What Insurance Companies Actually Do When They “Cancel” Policies
So what exactly does it mean when they say an insurance company canceled a bunch of insurance policies in a certain area? It may be because of natural disasters, fires, floods, hurricanes, earthquakes, whatever the case might be. You see a lot in the news where they say such and such insurance company has cancelled thousands of policies right before a disaster. Well, in reality, insurance companies don’t actually cancel policies. A policy while it’s in effect really can’t be cancelled by the insurance company except for two most important reasons: if the person with the insurance doesn’t pay their premium, meaning that if you pay your premium every month and you stop paying, they’re going to cancel your insurance. If you committed fraud on your application, they’ll cancel your insurance.

The Critical Difference Between Cancellation and Non-Renewal
But what they mean when they say canceled your insurance, it means they non-renewed your insurance. There’s a big difference. Insurance is a policy that has a time period of coverage. Usually you buy a one-year insurance policy and every year you renew your insurance, kind of like renewing your driver’s license. So at the renewal date or expiration date, your insurance agent who sells you the insurance, usually a month or two in advance, will say hey look, your homeowner’s policy, your car policy is up for renewal and you can review your coverages, make sure you have the right type of policy, you pay your premium.

How Insurance Premium Payments Actually Work
Now insurance premiums technically are an annual premium. So if your insurance is let’s say $1,100 a year, you can pay that $1,100 or some people finance it and they just pay you know $90 a month each month for a year. But in reality, it’s an annual policy. So when you hear that an insurance company canceled insurance, what they mean is they non-renewed insurance, which means that the people in a certain area, a certain neighborhood, a certain zip code, a certain state do not get to renew their insurance with that company because the company’s decided, you know, we don’t want to sell insurance in this area.

Why Insurance Companies Stop Selling in Certain Areas
And you might think, well gee, that’s terrible of them and you know they’re shutting these people out. Well think about it: if the company was making a big profit or it was viable for them to sell insurance, of course they would sell it, right? People want to sell stuff, companies want to sell things. The reason that they decide we’re not going to sell is because they’re going to lose money. And the reason sometimes they lose money is because the government in that state has put a cap on how much they can charge.

The Insurance Rate Approval Process
If you’re an insurance company and you want to sell insurance in a state for homeowners, auto, whatever the case might be, every year you have to go to that state and tell the insurance commissioner how much you’re going to charge for insurance and they have to approve your rates. That’s the one thing about insurance rates: they have to be approved by the insurance commission in that state, in every state you do business in. In addition, the terms and conditions of your policy are also reviewed by that commissioner to say yeah, this is good insurance.

How State Insurance Commissioners Control the Market
So if you have a policy that says I’m going to cover your house if it burns down and we’re going to charge x amount of dollars per year for the house, the insurance commissioner looks at it and says no, that’s too much money, or no, your policy is not good enough, you can’t sell that policy. So you have a choice: you can either not sell the insurance or you can change it to match what the insurance commissioner wants. And you might say why don’t they just lower the price? Well, that creates another problem.

Why Insurance Companies Can’t Just Lower Their Prices
If you lower the price of insurance where you’re not collecting enough money to be able to pay out claims, first of all, it’s going to create a problem for your company. But even if you were an insurance company that decided, you know what, we’re going to be nice to people, we’re going to lose money on insurance because we care about home owners, we care about property owners, and we’re not going to charge them that much even though we’re going to pay out more, well, the insurance commissioner will step in again and say this is not good.

Financial Requirements for Insurance Companies
Because as an insurance company, you have to show to the insurance commission that you are collecting enough money and you have enough money in the bank to be able to pay out claims when they come in. So if you decided just because you’re an altruistic or caring company that you’re not going to charge as much money for policies as it takes to pay out claims, the insurance company will shut you down. The insurance commissioner will shut you down. The insurance licensing board will shut you down.

The Mathematics Behind Insurance Pricing
So you have to submit to that licensing board your premiums you’re going to collect from, let’s say that whole neighborhood. Let’s say everybody in the neighborhood pays $1,000 a month and that’s unreasonable number but we’ll use it as a round number, and you have 100 policies in that neighborhood. So you’re collecting $100,000 a month, that’s about $1.2 million a year. But if your claims history shows you’re paying out $2 million a year on claims in that neighborhood, you’re not going to have enough money to pay claims.

