Whys, hows and whens of insurance refunds during a pandemic
There have been headlines about insurance companies giving refunds because of stay-at-home orders issued by state governments. This is a good time to explain why insurance refunds are being provided, how they will be determined and when we should expect to see them.
Insurance premiums are determined by actuaries who gather data and try to guess how many claims a group of insureds will have. The larger the group and the more data actuaries gather, the more accurate the guess.
When dealing with auto insurance, one of the data points is miles driven. Autos driven less should have fewer claims. Businesses that are closed should have fewer liability claims. Employees who are not working should not be getting hurt, thus fewer workers’ compensation claims.
Though this may sound simple, determining how much savings and returning them to customers is not an easy task. Under normal circumstances, insurance companies would wait until the policy period is over, count the premium they took in, subtract their expenses, decide what profit they want to make (usually 1% to 2%) and then set rates for the next policy period.
Actuaries are responsible for getting these numbers correct, so the need for a refund rarely occurs. As we know, this is a once-in-a-lifetime event, and because of the financial burden this pandemic has caused, refunding premiums quickly is desirable.
All car insurance companies should be issuing some amount of refund. The unknowns are the length of the stay-at-home order and the amount of claims experienced during that time. Also, understand that not all people fall under the stay-at-home order and not all abide by it. Others have increased their driving by delivering products needed by those who are staying at home.
To be fair to all their insureds, a refund should be based on the percentage of claim savings the insurance company experienced during the stay-at-home order. Numbers sometimes make this easier to understand.
Assume a six-month auto insurance policy with a premium of $400. Divide that premium by the number of days in six months (182), which reveals the cost-per-day ($2.20) for our insurance. Remember, we don’t know how long the stay-at-home order will last, but assuming it began on March 20 and lasts to May 31, that would be 70 days. Also assume the insurance company will have 25% fewer claims.
We multiply the number of days (70) by cost per day ($2.20) and get $154. To determine your refund, we take 25% of $154 and you get $38.50.
My example has several unknowns. Auto insurance premiums vary from customer to customer. The length of the stay at home and the cost savings are unknown. The desire to distribute some refund now will require insurance companies to make some guesses, and if their guesses are wrong, they leave the door open for more refunds in the future.
When should you expect a refund? Again, this is a once-in-a-lifetime event. There is no magic button.
Insurance companies are regulated by the state where you reside. Refunds must be approved by state regulators. An insurance company does not have billions of dollars just sitting around; assets must be liquidated. Also, remember those assets have been reduced because of the pandemic.
To provide an accurate refund to millions of customers, my guess is June. To be sure you are getting a refund, to adjust your policy to reflect your new driving habits, or to find out about a discount you may be entitled to, call your insurance agent, who would be pleased to help you.
Bob Hollick is a State Farm Insurance agent based in Washington.
To submit columns on financial planning, investing or business-related matters, email Rick Shrum at rshrum@observer-reporter.com.