1

Introduction to Insurance Practice

UNDERWRITING & CLAIMS RESERVING

2

Presentation Overview

Personal Introduction

Introduction to Insurance

Insurance Coverage Types / Varieties

Underwriting & insurance documentation

Claims reserving

3

Personal Introduction

Lori-Ann Maxwell - Manager FRM / Actuarial Services (KPMG in the Cayman Islands )

Helen Stephenson – VP & Senior Underwriter (Aon Cayman)

Module 1

Introduction to Insurance

5

Introduction to Insurance #1

Insurance & Risk Risk – many definitions/meanings

chance of having an accident

possibility of winning on lottery

hurricane affecting Cayman

new restaurant succeeding

will new apartment be worth more or less than you paid for it

likelihood of car being broken into

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Introduction to Insurance #2

Insurable Risks Financial / Non-Financial

Pure / Speculative

Particular / Fundamental

Fortuitous event to the Insured

Insurable Interest

Not contrary to public policy

Homogeneous exposures

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Introduction to Insurance #3

Components of Risk Uncertainty

Level of Risk – frequency / severity

Peril – that which gives rise to a loss

Hazard – that which influences effect of the peril

Physical hazard

Moral hazard

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Introduction to Insurance #4

Pooling of risk Basic concept of insurance is that the losses of the few who suffer

misfortune are met by contributions of the many who are exposed to similar potential loss

Law of large numbers

Equitable premiums

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Introduction to Insurance #5

Function of insurance Primary function of insurance is to act as a risk transfer mechanism,

i.e. to transfer a risk from one person, the insured, to another, the insurer.

The insured exchanges a large unknown financial risk for a much smaller known premium.

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Introduction to Insurance #6

Insurance Distinctions

General / Non Life Life / Long Term

Personal Business / Commercial

Property Casualty / Liability

Marine Non-Marine

Statutory Non-Statutory

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Introduction to Insurance #7 Classes of Insurance (Lines of Business)

Personal insurances

House / Home – buildings, contents, personal effects, valuables, liability

Car / Auto – liability to third parties, damage to own vehicle

Personal accident

Life insurance

Boat insurance - liability to third parties, damage to own vessel

Classes of Insurance (Lines of Business)

Commercial insurances

Auto Fleet

Workers’ Compensation / Employer’s Liability

Comprehensive General Liability & Products Liability

Property – fire & perils; theft; engineering breakdown

Pecuniary Covers – fidelity guarantee; legal expenses; credit; business interruption

Marine - Cargo; Hull; War; Protection & Indemnity / Marine Liabilities

Professional Indemnity; Medical Professional Liability

Employee benefits - Accidental death & disablement; long term disability

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Introduction to Insurance #8

Module 2

Insurance Coverage Types

Reinsurance vs. Insurance

Insurance contracts Transaction whereby Party A indemnifies Party B for loss covered under the

terms of the contract. Uncertainty exists over the loss amount and when the loss will be paid

(underwriting risk and timing risk). Losses covered must be insurable risks – losses sustained in gambling on a

horse race is not deemed to be an insurable risk.

Reinsurance contracts Transaction where reinsurer agrees to indemnify a ceding insurer against all

or part of a loss that the ceding insurer sustains in an underlying insurance policy.

In summary is insurance for insurers Retrocession involves reinsurance for reinsurers

Flow of Insurance

Insurable Risks

Underwriting Ceding Retrocede

Insured Insurance

Company

Reinsurance

CompanyRetrocessionaire

Why Reinsure?

Stability – insurers may wish to retain risk of loss up to specific limits per occurrence or in aggregate, therefore reinsuring losses above these limits.

Surplus relief – increases the capacity of the insurer to take on additional risks than it might prudently consider on a stand alone basis.

Catastrophe Protection – special forms of reinsurance allow insurers obtain protection from excess losses arising from a single event (e.g: a hurricane).

Underwriting Expertise – reinsurers deal with a variety of primary insurers and therefore accumulate apt knowledge of an industry, loss experiences as well as methods of underwriting and handling of claims.

Withdraw from a Line of Business – to avoid serious costs of canceling policies and refunding premiums, insurers who wish to discontinue a line of business can reinsure the unwanted business.

As a vehicle for off-shore Captives – this reason for reinsurance is more common for the Cayman Islands Insurance industry.

Types of Reinsurance

FacultativeTreaty/

Obligatory

Excess of Loss

Quota-Share

Excess of Loss

Quota-Share

Types of Reinsurance (continued) Facultative reinsurance:

The ceding insurer is free to choose whether or not to offer an individual policy to a reinsurer and the reinsurer is free to choose whether or not to accept the policy on a policy by policy basis.

Treaty/ Obligatory reinsurance:

A treaty exists between the insurer and the reinsurer whereby the insurer agrees to cede and the reinsurer is obliged to accept all the policies consistent with the treaty. Treaties are renewed on a regular basis.

