RMIN Test 3

Net Gain from Operations (life)

(net income) = total revenues - total expenses - policyholder dividends - federal income taxes

Source of Underwriting Information

-Application: type of info depends on type of insurance (ex: property insurance: features of building, type of construction, occupancy, exposures, type of fire protection, etc; life insurance: personal and family health history, gender, weight, etc.) -Agent's Report: an evaluation of the applicant done by the agent (especially important in property insurance where the agent or broker may submit an application that does not completely meet standards--agent's evaluation becomes very important) -Inspection Report: may require inspection by an outside agency, especially if agent suspects moral hazard -Physical Inspection: sometimes required in property insurance and casualty insurance before application is approved -Physical Examination: sometimes required before a life insurance application is approved; in addition may require an attending physician's report: a report from a physician who has treated the applicant in the past; a life insurer may also request a report from MIB Group, Inc. (Medical Information Bureau Report)

Types of Reinsurance

-Facultative Reinsurance -Treaty Reinsurance

Reasons for Reinsurance

-Increase Underwriting Capacity -Stabilize Profits -Reduce the Unearned Premium Reserve -Provide Protection Against a Catastrophic Loss It also enables an insurer to retire from a territory or class of business and to obtain underwriting advice from the reinsurer.

Other Insurance Company Functions

-Information Systems: depend heavily on computers/technology; computers revolutionized industry by speeding up processing and storage of information and by eliminating many routine tasks. -Accounting: responsible for financial accounting operations (financial statements, budgets, analyzing the company's financial operations, keeping track of cash flow); prepares reports and statements for company, public, policyholders, and GAAP if publicly traded. -Legal Function: attorneys widely used in advanced underwriting and estate planning, draft legal language and policy provisions, and stay updated on the frequently changing state and federal laws that affect the company and policyholders. -Loss-Control Services: advice on alarm systems, automatic sprinkler systems, fire prevention, occupational safety and health, etc.; can provide advice on construction of new building/plant to make it safer/more resistive to damage (can result in substantial rate reduction); can also assist underwriters.

Steps in Settlement of a Claim

-Notice of Loss Must be Given -The Claim is Investigated -A Proof of Loss may be Required -A Decision is Made Concerning Payment

Methods for Sharing Losses

-Pro Rata: the ceding company and reinsurer agree to share losses and premiums based on some proportion. -Excess-of-Loss: the reinsurer pays only when covered losses exceed a certain level. Examples of both methods: -Quota-share treaty -Surplus-share treaty -Excess-of-loss reinsurance -Reinsurance pool

Other Underwriting Considerations

-Rate Adequacy and Underwriting: property and casualty insurers are more willing to underwrite new business for a specific line if rates are considered adequate; if they aren't underwriting requires a more conservative approach to the acceptance of new business; if moral hazard is excessive, the business generally cannot be insured at any rate *(when rates are adequate underwriting is more profitable and becomes more liberal. when rates are inadequate losses occur and it becomes more restrictive). -Reinsurance and Underwriting: availability of reinsurance may result in more liberal underwriting; if it cannot be obtained on favorable terms, underwriting may be more restrictive. -Renewal Underwriting: In life insurance, policies are not cancelable; in property and casualty most can be canceled or not renewed; if the loss experience is unfavorable, the insurer may either cancel or not renew the policy (most states have placed restrictions on the insurer's right to cancel)

Most Important Operations of an Insurance Company:

-Rate Making -Underwriting -Production -Claims Settlement -Reinsurance -Investments

Types of Unfair Claim Practices Prohibited by Laws (modeled after the National Association of Insurance Commissioners' Model Act)

-Refusing to pay claims without conducting a reasonable investigation -Not attempting in good faith to provide prompt, fair, and equitable settlements of claims in which liability has become reasonably clear -Compelling insureds or beneficiaries to institute lawsuits to recover amounts due under its policies by offering substantially less than the amounts ultimately recovered in suits brought by them -Misrepresentation of material facts or policy provisions by insurers that pertain to a coverage issue

Alternatives to Traditional Reinsurance

-Securitization of Risk -Catastrophe Bonds Many insurers/reinsurers are now using capital markets as an alternative to traditional reinsurance (rather than relying on the limited financial capacity of the insurance industry).

