principles of insurance exam 2

Syndicates

-85 in existence -bear the risk and supply the insurance coverage -comprised of: 1. corporations 2. limited partnerships 3. names

Gram-Leach-Bliley Act of 1999

-Financial Modernization Act -allowed insurance companies, banks, securities firms, to all consolidate and have joint operations

Binder

-a temporary contract for insurance

underwriters can decide to:

-accept application outright -accept subject to restrictions/modifications -reject application outright

Balance sheet highlights

-admitted assets -loss reserves -policyholders surplus

Information asymmetries between insureds and insurers are associated with three major problems in insurance markets:

-adverse selections -moral hazard -attitudinal (aka morale) hazard

types of claims adjustors

-agent -company adjustor -independent adjustor -public adjustor

stock insurance company

-an insurer owned by stockholders -objective is to earn profits for stockholders

Producer

-anyone that sells insurance -commission -agents and brokers are producers

offer and acceptance

-applicant for insurance makes the offer -insurance company either rejects or accepts -property- offer and acceptance can be oral or written -life- application always in writing (reason: long term contracts)

underwriting principles

-attain an underwriting profit -select insureds according to the company's underwriting guide (purpose: reduce adverse selection equity among policyholders)

Insurable interest in life insurance

-beneficiary does not need insurable interest (you can leave money to whoever you want) -close family ties/marriage (reduce moral hazard) -pecuniary interest (ex. corporation can purchase life insurance on their leading sales person)

altitudinal (morale) hazard

-careless or indifferent to a loss which increases the frequency or severity of a loss -results in higher losses for insurers and ultimately higher premiums for insureds

Facultative reinsurance

-case by case basis -often used when primary insurer has an application for a large amount of insurance

Financial Service Industry

-consists of institutions that provide financial products and services to public -insurance industry is a subset

legal purpose

-contract must be for a legal purpose -dont want to promote illegal activities contrary to public interest

moral hazard

-dishonesty or character defects in an individual that increase frequency or severity of a loss -i.e. a mental attitude associated with intentional acts that cause a loss or increase its severity -presence of a risk transfer mechanism, such as insurance, often exacerbates (increases) moral hazard -when informational asymmetries are such that insurers cannot control moral hazard the result is higher than expected loss

income statement highlights

-earned premiums unearned premiums

increase underwriting capacity

-financial constraints limit the amount of risk a single primary insurer can assume -reinsurance takes risk "off the books" and increases UW capacity

methods of ensuring insurer solvency

-financial requirements -risk basked capital standards -annual financial statements -field examinations -early warning system (IRIS, FAST)

Regulated areas:

-formation and licensing of insurers -solvency regulation (capital and surplus requirements) -rate regulation (ensure rates are adequate and not excessive) -policy forms -sales practices and consumer protection (consumer complaints or unfair trade practices)

Reasons for reinsurance

-increase underwriting capacity -stabilize profits -provide protection against catastrophic losses

Life Cycle of the Insurance Policy

-insurance company must find risks they can insure -insurer underwrites (evaluates) applicant -policyholders receive claims payments if covered loss occurs -policy expires

reinsurance

-insurance for insurers -the primary insurer that initially writes insurance transfers otential losses to the reinsurer

concealment (nondisclosure)

-intentional failure of the applicant for insurance to reveal a material fact to the insurer Must prove: -concealed face was known by the insured to be material -insured intended to defraud the insurer

Reasons for insurance regulation include:

-maintenance of insurer solvency -compensate for inadequate consumer knowledge -ensure reasonable rates -make insurance available

provide protection against catastrophic losses

-natural disasters, industrial explosions, airline disasters, terrorism, etc. can lead to large losses for primary insurers

stabilize profits

-natural disasters, unexpected economic conditions, etc. can cause losses to fluctuate widely -reinsurance reduces the upper amount of potential losses for the primary insurer

Lloyd's of London

-not technically an insurance company -world's leading insurance market -investors join together to form syndicates to insure and pool risks -birthplace of the insurance mechanism

steps in claims settlement

-notice of loss must be given -the claim is investigated -proof of loss may be required -a decision is made regarding payment

For an insurance contract to be legally enforceable:

-offer and acceptance -consideration -competent parties -legal purpose

mutual insurance company

-owned by the policyholders -company has no stockholders -policyholders elect BOD who appoints managers

what supports insurable interest in PC insurance

-ownership of property -potential legal liability -secured creditors (ex. bank has an insurable interest in a house for which it has an existing mortgage outstanding.....bank gives you 300000 for house. your house burns. you dont want to pay loan anymore. bank can sell it bc no house. lose their collateral.) -contractual right (products shipped from south america to here. they get lost. didnt pay for them bc you didnt own them yet but you still lose profit bc of cant make products)

competent parties

-parties must have legal capacity to enter into a legally binding contract -exceptions- children, intoxicated, mentally disabled -minors- if a minor enters into an insurance contract, it is voidable (for any reason) at the discretion of the minor

Valued policy

-policies that pays the face amount of insurance if a total loss occurs -used to insure antiques, fine arts, family heirlooms, etc. -used in cases where determining AVC is difficult/impossible

purposes of insurable interest

-prevent gambling -reduce moral hazard -measure the amount of the insureds loss in property insurance

Purposes of subrogation

-prevents the insured from collecting twice for the same loss -used to hold the guilty person responsible for the loss -helps to hold down insurance rates

Goals of ratemaking (3 regulatory)