Which of these two structures carries more risk?

Basic Types of Reinsurance

Excess of loss: Covers losses in excess of a specific limit or attachment point. Limits can be per claim, per occurrence and/or per

aggregate/stop loss limit. Primary Coverage – First dollar losses up to prescribed per loss limit Excess coverage - Coverage provided above a prescribed limit

Purpose is to stabilize severity of losses retained.

Quota Share Reinsurance: The reinsurer accepts a stated percentage of each and every

risk within a defined category of business on a pro-rata basis Participation in each risk is fixed and certain. Often used where the risk of variability is low. Premiums and losses are shared in the same proportion.

Basic Types of Reinsurance

Catastrophe: Covers large claims arising from infrequent events May be for a specific peril (hurricane) for general risks during a

time period Provides protection against events that are low frequency, but

have great magnitude of severity Coverage is event based and across insurer’s portfolio of

policies

Aggregate / Stop loss: Covers the insurers losses above a predetermined total amount

for a specified period Applied to the entire book of business reinsured.

Insurance Coverage Types

Occurrence basis Insurable events occurring during a policy period are covered regardless of when

they are reported. Losses under occurrence based contract are accounted for when incident arises. Difficult to determine when lengthy reporting lags exist, and unforeseen claim

events are significant issues

Claims-made basis Insurable events are covered in the period when they are reported, regardless of

when they occurred (subject to retroactive dates). Losses under claims-made contracts are accounted for when claim is reported. Loss exposure increases in each renewal (as program matures).

Insurance Coverage Types

Claims-made contracts (cont) For claims reported in a policy period the retroactive date is a cut-off date in

terms of how far back an occurrence date can be for the claim to be covered Extended reporting date (tail coverage) is an endorsement that covers

claims reported after the policy expiry date for occurrences within the policy period up to a certain date in the future, if a claims contract was not renewed.

Common concerns with claims-made and occurrence For claims-made tail coverage must be recognized on the Parent’s books. Use of retroactive dates and extended reporting dates have major impact on

reserves. Gaps may arise for companies switching between claims-made and

occurrence on subsequent renewals Consecutively renewed claims-made policies with same loss limits and

consistent retro dates may yield very different loss exposures, and can impact ultimate loss levels.

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Module 3

Underwriting

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Underwriting #1

Function of Underwriter

Accepts risk on behalf of the insurer/reinsurer

Assesses the risk of each insured/reinsured

Decides whether to accept the risk / how much to accept

Determines terms, conditions and scope of cover

Calculates a premium to cover expected claims, provide a reserve, meet expenses and (generally) provide a profit

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Underwriting #2

Determining the price

Depends on class of insurance

Car / auto insurance rate tables –

Drivers: age, experience, driving record

Vehicle: age, performance, cost/ease of repairs, crash test results

In general -

Rate x exposure (payroll, sum insured, number of vehicles)

Actuarially determined

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Underwriting #3

Policy of insurance

Insurance policy is a legally binding agreement between the insured and an insurance company.

Unlike most contracts, it is a promise to fulfill obligations in future.

Insured’s duty to disclose material facts – principle of Utmost good faith

Insurer drafts and any ambiguity normally ruled in favour of insured (Contra proferentem)

Wording therefore of utmost importance.

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Underwriting #4

Typical insurance policy

Declarations – Insured, Insurer, Period, Limits, Deductibles, Premium

Definitions - Define important terms used in the policy language.

Insuring agreement - Describes the covered perils, or risks assumed, or nature of coverage, or makes some reference to the contractual agreement between insurer and insured. It summarizes the major promises of the insurance company, as well as stating what is covered.

Exclusions take coverage away from the Insuring Agreement by describing property, perils, hazards or losses arising from specific causes which are not covered by the policy.

Conditions - Provisions, rules of conduct, duties and obligations required for cover to apply. If policy conditions are not met, the insurer may be able to deny the claim.

Endorsements

Signature

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Underwriting # 5 Insurance Policy - Direct Contract between Insured and Insurer

With captives typically no broker involved.

Insurance Binder - Issued prior to policy. Superseded by Policy.Insurer to Broker.

Reinsurance Agreement - Contract between Reinsured and Reinsurer

Placement Slip - Temporary agreement of reinsurance terms andconditions arrangements for which coverage

has been effected

Cover Note - Issued prior to policy. Superseded by Policy.Broker to Insured.

Insurance Certificate - Certificate evidences coverage. Does notprovide cover in its own right.

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Underwriting #5

Common Issues with Policies

Policy Endorsements must be issued in respect of all amendments to cover (not only in respect of premium adjustments). Policy endorsements / contract addenda should be kept with and form part of the policy.

Previously issued policies must be formally cancelled and replaced once the decision to issue a revised policy has been made.