Business Objectives in Rate Making

-Simplicity: rating system should be easy to understand so that producers can quote premiums with minimum time/expense (important in personal lines because the don't justify large time/expense, and in commercial because they should know how their premiums are determined in order to lower insurance costs). -Responsiveness: rates should be responsive over time to changing loss exposures and changing economic conditions. -Stability: rates should not fluctuate or change rapidly over short periods of time so consumers do not become irritated/dissatisfied. -Encouragement of Loss Control: loss control techniques are designed to decrease the frequency and severity of loss and should be encouraged by insurance companies.

Basic Objectives in Claims Settlemet

-Verification of a Covered Loss: involves determining whether a specific person or property is covered under that policy, and the extent of the coverage -Fair and Prompt Payment of Claims: meaning the insurer should avoid excessive claim settlements and should resists the payment of fraudulent claims because they will ultimately result in higher premiums; if a valid claim is denied, the fundamental social/contractual purpose of protecting the insured is defeated, and the insurer's reputation and therefore sales may be hurt. -Provide Personal Assistance to the Insured: going beyond any contractual obligation (ex: helping a family find temporary housing after a fire)

3 rating methods in property/casualty:

1. Judgement Rating 2. Class Rating 3. Merit Rating -Scheduled Rating -Experience Rating -Retrospective Rating

Basic Underwriting Principles (3)

1. attain an underwriting profit 2. select prospective insureds according to the company's underwriting standards 3. provide equity among the policyholders

Decision Concerning Payment

3 possible decisions: 1. Claim can be Paid: in most cases, the claim is paid promptly according to the terms of the policy 2. Claim can be Denied: if the adjustor believes that the policy does not cover the loss or that the claim is fraudulent, they can deny it 3. Claim may be Valid, but there is a Dispute: between insurer and insured over the amount to be paid; in this case a policy provision may specify how to resolve a dispute---basically goes to mediation with two appraisers and an umpire (of the two's choosing, they must agree); disagreements over claim settlements get filed with the National Association of Insurance Commissioners (NAIC)

Overall Operating Ratio

= combined ratio - investment income ratio If it exceeds 100, the investment income was not enough to offset underwriting loss.

Combined Ratio

= loss ratio + expense ratio One of the most common measures of underwriting profitability; If it exceeds 1, it indicates an underwriting loss, if less than 1, and underwriting profit.

Investment Income Ratio

= net investment income/premiums earned

Expense Ratio

= underwriting expenses/premiums written Underwriting expenses include acquisition costs (commissions), general expenses, and underwriting costs. A low expense ratio is preferred; usually higher for commercial lines (as opposed to personal)

Judgement Method

A claim reserve is established for each individual claim; the amount is based on the judgement of someone in the claims department or estimated using a computer program

Increase Underwriting Capacity

A company may be asked to assume liability for losses in excess of its retention limit, and without reinsurance the agent would have to place large amounts of insurance with several companies or not accept the risk (awkward, may create ill will on behalf of the policyholder); reinsurance permits the primary company to issue a single policy in excess of its retention limit for the full amount of insurance.

Loss Reserves (property/casualty)

A large liability item; the estimated cost of settling claims for losses that have already occurred but that have not been paid as of the valuation date; an estimated amount for (1) claims reported and adjusted but not yet paid, (2) claims reported and filed but not yet adjusted, and (3) claims for losses incurred but not yet reported to the company **especially important to casualty insurers because bodily injury and property damage liability claims take a long time to settle (especially if there is litigation), whereas physical damage and personal property insurance claims are settled quickly and therefore have smaller reserves.

Unearned Premium Reserve

A liability item on the insurer's balance sheet that represents the unearned portion of gross premiums on all outstanding policies at the time of valuation; reflects the fact that premiums are paid in advance, but the period of protection has not yet expired; as time goes on, part of the premium is considered earned, the remainder unearned. Premium is fully earned when the period of protection ends.

Unearned Premium Reserve

A liability item that represents the unearned portion of gross premiums on all outstanding policies at the time of valuation; required by law to place the entire gross premium in this reserve when the policy is first written, and to replace renewal premiums in the same reserve.

Reserve for Amounts Held on Deposit (life)

A liability that represents funds owed to policyholders and to beneficiaries.

