Insurance : Domain

                                                               INSURANCE:
 

Ø  Insurance: A transfer system, in which one party – the insured – transfers the chance of financial loss to another party – the insurer.

Ø  Law of Large Numbers - A Mathematical principle which enables the insurers to make predictions about losses.

Ø  It states that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) based on these exposures also increases.

Ø  An exposure unit is a measure of loss potential and is used in pricing insurance.  

    E.g.: In a HO-W Insurance, each home is an exposure unit. The insurer insures thousands of home owners who face the same uncertainty.

Ø  Premium: Is a small periodic payment the insured pays for long term insurance coverage.

 Calculation of Premium:

                                 Premium = Rate x Number of exposure units

Ideally Insurable Loss Exposures:-

Ø  Insurance companies generally prefer to provide insurance for the loss exposures that have the following characteristics:

      a. Large number of similar exposure units.

      b. Losses that are accidental.

      c. Losses that definite and measurable.

      d. Losses that are not catastrophic.

      e. Losses that are economically feasible to insure.

Note:  Similar Exposure Units: Cars, Trucks, Offices & Homes.

Accidental: Indemnify, not a profit making business

Definite: Water leak from a pipe..dont know definite time & rotting floor for years

Catastrophic: Natural disaster, Flood or Nuclear fuel leak

Economically feasible to insure: Spare parts of a Automobile.

Check Point….

ü  Voice of a singer…is it an ideal loss exposure???

ü  Gambling is it an ideal loss exposure??

ü  Robbery \Theft is it an ideal loss exposure???

Note:-

1. No because this does not come under Similar Exposure Units

2. No it is speculative risk.

3. Yes it is accidental, but still the Insurance Company evaluates the theft

6.3. Insurance Operations:-

Main Operations of Insurance Companies are:

Ø      Marketing: Insurance Marketing is the process of identifying customers, selling and delivering a product or service. Other important aspects of marketing are advertising and marketing management.

Ø      Underwriting: Underwriting is the process by which insurance companies decide which potential customers to insure and what coverage to offer. Underwriters are insurance company employees responsible for selecting insured's, pricing coverage's, and determining policy terms and conditions.

Ø  Claim handling – enables insurance companies to determine whether a covered loss has occurred and, if so, the amount to be paid for loss. Claims are generally handled by Claim Representatives.

Rate Making:  Rate making is the process by which insurers determine the rates to charge the thousands of similar but independent insured's.

Check Point……….:

Ø  Line of insurance is just another way of saying type of insurance .

Ø  Personal Lines:  is any type of insurance purchased by individuals and families to cover non business loss exposures.

Ø  Commercial Lines: Insurance is any type of insurance that covers loss exposures for business and organizations.

Ø  Can you name some Policy types which come under Personal Lines?

Ø  Can you name some Policy types which come under Commercial Lines?

Note:-

Ø  Personal Lines: HO-W, Fire & allied Lines, Crime Insurance, Auto

Ø  Commercial Lines: Marine, Business Insurance

6.4. Types of Insurance:-

Ø  Property Insurance: Property Insurance covers the costs of accidental losses to an insured’s property. The insured could be a person insuring his house and personal property or a business insuring its building, inventory and equipment.

    E.g.: Fire & Allied lines, Crime, Ocean & inland marine insurance come under Property insurance.

Ø   Liability Insurance: Liability insurance also called as third-party insurance as, three parties are involved: the insured, the insurance company and the party who is injured or whose property is damaged by the insured.

    E.g.: Auto Liability & Personal Liability come under Liability Insurance.

Ø  Life Insurance:  Life Insurance generally reduces the adverse consequences of premature death of a family member, by providing funds to replace the lost income and to pay expenses associated with final illness.

   E.g.: Whole Life Insurance, Term Life Insurance & Universal life Insurance are the types of Life Insurances.

Ø  Health Insurance: Health Insurance is designed to protect individuals and families from financial losses caused by accidents and sickness.

    E.g.: Medical Insurance & Disability income insurance come under Health Insurance.

Types of Insurers:

Ø  Stock Insurers: Is an insurer that is owned by its stock – holders and formed as a corporation for the purpose of earning a profit for these stockholders.

      E.g.: Hartford and SAFECO Insurance Companies.

Ø  Mutual Insurers: Is an insurer that is owned by its policy holders and formed as a corporation for purpose of providing insurance to its policy holders.

      E.g.: State Farm Insurance Companies.

 

  Government Insurance Programs:

Ø  Some federal government insurance programs exist because huge amount of financial resources are needed to provide insurance to its citizens.

Ø  A Federal Government program provides insurance for catastrophic losses.

            E.g.: Social Security, National Flood Insurance Program.

SS not by private since not a ideally loss exposure….Retirement is certain. 

7.1. Agents & Brokers:

Ø  Agents:  Legal representatives of the insurance company for which they have contractual agreements to sell insurance.

Ø  Brokers: An independent business owner or firm that sells insurance by representing customers rather than insurer.

The authority of the Agent and Brokers are generally stated in a written document called an Agency agreement or Agency contract.

        Underwriting:

Ø  Underwriting is a heart of a Insurance Business. To a large extent  a company’s goals depends on the effectiveness of its underwriting.

Underwriting process involves:

            à Selecting Insured: Selecting those applicants who meet the company’s underwriting guidelines.

     àPricing Coverage: Pricing the coverage to charge the premium commensurate with the exposure.

Ø  Determining policy terms and conditions

Ø   Monitoring underwriting decisions to see whether they have desired effect or not.

Ø  Underwriting management sets the company’s guidelines in order to make optimal use of resources and avoid adverse selection.

Note: Monitor that if a Burglar Alarm or a Fire Alarm is fitted as per the recommendations made. Who is the applicant…who is the beficiary.

