Assignment 6: Overview of Insurance Operations Flashcards
Five Major Goals for Insurers
- Earn a profit
- Meet customer needs (conflicts with 1)
- Comply with legal requirements (conflicts with 1 and 2)
- Diversify risk (complements 1 and 5)
- Fulfill duty to society: minimum is to avoid causing public harm (conflict with other goals due to funds used)
Cooperative Insurers
Insurers owned by their policyholders and usually formed to provide insurance protection to their policyholders at minimum cost.
Mutual insurance companies, reciprocal exchanges, and fraternal organizations are examples of cooperative insurers. Other cooperatives include captive insurers, risk retention groups, and purchasing groups.
Proprietary Insurer
An insurer formed for the purpose of earning a profit for its owners; must earn profit to provide return on investment made by stockholders
This includes stock insurers (most prevalent type in the U.S.), Lloyd’s of London and American Lloyds, and insurance exchanges (like a marketplace)
Internal Constraints on Achieving Insurer Goals
- Efficiency
- Expertise
- Size
- Financial Resources
- Other Internal Constraints: these include lack of name or brand recognition or a damaged reputation
External Constraints on Achieving Insurer Goals
- Regulation
- Rating Agencies
- Public Opinion
- Competition
- Economic Conditions
Principal Function of Insurers
Acceptance of risks that others transfer to it through the insurance mechanism
Four Ways to Classify Property-Casualty Insurers
- Legal Form of Ownership: proprietary insurers, cooperative insurers, and other insurers (pools and government insurers)
- Place of Incorporation: domestic (in-state), foreign (out-of-state), alien (international)
- Licensing Status: admitted or non-admitted
- Insurance Distribution Systems and Channels: Independent agency and brokerage marketing system, direct writer marketing system, and exclusive agency marketing system
Lloyds
Lloyds are marketplaces (like a stock exchange) whose members are investors hoping to earn a profit from insurance operations; there are Lloyd’s of London and American Lloyds (which are smaller)
Reciprocal Insurance Exchanges
Also called a reciprocal, they consist of a series of private contracts in which subscribers, or members of the group, agree to insure each other; each member is both an insured and an insurer
Mutual Insurer
An insurer that is owned by its policyholders and formed as a corporation for the purpose of providing insurance to them; retained profits ensure its future financial health
Fair Access to Insurance Requirements (FAIR) plans
An insurance pool through which private insurers collectively address an unmet need for property insurance on urban properties, especially those susceptible to loss by riot or civil commotion
Residual Market
The term referring collectively to insurers and other organizations that make insurance available through a shared risk mechanism to those who cannot obtain coverage in the admitted market
Surplus Lines Broker
A person or firm that places business with insurers not licensed (non-admitted) in the state in which the transaction occurs but that is permitted to write insurance because coverage is not available through standard market insurers
Independent Agency and Brokerage Marketing System
An insurance marketing system under which producers (agents or brokers), who are independent contractors, sell insurance, usually as representatives of several unrelated insurers
Direct Writer Marketing System
An insurance marketing system that uses sales agents (or sales representatives) who are direct employees of the insurer
Exclusive Agency Marketing System
An insurance marketing system under which agents contract to sell insurance exclusively for one insurer (or for an associated group of insurers)
Distribution Channel
The channel used by the producer of a product or service to transfer that product or service to the ultimate customer
Meeting Profitability Goals
The following assist in understanding insurer profitability:
- Premiums and Investment Income
- Underwriting Performance
- Overall Operating Performance
- Estimation of Loss Reserves
These are more objective measures
Premiums and Investment Income (Profitability Goal)
Premium growth should not be from an increase in individual premium amounts, but from an increase in total premium
It is important to consider whether the growth resulted from a competitive advantage, relaxed underwriting, inadequate insurance rates, or a combination of these factors
Underwriting Performance (Profitability Goal)
Net Underwriting Gain or Loss = Earned Premiums - (Incurred Losses + Underwriting Expenses)
Three ratios are also used to measure underwriting performance:
- Loss Ratio
- Expense Ratio
- Combined Ratio (trade basis)
Loss Ratio
Incurred Losses (including LAE) / Earned Premiums
Expense Ratio
Incurred Underwriting Expenses / Written Premiums
Combined Ratio (trade basis)
Loss Ratio + Expense Ratio
Overall Operating Performance (Profitability Goal)
Overall Gain or Loss from Operations = Net Underwriting Gain or Loss + Investment Gain or Loss
Ideally, the investment profit is more than enough to offset the underwriting loss so the insurer has an overall gain from operations
A few measures are also used to determine overall operating performance:
- Investment Income Ratio
- Overall Operating Ratio
- Return on Equity
Investment Income Ratio
Net Investment Income / Earned Premiums
Overall Operating Ratio
Combined Ratio (trade basis) - Investment Income Ratio
Return on Equity
Net Income / Owners’ Equity
Estimation of Loss Reserves (Profitability Goal)
A pattern of under-reserving or over-reserving may ultimately lead to the insurer’s insolvency
Meeting Customer Needs
The following are considerations when evaluating whether the goal of meeting customers needs has been upheld:
- Complaints and Praise
- Customer Satisfaction Data
- Insurer’s Retention Ratio and Lapse Ratio
- Insurer-Producer Relationship
- State Insurance Department Statistics
- Consumer Reports
These are more subjective measures
Meeting Legal Requirements
An insurer’s success or failure in meeting legal requirements is indicated by the number of criminal, civil, and regulatory actions taken against the insurer; This can most easily be monitored through regulatory oversight (called market conduct regulation) and financial rating agencies
These are more objective measures
Meeting Social Responsibilities
No standard exists for performance judgement, but insurers have their own records and often publicize community efforts/initiatives on their websites, along with many employee benefits
These are more subjective measures
Core Functions (for Insurers)
- Marketing and Distribution
- Underwriting
- Claims
Underwriting
The process of selecting insureds, pricing coverage, determining insurance policy terms and conditions, and then monitoring the underwriting decisions made
Adverse Selection
In general, it is the tendency for people with the greatest probability of loss to be the ones most likely to purchase insurance
Supporting Functions (for Insurers)
- Risk Control: provides information to the underwriting function to assist in selecting and rating risks
- Premium Auditing: ensure equitable treatment of insureds by reviewing records to obtain accurate information on rating variables
- Actuarial
- Reinsurance
- Information Technology: provides the infrastructure that supports all of an insurer’s internal and external communications
Other Common Functional Areas (for Insurers)
- Investments
- Accounting and Finance
- Customer Service
- Legal and Compliance
- Human Resources
- SIUs (Special Investigation Units): established to combat insurance fraud
Fundamental Building Blocks of the Digitization of Insurance
- Data Capture: Expanding Data Sources (IoT, telematics sensors)
- Data Storage: The Blockchain (cloud computing, blockchain)
- Data Analytics: Advanced Analytics (AI, ML, often used to identify and prevent fraud)
The Blockchain
A virtual distributed ledger that maintains a dynamically updated list of data records; the records are recorded once they are encrypted, from a trusted source, and independently verified (through mining)
The Internet of Things (IOT)
The universal connectivity that allows people to interact with devices and for those devices to meaningfully interact with each other without human interaction
An insurer’s claims function can be transformed through the IoT’s ability to facilitate instantaneous communication between objects and people, which can make claims handling more efficient
