Agenda
• Rating and Ratemaking
• Underwriting
• Production
• Claims settlement
• Reinsurance
• Alternatives to Traditional Reinsurance
• Investments
• Other Insurance Company Functions
Chapter 6
Insurance Company
Operations
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Ratemaking refers to the pricing of
insurance and the calculation of insurance
premiums
A rate is the price per unit of insurance
An exposure unit is the unit of measurement
used in insurance pricing
Rating and Ratemaking
Total premiums charged must be adequate for paying all claims and expenses during the policy period
Rates and premiums are determined by an actuary, using the company’s past loss experience and industry statistics
Actuaries also determine the adequacy of loss reserves, allocate expenses, and compile statistics for company management and state regulatory officials.
Rating and Ratemaking
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Underwriting refers to the process of selecting, classifying, and pricing applicants for insurance
A statement of underwriting policy establishes policies that are consistent with the company’s objectives
The underwriting policy is stated in an underwriting
guide, which specifies:
Acceptable, borderline, and prohibited classes of business Amounts of insurance that can be written
Territories to be developed
Forms and rating plans to be used
Business that requires approval by a senior underwriter
Underwriting Principles
The basic principles of underwriting include: Attain an underwriting profit
Select prospective insureds according to the
company’s underwriting standards
Reduce adverse selection against the insurer Adverse selection is the tendency of people with a
higher-than-average chance of loss to seek insurance at standard rates. If not controlled by underwriting, this will result in higher-than-expected loss levels.
Provide equity among the policyholders
One group of policyholders should not unduly subsidize
another group
Underwriting
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Underwriting starts with the agent
Information for underwriting comes from: The application
The agent’s report
An inspection report
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Physical inspection
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A physical examination and attending physician’s report
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Steps in Underwriting
After reviewing the information, the
underwriter can:
Accept the application and recommend that the
policy be issued
Accept the application subject to restrictions or
modifications
Reject the application
Many insurers now use computerized underwriting for certain personal lines of insurance that can be standardized
Steps in Underwriting
MIB report
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Other factors considered in underwriting
include:
Rate adequacy
Availability of reinsurance
Whether policy can or should be cancelled or
renewed
Production
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Underwriting Considerations
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Production refers to the sales and marketing activities of insurers
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Agents are often referred to as producers
Life insurers have an agency or sales department
Property and liability insurers have marketing departments
The marketing of insurance has been characterized by a trend toward professionalism
An agent should be a competent professional with a high degree of technical knowledge in a particular area of insurance and who also places the needs of his or her clients first
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Several organizations have developed
professional designation programs for
insurance personnel:
The American College: CLU, ChFC
The American Institute for Chartered Property
and Casualty Underwriters: CPCU
Certified Financial Planner Board of Standards,
Inc.: CFP
National Alliance for Insurance Education &
Research: CIC
Claim Settlement
The objectives of claims settlement include: Verification of a covered loss
Fair and prompt payment of claims
Personal assistance to the insured
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Some laws prohibit unfair claims practices, such as:
Production
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Refusing to pay claims without conducting a reasonable investigation
Not attempting to provide prompt, fair, and equitable settlements
Offering lower settlements to compel insureds to institute lawsuits to recover amounts due
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Major types of claims adjustors include:
An insurance agent often has authority to settle
small first-party claims up to some limit A company adjustor is usually a salaried
employee who will investigate a claim, determine the amount of loss, and arrange for payment.
An independent adjustor is an organization or individual that adjusts claims for a fee
A public adjustor represents the insured and is paid a fee based on the amount of the claim settlement
Steps in Claim Settlement
The claim process begins with a notice of loss, typically immediately or as soon as possible after a loss has occurred.