Annual Pro Rata Method

A method used to calculate the unearned premium reserve; it is assumed that the policies are written uniformly throughout the year; it is assumed that all policies are written on July 1, which is the average issue date, therefore on December 31 the unearned premium reserve for all 1-year policies is one-half os the premiums attributable to these policies (for 2-year it is 3/4 of the premium income, for 3-year it is 5/6)

Chartered Property Casualty Underwriter (CPCU)

A professional program established by The American Institute for CPCU for property and casualty insurance that also requires professional exams.

Chartered Life Underwriter (CLU)

A professional program for life and health insurers established by The American College. To get this designation agents must pass certain professional exams.

Assets Valuation Reserve (AVR) (life)

A statutory account designed to absorb asset value fluctuations not caused by changing interest rates; net effect is to smooth the company's reported surplus over time.

Balance Sheet (property/casualty)

A summary of what a company owns (assets), what it owes (liabilities), and the difference between total assets and total liabilities (owners equity).

Steps in Underwriting

After policy is established, it must be communicated to the sales force. Initial underwriting starts with the agent in the field. Agent as First Underwriter: "field underwriting"; agent is told what is acceptable, borderline, and prohibited and it is important for them to follow company policy Making an Underwriting Decision: after evaluating information a decision must be made; 3 basic decisions in regards to an initial application: Accept, Accept subject to certain restrictions/modifications (ex: before crime insurance is issued, applicant may be required to instal a certain alarm system, put bars on windows, etc), Reject

Chartered Financial Consultant (ChFC)

Also awarded by The American College for professionals who are working in the financial services industry and requires the passing of certain exams.

Reinsurance

An arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance. Ceding Company: the primary insurer that initially writes the insurance Reinsurer: the insurer that accepts part or all of the insurance from the ceding company Retention Limit (Net Retention): the amount of insurance retained by the ceding company for its own account Cession: the amount of insurance ceded to the reinsurer Retrocession: when the reinsurer reinsures part or all of the risk with another insurer Retrocessionaire: the second reinsurer

Average Value Method

An average value is assigned to each claim; used when the number of claims is large, and the average claim amount is relatively small (loss reserves for auto physical damage claims are often based on this method).

Securitization of Risk

An insurable risk is transferred to the capital markets through the creation of a financial instrument, such as a catastrophe bond, futures contract, options contract, or other financial instruments (these instruments are also called risk-linked securities); insurers were among the first financial institutions to experiment with this.

Liabilities (property/casualty)

An insurer is required by law to maintain certain reserves on its balance sheet (to make sure that premiums received in advance will be available to pay future losses); A property and casualty insurer is required to maintain two principle types of financial reserves: -Loss Reserves -Unearned Premium Reserves

Stabilize Profits

An insurer may wish to avoid large fluctuations in annual financial results, and loss experience can fluctuate widely because of social and economic conditions, natural disasters, and chance. Reinsurance can be used to stabilize the effects of poor loss experience; ex: large, unexpected loss: reinsurer would pay that portion of the loss in excess of some specified limit; another arrangement would be to have the reinsurer reimburse the ceding insurer for losses that exceed a specified loss ratio during a given year.

Reduce the Unearned Premium Reserve

An insurer's ability to grow may be restricted by the unearned premium reserve requirement because the entire gross premium must be placed in the unearned premium reserve when the policy is first written. The insurer also incurs relatively heavy first-year acquisition expenses which aren't accounted for in the requirement, meaning that they must pay them out of their surplus (policyholders' surplus is the difference between assets and liabilities). More business = more rapid, short-term drain on surplus which could eventually impair a rapidly growing insurer's ability to write new business. Reinsurance reduces the level of the unearned premium reserve required by law, and temporarily increases the insurer's surplus position.

Facultative Reinsurance

An optional, case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit; reinsurance is not automatic and must be negotiated by the primary insurer and the reinsurer for each loss exposure (separate contract each time). Often used when the primary insurer has an application for a large amount of insurance. Advantages: flexibility--can be tailored to fit any type of case, can increase capacity of primary insurer to write large amounts of insurance, and can help stabilize the financial operations of the primary insurer by shifting part of a large loss to the reinsurer. Disadvantages: some uncertainty because the primary insurer doesn't know in advance whether the reinsurer will accept any part of the insurance, there can also be delay because the policy can't be issued until reinsurance is obtained, and during periods of poor loss experience reinsurance markets tend to tighten and this type may be more expensive and difficult to obtain.

