Finance 431:Property-Liability Insurance

Lecture 2: Overview of Insurance Operations

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Overview of Insurance Operations

Types of Insurers

Risk Transfer Process

Objectives of Insurers

Constraints of Achieving Objectives

Measurement of Insurer Performance

Functions Required to Meet Needs

Interdependence Among Functions

Types of InsurersLegal Form of Ownership

Proprietary Insurers

Stock Insurance Companies

Lloyds

Insurance Exchanges

Cooperative Insurers

Mutual Insurance Corporations

Reciprocal Exchanges

Captive Insurers

Risk Retention Groups and Purchasing Groups

Fraternal Organizations

Types of Insurers

Other Insurers

Health Maintenance Organizations (HMOs)

Blue Cross-Blue Shield

Banks

Pools and Associations

Governmental Insurers

Workers Compensation

Mine Subsidence

Federal Insurance Programs

What Type of Insurer is State Farm?

A) Stock insurance company

B) Mutual insurance company

C) Reciprocal exchange

D) Captive insurer

E) None of the above

What Type of Insurer is Allstate?

A) Stock insurance company

B) Mutual insurance company

C) Reciprocal exchange

D) Captive insurer

E) None of the above

What Type of Insurer is CNA?

A) Stock insurance company

B) Mutual insurance company

C) Reciprocal exchange

D) Captive insurer

E) None of the above

Place of Incorporation and Licensing Status

Domestic - incorporated in that state

Foreign - incorporated in another state

Alien - incorporated in another country

Admitted - licensed to provide insurance in a state

Nonadmitted - operating without a license

Surplus lines brokers can place business with nonadmitted insurers if admitted insurers will not write the coverage

For Illinois Policyholders What Type of Company is Sun Life of

Canada?A) Domestic

B) Foreign

C) Alien

D) Extraterrestrial

E) None of the above

Principal Steps in Risk Management1. Identify loss exposures

2. Measure loss exposures

3. Evaluate the different methods for handling the risk

• Risk assumption• Risk transfer• Risk reduction

4. Select a method

5. Monitor results and implement necessary changes

What step in the risk management process would involve estimating that the chance of getting into an automobile accident over the next year is 10%?

A) Identify loss exposures

B) Measure loss exposures

C) Evaluate the different methods for handling the risk

D) Select a method

E) Monitor results and implement necessary changes

What step in the risk management process would involve obtaining a quote for auto insurance?

A) Identify loss exposures

B) Measure loss exposures

C) Evaluate the different methods for handling the risk

D) Select a method

E) Monitor results and implement necessary changes

Risk Transfer ProcessRisk Manager

Consultants

Insurance Agents and Brokers

Insurers

Insurance Functions

Policy contract development

Pricing

Marketing

Underwriting

Loss adjustment

Loss control

Reinsurance

Investments

Objectives of InsurersProfit ObjectiveCustomer Needs Objective

Determinants of Insurance Cost1. Losses2. Expenses3. Profit

Legal Requirement ObjectiveHumanitarian and Societal Objectives

ContributionsEmployee benefits

Constraints on Achieving Objectives

InternalEfficiencyExpertiseSizeFinancial ResourcesMiscellaneous

Market recognition

Poor reputation

ExternalRegulationPublic OpinionCompetitionEconomic ConditionsRecessionInflationInvestment resultsDistribution SystemsMiscellaneousCatastrophes

Measurement of Insurer Performance

Profit Measurement

Problems in Measuring Profitability

Catastrophes

Loss Reserve Inaccuracy

Premium Volume

Impact of Growth

Components of Profit Measurement

Expense Ratio

Loss Adjustment Expenses/Earned Premium

Other Expenses/Written Premium

Loss Ratio

Incurred Losses/Earned Premium

Components of Profit Measurement

Combined Ratio

Statutory

Incurred Losses + LAE + Incurred Expenses

Earned Premiums Earned Premiums

Trade BasisIncurred Losses + LAE + Incurred Expenses

Earned Premiums Written Premiums

Combined Ratio ExampleWritten Premium $100 million

Earned Premium 95 “

Incurred Losses and LAE 76 “

Underwriting Expenses 19 “

Statutory Combined Ratio

76 + 19 = 100%

95 95

Trade Basis Combined Ratio

76 + 19 = 99%

95 100

Components of Profit Measurement

Investment Earnings

Investment Income

Interest

Dividends

Rents

Realized Capital Gains or Losses

Unrealized Capital Gains or Losses

Operating Ratio

Combined Ratio – (Investment Earnings/Earned Premium)

Property-Liability Industry Profitability Combined Operating

Year Ratio NII/EP Ratio1996 105.8 14.4 91.41997 101.6 15.3 86.31998 106.0 14.6 91.41999 108.0 14.0 94.02000 110.4 14.0 96.42001 115.9 12.2 103.72002 107.4 11.2 96.22003 100.1 10.2 89.92004 98.9 9.7 89.22005 101.2 12.0 89.22006 92.6 12.3 80.4Source: Best’s Aggregates and Averages Property/Casualty Edition 2007 U.S. Industry Ratios pp.

90-92

What elements of investment income are omitted in the operating ratio calculation on the prior exhibit?A) Realized capital gains and losses

B) Unrealized capital gains and losses

C) All capital gains and losses

D) Expenses associated with investments

E) None of the above

Measurement of Insurer Performance

Meeting Customers’ Needs

Meeting Legal Requirements

Meeting Social Responsibilities

Functions Required to Meet Needs

MarketingUnderwritingClaimsLoss ControlPremium AuditingReinsuranceActuarialInvestments

Interdependence Among Functions

Marketing and Underwriting

Underwriting and Loss Control

Loss Control and Marketing

Claims and Other Departments

Actuarial and Other Departments