Reinsurance:

Ø  One of the main important aspect of the Underwriter is to arrange for Reinsurance.

Ø  Types  of Reinsurance are:

      a. Treaty Reinsurance: Is an arrangement where by a reinsure  agrees to reinsure             automatically a portion of all eligible insurance of the primary insurer.

b. Facultative reinsurance: Involves separate transaction for each reinsured policy. That is, the reinsure evaluates individually each policy it  is asked to reinsure. 

Claims:

Ø  Claim: Demand by a person or business seeking to recover from an insurance company for a loss that might be covered in the insurance policy.

Ø  The employees of the insurance company who handle the claims are called as Claim representative or Adjuster.

Ø  The responsibilities  of a Claim representative are:

      a. Respond promptly to the submitted claim.

      b. Obtain adequate information

      c. Properly evaluate the claim

      d. To treat all parties fairly.

Ø  The person who submits the claim to an insurance company is called a claimant.

Ø  In liability insurance the claimant is the third party. In all other cases the claimant is the insured (primary or first – party).

Ø  Independent Adjusters are independent claim representatives who offer claim handling services to insurance companies for a fee.  

Claim Handling Process:

Ø  The Claim Handling process generally involves three steps:

       a. Investigation

       b. Valuation

       c. Negotiation and Settlement

Valuation:

Ø  Common Property Valuation Methods:

Ø   Actual Cash Value(ACV):  The cost to replace the property minus  an allowance  for  the property’s depreciation.

Ø   Cost to Replace: Is calculated on the basis of like kind & Quality.

Ø   Depreciation: Allowance for physical wear and tear.

Ø  Replacement Cost Analysis:  In this case, deduction for depreciation is not a part of the valuation.

Ø  Agreed Value: Agreed value is a method of valuating property in which the insurer and the insured agree on the value of the property at the time the policy is written and that amount is stated in the policy declarations.

Note:

Ø  Ryan’s sofa purchased for $500, five years back is damaged in a hostile Fire accident, Ryan has a Personal Property policy with ABC Insurance.

 Q1. By ACV Method what amount will ABC pay if depreciation is  $300 & Replacement Cost is $500???

Negotiate and Settle:

Ø  After the claim representative and the insured agree on the amount of the settlement, Other factor that can affect the insurers cost for property claims is: “Subrogation”

Ø  Subrogation: Subrogation is  the insurers right to recover payment from a negligent third party. When an insurer pays an insured for a loss, the insurer assumes the insured’s right to collect damages from a third party responsible for loss.  

Solvency of Insurance Company:

Ø  The ability to pay expenses and still make a reasonable profit is a measure of an insurance company’s solvency, that is, its long – term financial strength.

Ø  Income: Insurance companies receive income from two major sources. The first is the sale of insurance and the second is from investments it makes.

Ø  Written Premium: Total Premium on all policies put into effect, or “written” during a given period. Even if the premium is not collect

Ø  Earned Premium: Is the portion of the written premium that applies to the part of the policy period that has already occurred.

Ø  Unearned Premium: The portion of the written premium that applies to the part of the policy period that has not yet occurred.

Ø  Investment Income:  As insurance company handles large amount of money , it invests available funds  in the stock market or purchase bonds to generate additional income.

Ø  Insurance companies select high-quality investments that are relatively secure and that can be readily converted to cash. E.g.: Stocks & Bonds.

Note:

ü  Sam paid a premium of  $1200 on January 1st 2010 for a Annual policy.

 Q1. As on Jan 1st 2010. How much is the Written Premium???

 Q2. As on May 1st 2010. How much is the Earned Premium??

Q3. As of May 1st 2010. How much is Unearned Premium.??

Q4. If Sam cancels the policy on September 1st 2010. How much is the Written Premium.??

Ø  EXPENSES: The major expenses incurred by an insurance company are claim payments for insured's who have suffered losses and the costs associated with handling those claims.

Ø  Other expenses are General expenses that relate to Marketing, day to day Operations, staffing, accounting and maintenance.

Ø  For an insurer to be Profitable,

    Premium + Investment Income > Total loss payments and other expenses.

Profitability Ratio:

Ø  Profitability ratios are generally used to analyze the financial performance of the insurance company.

Ø  Loss ratio = Incurred loss expenses/Earned Premium

Ø  Expense ratio =  Incurred Underwriting expenses /  Written Premium

Note:  Incurred Losses : Claims PaymentsIncurred

underwriting expenses: Agents, Brokers expenses, Commissions staff, IT related expenditure.

Ø  Combined Ratio :  Loss ratio + Expense Ratio

Ø  Investment  income ratio:  Net investment Income/Earned Premium

Ø  Overall Operating ratio: Combined ratio – Investment ratio

Overall Operating Ratio:

Ø  If the Overall Operating ratio is greater than 100%, it indicates that an operating loss has occurred because expenses are greater than revenues.

Ø  If the Overall Operating ratio is less than 100%, it indicates an overall operating gain because revenues are greater than expenses.

Ø  An insurer with an overall operating ratio of 100% breaks even.

Ø  Even monitoring financial results from past years helps to determine the accuracy of the insurance company’s loss reserve estimates.

Questions Time:

ü  Determine based on the following the Solvency of A Insurance Company.

•         Earned Premium:  $ 50,000

•         Written Premium: $100,000

•         Incurred Loss: $20,000

•         Incurred underwriting expenses: $10,000

•         Net Investment Income: $5,000

  Q1. Loss Ratio =  

  Q2. Expense Ratio=

  Q3. Combined Ratio=

  Q3. Net Investment Ratio =

  Q4. Overall Operating Ratio =

  1. Profit

  2.Loss

  3.Break Even