Reinsurance Pool

An organization of insurers that underwrites insurance on a joint basis; formed because a single insurer alone may not have the financial capacity to write large amounts of insurance, but the insurers as a group can combine their financial resources to obtain the necessary capacity. (ex: aviation, nuclear energy exposures, marine insurance, insurance in foreign countries, etc.) Either done by percentages or in an excess-of-loss way where each insurer pays up to a certain point beyond which they all share the loss and pay.

Independent Adjustors

An organization or individual that adjusts claims for a fee; highly trained individuals who adjust claims on a full-time basis; often used by property and casualty insurers when catastrophic loss occurs in a given geographical area and a large number of claims are submitted at the same time; they also include individuals who reside in certain geographical areas where the volume of claims is too low to justify the expense of a branch office with full-time adjustors.

Investments

Because premiums are paid in advance, they can be invested until needed to pay claims and expenses.

Revenues (property/casualty)

Cash inflows that the company can claim as income; two principle sources for an insurance company are premiums and investment income.

Expenses (property/casualty)

Cash outflows; cost of adjusting claims, underwriting expenses (commissions, taxes).

Other professionals important in the insurance industry:

Certified Financial Planner (CFP) Certified Insurance Counselor (CIC)

Types of Claims Adjustors

Claims Adjustors: personnel who adjusts claims -Agents -Staff Claims Representatives -Independent Adjustors -Public Adjustors

Gross Rate

Consists of the pure premium and a loading element

Catastrophe Bonds

Corporate bonds that permit the issuer of the bond to skip or reduce scheduled interest payments if a catastrophic loss occurs; they are complex financial instruments issued by insurers and reinsurers; pay relatively high interest rates and help institutional investors to diversify their portfolios because of the random/unpredictable nature of natural disasters. Made available to institutional investors in the capital markets through an entity called a special purpose reinsurance vehicle (SPRV): they collect premiums from insurers and reinsurers and the principle from bond investors; the funds collected are held in trusts and invested in U.S. government bonds/other highly rated securities. Typically purchased by institutional investors seeking higher-yielding, fixed-income securities; generally not available for direct purchase by individual retail investors.

Judgement Rating (property/casualty)

Each exposure is individually evaluated, and the rate is determined largely by the judgement of the underwriter; used when the loss exposures are so diverse that a class rate cannot be calculated or when credible loss statistics aren't available (ex: ocean/marine insurance because ocean-vessels and waters traveled are so diverse).

Staff Claims Representatives

Employees of an insurer who adjust most claims; typically salaried employees and represent only one insurer; after notice of loss is received, they will investigate the claim, determine the amount of loss, and arrange for payment.

Loss Ratio Method (Loss Reserves)

Establishes aggregate loss reserves for a specific coverage line; under the loss ratio method, a formula based on the expected loss ratio is used to estimate the loss reserve. Expected loss ratio is multiplied by premiums earned during a specific time period; loss and loss-adjustment expenses paid to date are subtracted from the ultimate loss figure to determine to current loss reserve. This method is required for certain lines of insurance (i.e. workers compensation).

Claims Settlement

Every insurance company has a claims department for adjusting claims

Notice of Loss

First step; typically requires the insured to give notice immediately or as soon as possible after the loss has occurred.

Economic and Social impact on the Nation of Life Insurance Investments

First, life insurance contracts and therefore their liabilities are long-term so safety of principle is the primary concern, so the majority of investments are in bonds. Second, investment income is very important in reducing cost of insurance to policyholders because the premiums can be invested and earn interest; the earned interest is reflected in the payment of dividends to policyholders, which reduces the cost of life insurance. Finally, they are an important source of capital funds to the economy; the funds are invested in shopping centers, housing developments, office buildings, hospitals, new plants, and other economic and social programs.