-rates should be adequate (rates charged by insurer should be high enough to pay all losses and expenses) -rates should not be excessive (rates should not be so high that policyholders are paying more than the actual value of their protection) -rates should not be unfairly discriminatory (exposures that are similar with respect to losses and expenses should not be charged significantly different rates)

information asymmetries

-refers to a situation where one party has an info. advantage cover another -occurs when the insured has more information about its chance of loss than the insurance company -creates problems in the risk selection and insurance pricing decision of insurance companies

legal doctrines that support utmost good faith

-representations -concealment (nondisclosure) -warranty if any of these are violated, insurer has right to void coverage

Broker

-represents the insured -have better knowledge of the inured which reduces informational asymmetries

Agents

-represents the insurer -can issue a binder (temporary insurance policy that lasts until the actual insurance policy is written)

warranty

-statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects

Representations

-statements made by the applicant for insurance three aspects: -material: if the insurer knew the true facts, the policy would not have been issued or the policy would have been issued on different terms -false: the statement is not true or misleading -reliance: the insurance relies on the misrepresentation on issuing the policy at a specific premium

principle of insurable interest

-states the insured must be in a position to lose financially if a covered loss occurs -insurance contracts must be supported by an insurable interest to be legally enforceable

Actual Cash Value

-supports the principle of indemnity determined by: -fair market value (amount a normal person would pay) -broad evidence rule (include all relevant value) -replacement cost less depreciation

subrogation

-the insurer is entitled to recover from a negligent third party any loss payments made to the insured -strongly supports the principle of indemnity

ratemaking

-the pricing of insurance and the calculation of insurance premiums -rates are the price per unit of exposure -rates reflect expected losses

underwriting

-the process of selecting, classifying, and pricing applicants for insurance -the underwriter is the person who decides to accept or reject an application for insurance -top level management must determine the company's underwriting policy

What entity is responsible for regulating insurers?

-the state regulates insurance through an insurance regulation department -insurance commissioner oversees the regulatory duties (elected or appointed)

Adverse selection

-the tendency of people with higher than average chance of loss to seek insurance at standard rates -results in higher than expected loss levels to the insurance company

consideration

-the value that each party gives to the other -insurer- promise to do certain things specified in the contract -insured- payment of premium

Exceptions to the principle of indemnity

-valued policy -replacement cost insurance -life insurance

replacement cost insurance

NO deduction for physical depreciation in determining the amount paid for a loss

When must insurable interest exist?

Property insurance- at the time of the loss Life insurance- at the time of the purchase

Principle of utmost good faith

a higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts -if utmost good faith violated, coverage is void

claims adjustor

a person who helps determine the extent of a covered loss and the associated indemnification

familiar stock insurers

aetna, cigna, american international group, geico, traveler's

Paul vs Virginia (1868)

affirmed states rights to regulate insurance

sources of information for underwriters

agents, applications, physical inspection reports, medical examination, prior claims history, etc.

Financial Modernization Act of 1999 (Gramm-Leach-Bliley)

allowed banks and insurers to operate together

AVC in business income insurance

amount paid is based on the amount of profits lost by the business

AVC in life insurance

amount paid is based on the face value of the policy

PC insurer investments

approximately 1.4 trillion held in assets -majority of investments held in relatively liquid securities like high quality bonds, stocks, and cash

life insurer investments

approximately 5.5 trillion held in assets -majority are assets like bonds, mortgages, and real estate

admitted assets

assets that are permitted by state law to be included on financial statements

McCarran-Ferguson Act (1945)

congress gave insurance regulation back to the states

judgement rate

each exposure is individually evaluated and rate is determined by judgment of underwriter

loss reserves

estimated cost of settling a claim for losses that have occurred but have not yet been paid

class rating

exposures with similar characteristics are placed in the same underwriting class and each is charged the same rate

actuaries

highly skilled mathematician that prices insurance

Loss ratio equation

incurred losses + loss adjustment expenses ______________________________________________ premiums earned

personal contract (assignments)

insurance contracts do not transfer with the property

AVC in liability insurance

insurer pays up to the policy limit the amount an insured is legally obligated to pay

open competition

insurers are not required to file their rates

use and file law

insurers can put into effect immediately any rate change, but rates must be filed within a certain period of time

combined ratio

loss ratio + expense ratio

conditional contract

obligation to pay depends on whether the insured has complied with all policy conditions (insurance company doesnt have to pay until you satisfy every term)

independent adjustor

offers services to many insurance companies for a fee

unilateral contract

only one party makes a legally enforceable contract (insurer)

investments of private insurers

premiums are paid in advance, they can be temporarily invested until they are needed to pay claims

Prior approval laws

rates must be filed and approved by the state before use

file and use law

rates must be filed and can be used immediately after filing

treaty reinsurance

reinsurer agrees to automatically accept business that falls within a pre-arranged agreement

exclusive agency

represents only one insurer or group of insurers under common ownership ex. allstate

public adjustor

represents the insured

Independent agency

represents unrelated insurers

U.S. vs Southeastern Underwriters Association (1944)

reversed paul vs virginia

company adjustor

salaried employee of the insurance company

direct writer

salesperson is an employee of the insurer ex. geico

familiar mutual insurers

state farm, mutual of omaha, liberty mutual

principle of indemnity

states that the insurer agrees to pay no more than the actual amount of the loss Purposes: -prevent the insured from making a profit -reduce moral hazard

types of private insurers

stock mutual lloyds of london

ment rating

the class or manual rate is adjusted based on past loss experience

policyholders surplus

the difference between assets and liabilities -provides cushion for insurers if losses are greater than expected

unearned premiums

the portion of the premium paid to the insurer but for which the insurer has not provided protection

earned premiums

the portion of the premiums for which the insurer has provided protection

Claims settlement

the process in which an insured is indemnified for a loss

expense ratio

underwriting expenses ________________________ premiums written

aleatory contract

unequal values exchanged