Insurance Commissioner Oversight and Business Viability
The insurance commissioner is going to say you won’t be able to last in business, so we’re going to shut you down. Or even if you pay out only 1.2 million in claims, the insurance commissioner is going to say, well where’s your money for your payroll, for your rent, for all of your expenses, your insurance? And they’re going to make sure that you have enough income to cover the expense of paying out claims.

The Fine Line Insurance Companies Must Walk
And the insurance company has to walk a fine line. They can’t charge too much because then people won’t buy insurance and the insurance commissioner won’t accept it. But if you charge too little, you won’t be able to pay out claims even if you wanted to because you’ll have no money in the bank. And the insurance commissioner will look at your balance sheet and your profit and loss statement and say, this is not a – the math doesn’t work. This insurance business strategy, this business plan is not going to be sustainable.

How Insurance Companies Calculate Their Premiums
So even though it might seem like insurance companies charge too much, they gauge and they calculate their premiums based on what they estimate the payouts are going to be, and that’s sometimes based on the past but also based on what they think is going to change in the future. Certainly they’re going to make a profit – that’s the reason that they do this because all their employees have to get paid, they have stockholders. The question is, how much is too much profit? Insurance companies are usually on par with other types of companies.

Why Insurance Companies Need to Make Competitive Returns
The other thing is, if they weren’t making an average amount of profit that companies do, they would also get out of the business. Because the capital and the cash involved to go into a business, to fund everything, to finance everything, to buy buildings, to pay for payroll – if you weren’t making a good return on that, you would just put it in the bank, put it in a CD at 6%, or invest in real estate at 8%. So unless you’re making a higher return, what’s the reason for putting it into an insurance company when you could get wiped out in a year if there’s a big fire or an earthquake or a flood or hurricane?

The Risk Factor in Insurance Investment
So insurance companies have risk, and the investors and the owners of the insurance company have to calculate: is it worth putting my money into this company when I can’t charge enough money to pay out claims?

When Insurance Companies Take Advantage vs Legitimate Business Decisions
I can’t charge enough money to be profitable, and again it’s a fine line. The question comes is when the insurance companies take advantage of that and when they are not being responsive to claims. For most P&C Property and Casualty Insurance, which is auto, home owners, physical damage, those kind of things, the rates and the coverages are very, very well managed and regulated by the insurance commission in that state. So they usually don’t get too far out of whack. If anything, sometimes they charge too little.

Why Some Companies Undercharge for Insurance
It’s easier for a company to undercharge for insurance than it is to overcharge, because they could say, well we won’t pay out that many claims, we don’t need to charge that much money. And sometimes a new insurance company trying to break into a market will undercharge for premiums to try to get market share, steal customers from other companies. That’s why you see Geico “15 minutes to save you 15% on car insurance,” right? You don’t see that as much anymore because when they first did that marketing campaign, they were trying to be a new player to gain market share. Now that they have the market share, they’ve ramped up their rates more in line with the rest of the companies.

Different Types of Insurance Have Different Regulations
Other types of insurance, not so much. Health insurance, there’s not as much regulation and it’s easier to over-inflate. But Property and Casualty, even though it’s an easy punching bag to kick when they’re down, when there’s a big event – fire, hurricane, flood, earthquake – again, those executives and those actuarials try to calculate very, very carefully how much they can charge and not try to charge too much because if they charge too much, they’ll lose business to another company. Remember, there’s competition with insurance.

The Reality Behind Insurance Companies Pulling Out of Markets
So if you see a big company pulling out of a market or non-renewing policies, it’s not because they’re trying to be a jerk. It’s because they looked at that market and said, I probably can’t pay out claims if I only charge this much in the long run. And if I charge a lower amount or the amount that the insurance commissioner doesn’t let me go above, you know, I might be out of business if I have a big event, you know, an earthquake or fire.

Insurance Companies Are Businesses, Not Charities
So again, insurance companies, you know, they’re not charities, they’re not doing this for free, they are making money. But in many cases, the profit that they make is in line with every other company you do business with. You buy a pair of Nike shoes, they probably make more profit on the Nike shoes than on your insurance policy. And certainly it’s more sensitive because the insurance company is there to look out for you when they have to pay a claim. You’re depending upon them to fix your house or buy you a new house or to repair your car. So it’s a little bit more sensitive and a little bit more emotional when that happens.