Regulatory Objectives in Rate Making

Goal: to protect the public 1. Rates must be adequate: should be high enough to pay all losses and expenses; if not, the insurer may become insolvent/be unable to pay claims therefore hurting policyholders. Complicated because insurers don't know actual costs when policies are sold. 2. Rates must not be excessive: rates should not be so high that policyholders are paying more than the actual value of their protection. 3. Rates must not be unfairly discriminatory: exposures that are similar with respect to losses and expenses should not be charged significantly different rates (if loss exposures are substantially different it is fair to charge different rates).

Statement of Underwriting Policy

How underwriting starts; an insurer must establish an underwriting policy that is consistent with company objectives; classes of businesses that are acceptable, borderline, and prohibited must be clearly stated, as well as the amounts of insurance that can be written on acceptable and borderline businesses. Underwriting policy is determined by top-level management, and it is stated in detail in an underwriting guide.

Other Reasons for Reinsurance

Insurer can use it to retire from the business or from a given line of insurance or territory; permits the insurer's liabilities for existing insurance to be transferred to another carrier, thus, policyholders' coverage remains undisturbed. Also allows for an insurer to obtain the underwriting advice and assistance of the reinsurer; an insurer may wish to write a new line of insurance that they have little experience with, and the reinsurer can provide valuable assistance with respect to rating, retention limits, policy coverages, etc.

Excess-of-Loss Reinsurance

Is designed largely for protection against a catastrophic loss; he reinsurer pays part or all of the loss that exceeds the ceding company's retention limit up to some maximum level. Can be written to cover a single exposure, a single occurrence, or excess losses when the primary insurer's cumulative losses exceed a certain amount during some stated time period.

Life Insurance Investments

Life insurer divides assets into two accounts: -General Account: fund the contractual obligations for guaranteed fixed dollar benefits, such as traditional whole life insurance death benefits. -Separate Account: fund the liabilities for investment-risk products, such as variable annuities, variable life insurance, and private pension benefits. State laws place restrictions on types of assets in the general account--because life insurance tends to be long term, most investments are in bonds, mortgages, and real estate, only a small percentage in stocks. Less restrictive laws on the separate account, much more invested in stocks.

Tabular Value Method

Loss reserves are determined for claims for which the amounts paid depend on life expectancy, duration of disability, and similar factors (often used to establish loss reserves involving permanent disability, partial permanent disability, survivor benefits, and similar claim); called a "tabular reserve" because the duration of the benefit period is based on data derived from mortality and morbidity tables.

Case Reserves (property/casualty)

Loss reserves that are established for each individual claim when it is reported; major methods of determining include the judgement method, the average value method, and the tabular method.

Filing a Proof of Loss

May be required before a claim is paid; a sworn statement by the insured that substantiates the loss (ex: homeowners insurance: insured would have to indicate the time and cause of the loss, interest of the insured and others in the damaged property, other insurance that may cover the loss, and any change in title or occupancy of the property during the time of the policy).

3. Equity Among Policyholders

Meaning that equitable rates should be charged, and that each group of policyholders should pay its own way in terms of losses and expenses; in other words, one group of policy holders should not unduly subsidize another group (ex: 80 year olds and 20 year olds should not pay the same premium rate for individual life insurance) *because of competition*: if this was to occur and the younger group realized that they were being overcharged they would seek another company with a more equitable system, thus leaving the first company with a disproportionate amount of elderly people and rendering underwriting unprofitable.

2. Selecting Prospective Insureds According to the Company's Underwriting Standards

Meaning that underwriters should only select applicants whose actual loss experience is not likely to exceed the loss experience assumed in the rating structure. The purpose of the underwriting standards is to reduce adverse selection against the insurer ("select or be selected against")

Property and Casualty Insurance Investments

Most assets are invested in securities that can be quickly sold to pay claims if a major catastrophe occurs (high-quality bonds, stocks, and cash). In contrast to life insurance, property insurance contracts short-term in nature (one year or less) and claims are usually settled quickly. Life insurance claims are usually fixed in amount, but property insurance claim payments can vary widely depending on catastrophic losses, inflation, medical costs, construction costs, auto repair costs, the economy, and changing value judgements by society. So, liquidity is very important. Investment income is extremely important in offsetting unfavorable property and casualty underwriting experience; the investment of capital and surplus funds along with funds set aside for loss reserves and the unearned premium reserve, generate investment earnings that usually permit an insurer to continue its insurance operations despite an underwriting deficit.

