Assignment 6: Overview of Insurance Operations

Question 1

Five Major Goals for Insurers

Answer 1

1. Earn a profit
2. Meet customer needs (conflicts with 1)
3. Comply with legal requirements (conflicts with 1 and 2)
4. Diversify risk (complements 1 and 5)
5. Fulfill duty to society: minimum is to avoid causing public harm (conflict with other goals due to funds used)

Question 2

Cooperative Insurers

Answer 2

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.

Question 3

Proprietary Insurer

Answer 3

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)

Question 4

Internal Constraints on Achieving Insurer Goals

Answer 4

• Efficiency
• Expertise
• Size
• Financial Resources
• Other Internal Constraints: these include lack of name or brand recognition or a damaged reputation

Question 5

External Constraints on Achieving Insurer Goals

Answer 5

• Regulation
• Rating Agencies
• Public Opinion
• Competition
• Economic Conditions

Question 6

Principal Function of Insurers

Answer 6

Acceptance of risks that others transfer to it through the insurance mechanism

Question 7

Four Ways to Classify Property-Casualty Insurers

Answer 7

1. Legal Form of Ownership: proprietary insurers, cooperative insurers, and other insurers (pools and government insurers)
2. Place of Incorporation: domestic (in-state), foreign (out-of-state), alien (international)
3. Licensing Status: admitted or non-admitted
4. Insurance Distribution Systems and Channels: Independent agency and brokerage marketing system, direct writer marketing system, and exclusive agency marketing system

Question 8

Lloyds

Answer 8

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)

Question 9

Reciprocal Insurance Exchanges

Answer 9

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

Question 10

Mutual Insurer

Answer 10

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

Question 11

Fair Access to Insurance Requirements (FAIR) plans

Answer 11

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

Question 12

Residual Market

Answer 12

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

Question 13

Surplus Lines Broker

Answer 13

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

Question 14

Independent Agency and Brokerage Marketing System

Answer 14

An insurance marketing system under which producers (agents or brokers), who are independent contractors, sell insurance, usually as representatives of several unrelated insurers

Question 15

Direct Writer Marketing System

Answer 15

An insurance marketing system that uses sales agents (or sales representatives) who are direct employees of the insurer

Question 16

Exclusive Agency Marketing System

Answer 16

An insurance marketing system under which agents contract to sell insurance exclusively for one insurer (or for an associated group of insurers)

Question 17

Distribution Channel

Answer 17

The channel used by the producer of a product or service to transfer that product or service to the ultimate customer

Question 18

Meeting Profitability Goals

Answer 18

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

Question 19

Premiums and Investment Income (Profitability Goal)

Answer 19

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

Question 20

Underwriting Performance (Profitability Goal)

Answer 20

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)

Question 21

Loss Ratio

Answer 21

Incurred Losses (including LAE) / Earned Premiums

Question 22

Expense Ratio

Answer 22

Incurred Underwriting Expenses / Written Premiums

Question 23

Combined Ratio (trade basis)

Answer 23

Loss Ratio + Expense Ratio

Question 24

Overall Operating Performance (Profitability Goal)

Answer 24

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

Question 25

Investment Income Ratio

Answer 25

Net Investment Income / Earned Premiums

Question 26

Overall Operating Ratio

Answer 26

Combined Ratio (trade basis) - Investment Income Ratio

Question 27

Return on Equity

Answer 27

Net Income / Owners’ Equity

Question 28

Estimation of Loss Reserves (Profitability Goal)

Answer 28

A pattern of under-reserving or over-reserving may ultimately lead to the insurer’s insolvency

Question 29

Meeting Customer Needs

Answer 29

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

Question 30

Meeting Legal Requirements

Answer 30

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

Question 31

Meeting Social Responsibilities

Answer 31

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

Question 32

Core Functions (for Insurers)

Answer 32

1. Marketing and Distribution
2. Underwriting
3. Claims

Question 33

Underwriting

Answer 33

The process of selecting insureds, pricing coverage, determining insurance policy terms and conditions, and then monitoring the underwriting decisions made

Question 34

Adverse Selection

Answer 34

In general, it is the tendency for people with the greatest probability of loss to be the ones most likely to purchase insurance

Question 35

Supporting Functions (for Insurers)

Answer 35

• 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

Question 36

Other Common Functional Areas (for Insurers)

Answer 36

• Investments
• Accounting and Finance
• Customer Service
• Legal and Compliance
• Human Resources
• SIUs (Special Investigation Units): established to combat insurance fraud

Question 37

Fundamental Building Blocks of the Digitization of Insurance

Answer 37

1. Data Capture: Expanding Data Sources (IoT, telematics sensors)
2. Data Storage: The Blockchain (cloud computing, blockchain)
3. Data Analytics: Advanced Analytics (AI, ML, often used to identify and prevent fraud)

Question 38

The Blockchain

Answer 38

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)

Question 39

The Internet of Things (IOT)

Answer 39

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