The Terminology Problem: Cancellation vs Non-Renewal
And again, I’m not saying the insurance companies are making money, they’re executives or multi-millionaires – that’s not the issue. It’s that first of all, the word cancellation really isn’t accurate because they really don’t cancel policies, they non-renew it, which for many consumers seems like a cancellation. You know, you have your policy every year, you pay your premium, and all of a sudden they tell you we’re not going to renew your policy. Nowhere does the word cancellation appear in those notices. It always says non-renew.

True Cancellation vs Non-Renewal Explained
Cancellation would happen is if in the middle of your one-year policy they say we’re cancelling, we’re pulling your policy. They can’t do that – it’s a contract. They can only do it if you don’t pay the bill or if you committed fraud on your application, you lied to them some way. Now most people don’t realize their policies are annual because they just pay in a monthly premium – they basically finance their insurance. So they don’t really know that there’s a renewal every year. They just think, oh I just got this notice I can’t have insurance anymore, that must mean it got canceled. That’s not what happened.

What Actually Happens at Policy Renewal Time
What happened was at the end of that policy term, that one-year term, the insurance company said, you know, we’ve looked at this and this rate we’re charging you and the risk we have and the amount we have to pay, it doesn’t make sense. We’re not going to be able to pay out the claims. The insurance commissioner will look at our bank account and say you don’t have enough money to pay claims because you haven’t collected enough from the consumers. So we’re not going to be able to do this.

Real-World Examples: Florida vs California
And if you notice, the places where this is happening are in places where they’re not allowed to increase rates. Good example is Florida and California, right? They both have big insurance problems. In California, people can’t get coverage. In Florida, the rates are too high. In Florida, you can get insurance coverage if you’re in a hurricane zone, a flood zone – you can get insurance cover, it’s going to probably cost you a lot of money. There’s some people paying 10, 15, 20,000 a year for insurance, but at least you can buy it.

Why California Has More Insurance Problems Than Florida
In California, the companies are pulling out. Why? Because California has put a cap – you can’t charge more than this much money. And so the insurance company says, well if I can’t charge what it takes to pay the bills, then I have to stop. I have to – it’s almost like saying if you were – I’m trying to think of a – you were a lemonade stand, right? If you had a lemonade stand on the corner of your house and for every cup of lemonade you spent 8 cents on sugar, lemons, the cup, the water and the ice – eight cents, that was your cost – and you sold your lemonade for 20 cents a cup.

The Lemonade Stand Analogy
And all of a sudden the government came in and says you can only charge 5 cents for a cup of lemonade max, you can’t charge more than 5 cents. Okay, well maybe you could for a while because if you wanted to be nice to the community and kick in the other three cents yourself, you could do that. But at some point you’d run out of money and you wouldn’t be able to continue. And if the government also said we’re only letting you charge 5 cents, we’re also going to look at your bank account to make sure that it’s growing, you’d have to shut down the same day.

Acknowledging Insurance Company Faults While Understanding Market Reality
So again, it’s an oversimplification. I’m not trying to be an apologist for the insurance companies because certainly they all have their faults, they all do things wrong. But we do need to have insurance, we do need to have a viable, sustainable, financially sound insurance market. We need to have companies that are willing to sell insurance because the more companies that pull out, the ones that are left, they’re taking more risk. It’s not divided up over 10 companies, it’s only divided up over three.

The Danger of Too Few Insurance Companies
So now if you have a catastrophic event – one hurricane, one earthquake, one fire – could wipe out the remaining three companies. If it was divided up over 10, yeah they might struggle, but at least they could pay out the claims and stay in business.

The Reality of Insurance “Cancellation”
I’m certain that everybody has very strong opinions about this insurance reality. I’d love to hear in the comments below what you think. Again, don’t shoot the messenger – we’re just trying to describe, first of all, the reality that insurance being cancelled is not really what’s happening because they’re not just yanking the rug off from under you in the middle of your policy. Usually you have two or three months notice before your policy’s due to find another one if they’re not going to renew it.

How Insurance Pricing Actually Works
And at the same time, the insurance rates, yeah they’re high and they’ve gone up, but they’re also calculated by the insurance company figuring what is the minimum we can charge and still be able to pay claims. And the minimum is because companies want market share, they want to sell as many policies as they can, they want to grow their business. So by having lower prices, they’ll grow their business, especially when there’s competition. If they jack up the rates too much and there’s other people that are willing to sell it for a dollar less, they’ll lose market share. So in most cases, the economy works. In some cases it gets a little bit crazy, but at least there is a huge amount of regulation at the state level for what they can charge by your insurance commissioner and the board that looks at rates and coverages.