Insurance Agents

Often have authority to settle small first-party claims up to some maximum limit First-Party Claim: a claim submitted by the insured directly to the insurer (i.e. a small theft) who then has the authority to pay up to some specified amount. Advantages: speedy, reduces adjustment expenses, and preserves the policyholder's goodwill.

Provide Protection Against a Catastrophic Loss

Often these losses occur due to natural disasters, industrial explosions, commercial airline disasters, etc. The reinsurer pays part or all of the losses that exceed the ceding company's retention up to some specified maximum limit.

Gross Premium

Paid by the insured; consists of the gross rate multiplied by the number of exposure units

Liabilities (life)

Policy reserves ("legal reserves") are the main liability--excess premiums paid during early years (they are higher than necessary to pay death claims because premiums paid in later years are insufficient) result in the creation of policy reserves. This is a liability that must be offset by assets of equal value; they represent an obligation of the insurer to pay future policy benefits.

Measuring Financial Performance (life)

Pre-tax or after-tax net income could be compared to total assets to determine performance; rate of return on policyholders' surplus can be used.

Rate

Price per unit of insurance

Assets (life)

Primarily financial assets, just like property/casualty, but 3 main differences: 1. the average duration of investments: life insurance is more long-term than property/casualty which focuses on liquidity 2. life insurance charges interest on life insurance policy loans ("contract loans", "policy loans") 3. life insurance company may have separate account assets because they are not subject to the government restrictions that a life insurance company's general investments are; use separate accounts for assets backing interest-sensitive products (i.e. variable annuities, variable life insurance, and universal-variable life insurance)

Assets (property/casualty)

Primary assets for an insurance company are financial; they invest the money that they get from premiums and retained earnings and invest them in financial assets.

Earned Premiums

Represent the portion of the premiums for which insurance protection has been provided; with the passage of time, the insurer "earns" the premium and can claim it as income under insurance accounting rules.

Public Adjustors

Represents the insured rather than the insurance company, and is paid a fee based on the amount of the claim settlement; may be employed by the insured if a complex loss situation occurs and technical assistance is needed, and also in those cases where the insured and insurer cannot resolve a dispute over a claim.

Agency Department

Responsible for recruiting and training new agents and for supervising general agents, branch office managers, and local agents. Special Agent: a highly specialized technician who provides local agents in the field with technical help and assistance with their marketing problems.

Income and Expense Statement (life)

Revenues: premiums received, investment income Expenses: claims payments, surrender benefits (paid to policyholders who choose to terminate their cash-value life insurance coverage), increased reserves, general expenses, commissions, taxes, fees.

Investigation of the Claim

Second step; an adjustor must determine that a covered loss has occurred and must also determine the amount of the loss; series of questions must be answered before the claim is approved: -Is the person an insured under the policy? -Did the loss occur during the policy period? -Is the cause of loss (peril) covered under the policy? -Is the damaged property covered under the policy? -Are the amount of loss or damages covered under the policy? -Is the location where the loss occurred covered under the policy? -Are there any exclusions that apply to the loss? -Does any other insurance apply to the loss? The insured has a contractual obligation to cooperate with the insurer in the investigation of a claim, and failure to do so can result in denial of the claim.

Incurred-But-Not-Reported (IBNR) Reserve (property/casualty)

Some losses occur near the end of the accounting period but are not reported until the next period, so this is a reserve that must be established for claims that have already occurred but have not yet been reported to the insurer.

Income and Expense Statement

Summarizes revenues received and expenses paid during a specified period of time.

Pure Premium

That portion of the rate needed to pay losses and loss-adjustment expenses

Loading

The amount that must be added to the pure premium for other expenses, profit, and margin for contingencies

Quota-Share Treaty

The ceding company and reinsurer agree to share premiums and losses based on some proportion; the ceding company's retention is stated as a percentage rather than as a dollar amount. Premiums are also shared based on the same percentage, however the reinsurer pays a ceding commission to the primary insurer to help compensate for the expenses incurred in writing the business. Advantage: primary insurer's unearned premium reserve is reduced

Policyholders' Surplus (life)

The difference between a life insurer's total assets and total liabilities; given life insurance's long-term nature, conservative long-term investments, and the lower risk of catastrophic loss, policyholders' surplus is less volatile in life insurance than property/casualty.

