have another claim in the next 5 years, you may see your homeowners insurance canceled.

Sometimes broader coverage is worth the money, if it gives you better protection from catastrophic claims.

For example, dwelling insurance can be on a more limited “named peril” basis (the policy states what causes of damage are covered, such as fire, falling objects, windstorm) or and “open peril” basis (if the cause of damage is not excluded from coverage in the policy, it is covered).

Open peril coverage is always worth purchasing.  I once heard of an homeowners insurance claim denied by an insurance company, when a dam broke and flooded the home. Damage from flood was specifically excluded under the “open peril” policy, but the case went to court, and a judge determined the cause of damage to the home was the breaking of the damn, not a flood, which was NOT excluded under the “open peril” policy. If the homeowner had a named peril policy, there would have been no coverage.

Shop for the insurance you need, and ignore the hype of broader coverage covering only small claims you can afford to pay yourself.

Have you filed a small insurance claim and regretted it? Tell me about it. Please leave a comment on my facebook page. Follow me on Twitter for important insurance consumer news and new blog entries at CarInsWatch.