Where captive does not retain 100% exposure but cedes in part or in whole to reinsurers we need to be very careful about Difference in Conditions / Differences in Limits (DIC/DIL) exposure to captive.

Stamp Duty Payments

Signing Authority & Location

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Underwriting #6 Insurance Certificates

Certificates are used for informational purposes only. Certificates do not change coverage or terms of the insurance contract. Refrain from using “ … is added as additional insured”

Party to which the Certificate of Insurance is given does not become a part of the insurance contract, they generally gain no rights as a result of receiving the insurance certificate. The certificate of insurance only informs them that the coverage existed at the time the certificate of insurance was issued.

Most certificates read “THIS CERTIFICATE IS ISSUED AS A WRITTEN MATTER OF INFORMATION ONLY AND CONFERS NO RIGHTS UPON THE CERTIFICATE HOLDER. THIS CERTIFICATE DOES NOT AMEND, EXTEND OR ALTER THE COVERAGE AFFORDED BY THE POLICIES BELOW”.

Notice of Cancellation - the certificate of insurance does not grant the holder of the certificate any rights (informational purposes only) therefore no notice of cancellation is required.

Often a party with a valid insurable interest will request a certificate of insurance. Examples include additional interest insureds, lessors, mortgagees etc.. These interests need to be added to the policy by endorsement, if not already included. Issuing a certificate of insurance does not change the policy.

Module 4

Claims Cycle & Reserving

Claims Cycle For an insurance company, claims develop through a claims cycle whose length

and timing depends on the nature of the underlying risk and the type and level of coverage provided. The claims cycle is as follows:

- Occurrence

- Reporting

- Establishing an initial reserve

- Updating initial reserve estimates

- Settlement

- Closure

Case Evaluation and Reserving

Life Cycle of a ClaimV

alue

($0

00s)

150

12 240 6 36

15

75

Event

Report

Registration

Assignment

Investigation

Negotiation

Settlement

100

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Loss Estimation

At a given point in time (the evaluation date), there is less than complete information as claims are at various stages of the life cycle.

Consequently, an insurance company or reinsurance company has to rely on estimates to determine the ultimate cost of claims that will be settled at future dates.

Estimates of ultimate claims cost are important and are required to satisfy: Business Requirements – Premium / Funding & Loss Reserves Regulatory Reporting Accounting Standards /Financial Reporting

Actuaries assist in providing estimates of ultimate claims settlement costs

Who Are Actuaries / What Do They Do?

Actuaries apply mathematical & statistical models and business judgment to evaluate and quantify risk, as it pertains to the possible outcomes and consequences (financial and otherwise) associated with uncertain future events.

An actuary is a business professional who analyzes the financial consequences of risk. Actuaries use mathematics, statistics, and financial theory to study uncertain future events, especially those of concern to insurance and pension programs.

Key Terms in the Definitions of Actuaries• Risk• Financial Consequences• Mathematics and Statistics• Financial Theory• Uncertain Future Events

Actuarial Studies Funding and Reserving Actuarial Studies for Insurance captives can take the form of either a funding study

or a reserving study.

Funding Study:

- Prospective in nature.

- Covers anticipated events that have not occurred.

- Mainly used to set premiums for future periods. Reserve Study:

- Retroactive in nature.

- Covers events that have occurred and are reported but not settled, events that have occurred but not been reported and events that have been reported but not recorded.

- Mainly used to assist in setting loss reserves for financial reporting purposes.

Actuarial Estimates Ultimate Losses Are Made Up of Three Key Components

Paid losses (reported and paid) Case reserves (reported and estimated) IBNR (unreported and estimated)

A Critical Aspect of the Actuary’s Work is Estimating IBNR How do we value IBNR liability

Actuary – projects ultimate losses. Total reserve = ultimate losses minus cumulative paid losses Total reserve = case reserves plus IBNR

Components of IBNR Losses occurring but not reported as of an evaluation date Adverse development on case reserves Reported but unrecorded claims (pipeline claims) Reopened claims

Actuarial Methods Paid Loss Development

Reported (Incurred) Loss Development

Case Reserve Development

Frequency-Severity

Bornhuetter-Ferguson

Expected Loss -Loss rate per Exposure Unit

Actuarial Assumptions & Estimation IssuesINTERNAL

Availability and reliability of Loss experience Data

Consistency of Exposure

EXTERNAL

Loss and Exposure Trends and Leveraging Effect

Judicial and Legislative Venues

Economic Factors: Unemployment and Interest Rates

Changes in Case Reserving and claims handling

Claims reporting lags (significant for GL)

Potential for Catastrophe- Property

Terrorism Issue - Potential Casualty Catastrophe

Benefit Changes / Statutory Benefits- Workers Comp

Inherent volatility- Med-mal

UNANTICIPATED

Contract Interpretation- Asbestos, Pollution

Unanticipated Claims- Mold, Pandemics