Premium leakage is a major issue in the insurance industry, causing billions of dollars in losses each year. In this article, we will explore the causes of premium leakage, the cost to insurance companies, and the strategies that insurers can use to prevent it.
What is Premium Leakage?
Premium leakage refers to any situation in which an insurance company loses money due to a mistake made in the policy issuance or claims process. It occurs when policyholders pay less than the actual amount of risk they represent, either through intentional fraud or unintentional errors. This can happen for a variety of reasons, including underwriting errors, applicant misrepresentation, and claims fraud. It is estimated that up to 10% of policies have some form of leakage.
Types of Premium Leakage
There are several different types of leakage that can occur, including:
- Underwriting leakage: This occurs when an insurance company issues a policy at a premium that is too low for the level of risk involved. This can happen when underwriters fail to properly assess the risk of a prospective customer due to a lack of accurate data.
- Policyholder leakage: This occurs when a policyholder provides inaccurate or incomplete information when applying for insurance. Applicants often adjust or manipulate their answers to receive lower rates.
- Agent leakage or “Gaming”: This occurs when an agent intentionally manipulates an application to receive a lower quote for their prospective customer.
- Claims leakage: This occurs when an insurance company pays more in claims than it should. This can happen for a variety of reasons, including incorrect valuation of the claim, overestimation of the loss, manipulated information submitted during the claims process, or lack of documentation.
Causes of Premium Leakage
There are numerous factors that can contribute to leakage, including:
- Fraudulent activity: Fraudulent activity is one of the most common causes of premium leakage. This can include intentionally misrepresenting information on an application or claim, staging accidents, or submitting multiple claims for the same loss.
- Unintentional errors: Unintentional errors can also lead to premium leakages, such as mistakes made during underwriting or claims processing, or failing to update policy information when it changes.
- Inefficient processes: Inefficient processes can also contribute to premium leakages, such as inadequate monitoring and control systems, or reliance on outdated data sources.
Premium Leakage Costs and Statistics
According to the Insurance Research Council (IRC), premium leakage will cost the US property and casualty insurance industry between $29 billion and $36 billion in 2022. Verisk backs this statistic up, as well. The IRC report also found that it can account for up to 10% of an insurer’s loss and loss adjustment expenses, which can significantly impact their profitability.
Fraud is also a major contributor, with the Coalition Against Insurance Fraud estimating that fraud accounts for 10% of the property and casualty insurance industry’s incurred losses and loss adjustment expenses, which can include premium leakage. The National Insurance Crime Bureau (NICB) reports that insurance fraud costs the US insurance industry an estimated $40 billion per year.
Carriers and Applicants alike bear the cost
Premium leakage can have a range of negative consequences for insurers and customers alike. One of the most immediate impacts is financial loss for carriers. When premiums are not accurately calculated or collected, insurers lose revenue that they may never be able to recover. This can result in reduced profitability and affect the financial stability of an insurer over time.
To combat this, carriers often price in leakage, leading to higher premiums for the average consumer. Roughly 14% of premium costs are attributed to covering leakage from other policyholders. For context, seemingly minor tweaks to an application, such as removing drivers with previous claims, can result in a policy being several thousand dollars cheaper than it should be. Looking at the insurance industry more broadly, the average family pays $400-700 per year in additional insurance premiums to cover the costs of premium leakage and fraud.
Additionally, premium leakage can lead to reputational damage. When customers discover that their premiums were not accurately calculated or collected, it can lead to a loss of trust and confidence in the insurer. In an industry where trust is critical, this can be a significant issue that can result in long-term damage to an insurer’s brand.
To combat premium leakage, insurers must take proactive steps to prevent and detect it. Some of the solutions include:
- Data analytics: Data analytics can be used to identify patterns of fraudulent activity, such as unusually high claim amounts or multiple applications for the same policy with different names or addresses within a short period of time.
- Identity verification services: Identity verification services can help insurers verify the identities of policyholders and reduce instances of identity theft, which can contribute to premium leakage.
- Real-time Behavioral Intent Data: Behavioral data science companies can provide first-party behavioral data to identify risky behavior and premium leakage during the application process to triage applications during the underwriting process. For example, ForMotiv has proven highly effective at uncovering and preventing misrepresentation, premium leakage, and non-disclosure by analyzing how applicants and agents fill out digital applications.
Premium leakage is a significant problem for the insurance industry, resulting in financial losses and reputational damage. However, by understanding the different types of leakage and implementing effective solutions, insurers can address this issue and improve their profitability and customer trust. Advanced data analytics, identity verification services, and real-time behavioral intent data are some of the most effective solutions that insurers can implement to prevent leakage and ensure the accuracy of underwriting decisions.