Types of Claims Adjustors
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Next, the claim is investigated
An adjustor must determine that a covered loss
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has occurred and determine the amount of the loss
The adjustor may require a proof of loss before the claim is paid
The adjustor decides if the claim should be paid or denied
Policy provisions address how disputes may be resolved
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Reinsurance is an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer part or all of the potential losses associated with such insurance
Reinsurance
The primary insurer is the ceding company
The insurer that accepts the insurance from the ceding company is the reinsurer
The retention limit is the amount of insurance retained by the ceding company
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Reinsurance
Reinsurance is used to:
Increase underwriting capacity
Stabilize profits
Reduce the unearned premium reserve, which
represents the unearned portion of gross premiums on all outstanding policies at the time of valuation
Provide protection against a catastrophic loss
Retire from business or from a line of insurance or territory
Obtain underwriting advice on a line for which the insurer has little experience
The amount of insurance ceded to the reinsurer is known as a cession
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There are two principal forms of reinsurance:
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There are two basic methods for sharing losses:
Types of Reinsurance Agreements
Facultative reinsurance is an optional, case-by- case method that is used when the ceding company receives an application for insurance
that exceeds its retention limit
Often used when the primary insurer has an
application for a large amount of insurance
Treaty reinsurance means the primary insurer has agreed to cede insurance to the reinsurer,
and the reinsurer has agreed to accept the
business
All business that falls within the scope of the
agreement is automatically reinsured according to the terms of the treaty
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Methods for Sharing Losses
Under the Pro rata method, the ceding company and reinsurer agree to share losses and premiums based on some proportion
Under the Excess method, the reinsurer pays only when covered losses exceed a certain level
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Under a quota-share treaty, the ceding insurer and the reinsurer agree to share premiums and losses based on some proportion
Example: assume that Apex Fire Insurance and Geneva Re enter into a quota-share arrangement by which losses and premiums are shared 50-50
If a $100,000 loss occurs, Apex Fire pays $100,000 to the insured but is reimbursed by Geneva Re for $50,000
Methods for Sharing Losses
Under a surplus-share treaty, the reinsurer agrees to accept insurance in excess of the ceding insurer’s retention limit, up to some maximum amount
Example: assume that Apex Fire Insurance has a retention limit of $200,000 (called a line) for a single policy, and that four lines, or $800,000, are ceded to Geneva Re. Assume that a $500,000 property insurance policy is issued. Apex Fire takes the first $200,000 of insurance, or two-fifths, and Geneva Re takes the remaining $300,000, or three- fifths.
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Methods for Sharing Losses
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If a $5000 loss occurs:
Apex Fire
Geneva Re
Total Underwriting Capacity $500,000 policy issued
Apex Fire
Geneva Re
$5000 loss occurs
Apex Fire Geneva Re
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An excess-of-loss treaty is designed for protection against a catastrophic loss
Methods for Sharing Losses
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$200,000 (1 line) $800,000 (4 lines) $1,000,000
$200,000 (2/5) $300,000 (3/5)
$2000 (2/5) $3000 (3/5)
Methods for Sharing Losses
A treaty can be written to cover a single exposure, a single occurrence, or excess losses
Example: Apex Fire Insurance wants protection for all windstorm losses in excess of $1 million. Assume Apex enters into an excess-of-loss arrangement with Franklin Re to cover single occurrences during a specified time period. Franklin Re agrees to pay all losses exceeding $1 million but only to a maximum of $10 million.
If a $5 million hurricane loss occurs, Franklin Re would pay $4 million.
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A reinsurance pool is an organization of insurers that underwrites insurance on a joint basis
Reinsurance pools work in two ways: Each pool member agrees to pay a certain
percentage of every loss.
Each pool member pays for his or her share of
losses below a certain amount; losses exceeding that amount are then shared by all members in the pool.
Alternatives to Traditional Reinsurance
Some insurers use the capital markets as an alternative to traditional reinsurance
Securitization of risk means that an insurable risk is transferred to the capital markets through the creation of a financial instrument, such as a catastrophe bond or futures contract
Catastrophe bonds are corporate bonds that permit
the issuer of the bond to skip or reduce the interest
payments if a catastrophic loss occurs Catastrophe bonds are growing in importance and are
now considered by many to be a standard supplement to traditional reinsurance.
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Methods for Sharing Losses
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Because premiums are paid in advance, they can be invested until needed to pay claims and expenses
Investment income is extremely important in reducing the cost of insurance to policyowners and offsetting unfavorable underwriting experience
Life insurance contracts are long-term; thus, safety of principal is a primary consideration
In contrast to life insurance, property insurance contracts are short-term in nature, and claim payments can vary widely depending on catastrophic losses, inflation, medical costs, etc
Exhibit 6.1 Growth of Life Insurers’ Assets
Investments
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Exhibit 6.2 Asset Distribution of Life Insurers, 2010
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Exhibit6.3 Investments,Property/Casualty Insurers, 2010
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Information systems are extremely important in the daily operations of insurers.
Other Insurance Company Functions
Computers are widely used in many areas, including policy processing, simulation studies, market analysis, and policyholder services.
The accounting department prepares financial statements and develops budgets
In the legal department, attorneys are used in advanced underwriting and estate planning
Property and liability insurers also provide many loss control services
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