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Lecture-3

Insurance Company Operations

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Agenda

• Rate making

• Underwriting

• Production

• Claim settlement

• Reinsurance

• Investments

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Rate making

• Rate making refers to the pricing of insurance.– 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 like births, deaths, marriage, disease, employment, retirement, and accidents. (Actuaries receive highest salary around the globe)

– Based on the info., the actuary determines the rate for life and health insurance policies.

– The objectives are to calculate premiums that will make business profitable, enable company to compete effectively with other insurers, and allow the company to pay claims and expenses as they occur.

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Underwriting

• Underwriting refers to the process of selecting, classifying, and pricing applicants for insurance.

• The underwriter is the person who decides to accept or reject an application.– The objective is to produce a profitable book of business.

• A statement of underwriting policy establishes policies that are consistent with the company’s objectives, such as– Acceptable classes of business (targeted client segment)– Large volume of business with low unit profit & Vice-versa.– Amounts of insurance that can be written

• A line underwriter makes daily decisions concerning the acceptance or rejection of business.

Inclusions of Underwriting Policy in Underwriting guide

• Lines of insurance to be written (Acceptable variety of insurance)

• Territories to be developed

• Forms and rating plans to be used

• Acceptable, borderline, and prohibited business

• Amounts of insurance to be written

• Business that requires the approval of senior management etc.

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Underwriting

• There are three important principles of underwriting:– The underwriter must select prospective insured

according to the company’s underwriting standards (F.E: based on estimated loss experience, let’s assume 30% loss)• Purpose is to reduce Adverse Selection (High risk people pays low premium)

– Underwriting should achieve a proper balance within each rate classification. (Matching below and above to average)

• In class underwriting, exposure units with similar loss-producing characteristics are grouped together and charged the same rate

– Underwriting should maintain equity among the policyholders. (F. E: Premium should be set according to expected loss (20 vs. 80 insured group are not same)……one group shouldn’t subsidize the other group)

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Steps in Underwriting

• Underwriting starts with the agent in the field. The agent is told what types of applicants are acceptable or not. (F.E: Not to sell policy to drunk drivers for auto insurance; drivers under 21 years old and sport cars).

• Information for underwriting comes from:– The application-basic source of information– The agent’s report-agents evaluation on the prospective insured– An inspection report (may be required when suspecting moral hazard)– Physical inspection-specially applicable for property and liability insurance– A physical examination and attending physician’s report-for Life insurance

(examining weight, blood pressure, heart condition, urinary system and other parts of body)

– MIB report (Medical info. Bureau): Applies to life insurance

• After reviewing the information, the underwriter can:– Accept the application– Accept the application subject to restrictions or modifications

• (For Crime insurance: install alarm system on window)

– Reject the application

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Production

• Production refers to the sales and marketing activities of insurers.– Agents are often referred to as producers– Life insurers have an agency or sales department

• (Dept is responsible for hiring agents, supervising agents, branch offices and local managers).

– Property and liability insurers have marketing departments. To assist agents in the field, special agent is a highly specialized technician. (F.E: Explain new policy/new rating plans)

• An agent should be a competent professional with a high degree of technical knowledge in insurance and who also places the needs of his or her clients first.– A professional agent identifies the prospective clients, analyzes their

needs, and recommends the best solution to the client.– After sales, they provides follow-up services and finally abides by a code

of ethics.

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Claim Settlement

• The objectives of claims settlement include:– Verification of a covered

• Loss: whether the loss occurred and does it covered by the policy

– Fair and prompt payment of claims• Valid claims should be promptly settled and fraudulent claims should be

traced and resisted.– Personal assistance to the insured-helping the insured in distress

• Some laws prohibit unfair claims practices, such as:– Refusing to pay claims without conducting a reasonable

investigation– Not attempting to provide prompt, fair, and equitable settlements – Offering lower settlements to compel insured to institute lawsuits to

recover amounts due

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Steps of Claim Settlement

• The claim process begins with a notice of loss.• Next, the claim is investigated

– A claims adjustor determines if a covered loss has occurred and 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

• 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– 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– The amount of insurance ceded to the reinsurer is

known as a cession.

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Reinsurance

• Reinsurance is used to:– Increase underwriting capacity– Stabilize profits– 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.

Ceding Company: The insurance company that transfers the insurance it has written to another insurance company.

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Types of Reinsurance

• There are two principal forms of reinsurance:– 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.

– In other words, situation where the principal (original) insurer determines what level of risk it should maintain on any one policy, and offers to share the remaining risk with another insurer for a premium.Facultative Reinsurance, which is negotiated separately for each insurance policy that is reinsured.

– Facultative reinsurance is normally purchased by companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties.

– Underwriting expenses, and in particular personnel costs, are higher for such business because each risk is individually underwritten and administered.

Treaty reinsurance An automatic reinsurance contract that establishes the conditions under which a class of businesses will be reinsured.

The reinsurer then covers the specified share of more than one insurance policy issued by the ceding company which come within the scope of that contract.

The reinsurance contract may oblige the reinsurer to accept reinsurance of all contracts within the scope.• Under a quota-share treaty, the ceding insurer and the reinsurer agree

to share premiums and losses based on some proportion.• 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.

• An excess-of-loss treaty is designed for catastrophic protection. • A reinsurance pool is an organization of insurers that underwrites

insurance on a joint basis .

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Reinsurance Alternatives

• 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 catastrophic bond, futures contract or option contract. (Also called risk-linked securities).

• Catastrophe bonds are corporate bonds that permit the issuer of the bond to skip or reduce the interest payments if a catastrophic loss occurs. It provides high interest rates and thus attractive for the institutional investors.

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Investments

• 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

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Exhibit 6.3 Asset Distribution of Life Insurers 2004

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Exhibit 6.4 Investments of Property and Casualty Insurers, 2004

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Other Insurance Company Functions

• The electronic data processing area maintains information on premiums, claims, loss ratios, investments, and underwriting results

• The accounting department prepares financial statements and develops budgets

• In the legal department, attorneys are used in advanced underwriting, estate planning. In addition, they works as the legal advisor to stand on behalf of the company when a policy is brought to court.

• Property and liability insurers provide numerous loss control services

Thanks for your patient hearing!

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