Policyholders' Surplus (property/casualty)

The difference between an insurance company's assets and liabilities; not calculated directly, it is the "balancing" item on the balance sheet. If the insurer were to pay all liabilities using assets, this is what would be left. A cushion that can be draw upon if liabilities are higher than expected. Represents the paid-in-capital of investors plus retained income from insurance operations and investments over time; level is a good determinate of the amount of new business a company can write.

A property and casualty insurance company can lose money on its underwriting operations, but still report positive net income IF:

The investment income offsets the underwriting loss.

Professionalism in Selling

The modern agent should be a competent professional who has a high degree of technical knowledge in a particular area of insurance and who also places the needs of his or her clients first. They identify potential insureds, analyzes their insurance needs, and recommends products to meet their needs. After the sale, they have the responsibility of follow-up service and keeping policies up to date. They abide by a code of ethics.

Actuary

The person who determines rates and premiums; highly skilled mathematician, involved in all phases of insurance company operations (including planning, pricing, and research); they study data in order to determine rates and premiums (ex: life insurance: look at data on births, deaths, marriages, disease, employment, etc) with the objective of making the business profitable, competing with other companies, and allowing the company to pay claims and expenses as they occur. Certification determined by examinations administered by the Society of Actuaries (life insurance) or the Casualty Actuarial Society (property and casualty insurance).

Rate Making

The pricing of insurance and the calculation of insurance premiums. The premium paid by the insured is determined by multiplying the rate determined by actuaries by the number of exposure units, and then adjusting by various rating factors. Rate: price per unit of insurance Exposure Unit: the unit of measurement used in insurance pricing (varies by line of insurance)

Treaty Reinsurance

The primary insurer has agreed to cede insurance to the reinsurer, and the reinsurer has agreed to accept the business; all business that falls within the scope of the agreement is automatically reinsured. Advantages (for primary): automatic/no delay, economical because no shopping around for a reinsurer for each case. Disadvantages (for reinsurer): can be unprofitable because they have to rely on the primary's underwriting, premium received could be inadequate. *if a primary insurer consistently cedes unprofitable business to its reinsurers the ceding insurer will find it difficult to operate because reinsurers won't want to do business with it.

Underwriting

The process of selecting, classifying, and pricing applicants for insurance. Underwriter: the person who decides to accept or reject and applicant.

Loss Ratio

The ratio of incurred losses and loss adjustment expenses to premiums earned. = (incurred losses + loss adjustment expenses)/premiums earned

Surplus-Share Treaty

The reinsurer agrees to accept insurance in excess of the ceding insurer's retention limit up to some maximum amount; the retention limit is referred to as a line and is stated as a dollar amount. They share premiums and losses based on the fraction of total insurance retained by each party. Advantage: the primary insurer's underwriting capacity on any single exposure is increased. Disadvantage: increase in administrative expenses (more complex, requires more record keeping).

Production

The sales and marketing activities of insurers; agents who sell insurance are often referred to as producers. It is called this because the company can be set up and built, but until policy is sold no business is produced.

Adverse Selection

The tendency of people with a higher-than-average chance of loss to seek insurance at standard (average) rates, which if not controlled by underwriting, will result in higher-than-expected loss levels.

1. Attain an Underwriting Profit

The underwriter constantly strives to select certain types of applicants and to reject others so as to obtain a profitable portfolio of business

Exposure Unit

The unit of measurement used in insurance pricing

Fundamental purpose of the unearned premium reserve:

To pay for losses that occur during the policy period/to assure policyholders that future losses will be paid. Also necessary so that premium refunds can be paid to policyholders in the event of coverage cancellation (if a policyholder cancels a policy, a full pro rata premium refund based on the unexpired portion of the policy term must be paid to them). Finally, if the business is reinsured, the unearned premium reserve serves as the basis for determining the amount that must be paid to the reinsurer for carrying the reinsured policies until the end of their terms.

How does pricing insurance differ from pricing normal consumer products?

With products producers generally know the cost of production beforehand, so prices can be set to cover costs and produce profit. With insurance costs are not known beforehand, so the premiums charged may or may not be enough to cover claims and expenses and yield a profit. An insurer can only determine losses and expenses after the period of protection has expired.