Chapter 1: Insurance products - background Flashcards
Conditions for a risk to be insurable
- policyholder must have an interest in the risk being insured to distinguish between insurance and gambling
- risk must be of financial and reasonably quantifiable nature
- amount payable by insurance policy in the event of a claim must bear some relationship to the financial loss incurred
Criteria of insurable risk
- inidividual risk events should be independent
- probability of risk event should be relatively small
- large numbers of similar risks should be pooled to reduce the varaiance of the average claim size and hence achieve more certainty
- should be overall limit on liability undertaken by the insurer
- moral hazards should be eliminated as far as possible
- should be existing sufficient statistical data/information to estimate the size and likelihood
Moral hazard
The risk that the insured may behave in a less risk averse manner when they are insured
Uberrima fides
Latin for “utmost good faith”
The honesty principle is assumed to be observed by the parties to an insurance or reinsurance contract. An alternative form is uberrimae fidei: “of the utmost good faith”
Misrepresentation/non-disclosure of material fact in the proposal can make the policy void.
Possible reasons for Nil claims
- claim is found not to be valid
- amount of the loss turns out to be no greater than the excess
- policyholder has reported a claim to comply with the conditions of the policy, but has elected to meet the costs to be able to preserve entiltlement to no-claims discount
Nil claim
Claim that results in no payment by the insurer
Why is underinsurance a hazard to the insurer?
The insurer bases premium rates on expected claim amounts. It takes into account frequency and expected size of claim.
Higher sum insured = higher premium. Therefore, with underinsurance, there is a risk that the premiums are inadequate.
Principle of average
If the sum insured is less than the full value of a property at the time of a loss the insurance payment will only be a proportion of the value of the loss
The same proportion as the sum insured bears to the full value
First loss
Form of insurance cover for which the chosen sum insured is restricted, with the insurer’s agreement, to a figure less than the full reinstatement-as-new value of the property.
Insured bears any loss in excess of the sum insured
Subrogation
The substitution of one party for another as creditor, with a tranfer of rights and responsibilities. This means that:
- insurer replaces policyholder in law
- acquires all rights and responsibilities in legal matters regarding the loss suffered (before of after claim has been settled)
Discovery period
A time limit, defined in policy wording or through legislative precedent, placed on the period within which claims must be reported.
Underwriting
Process of consideration of insurance risk on individual policies.
Includes assessing whether risk is acceptable and if so:
- Appropriate premium
- Terms and conditions of the cover
The term is also used to denote the acceptance of reinsurance and the transacting of insurance business.
The policy document
Legally binding contract that sets out the terms and conditions under which an insurer is liable to pay insurance claims in specific circumstances.
A schedule (on a policy document)
Policy forms are normally standard for all personal lines business and small commercial policies, in the sense that the insurer will issue the same wording to all policyholders.
Items that vary between policyholders will be included in a schedule.
Common items in a schedule
- details of vehicle/property/people covered
- excess applied
- any limits on the cover
- exclusions
- time limits (e.g. hours clause)
- whether/no any optional covers have been taken
- details of insurance premium paid
Aims of having an excess
- reduce amount of each claim
- reduce the number of claims
- eliminates small claims just above the excess
- encourages policyholders to be more careful
- allows company to reduce premiums and appear more competitive
Deductible
A portion of a loss that is paid by the policyholder. It may be an amount of percentage.
Exclusions
Clauses in a policy that limit the circumstances in which a claim may be paid.
Examples of common exclusions
- self-inflicted injuries (for personal-accident benefits)
- dangerous pastimes
- loss resulting from an illigal activity by the policyholder
- war, terrorism, civil riots
Exclusions are used to avoid payment by the insurer in situations where:
- policyholder is at an advantage through possessing greater personal information about the likelihood of a claim
- claim event is largely under the control of the policyholder
- claim event would be difficult to verify
- loss occurs as part of the normal course of events and could be considered to be depreciation
SASRIA
South African Special Risks Insurance Association
SASRIA insures extraordinary risks that conventional insurers are reluctant or unable to cover such as damages arising from civil unrest, terrorism, labour action etc.
War risk is specifically excluded.
Reasons for applying exclusions to an insurance policy
To avoid payment in situations where:
- policyholder is at an advantage through possessing greater personal information about the likelihood of a claim
- claim event is largely under the control of the policyholder
- claim event would be difficult to verify
- loss occurs as part of the normal course of events and could be considered to be depreciation
Where risk can’t be reliably estimated by the insurer
When the probability of loss is very high
Risk is covered by a third party such as the government
Limit the scope of the policy to make it more appropriate for a particular target market
Reduce premium for competitive reasons
Reduce the risk of moral hazard and fraud
Types of general insurance cover
- liability
- property damage
- financial loss
- fixed benefits
Liability insurance
Indemnity against the risk of being held legally liable to pay compensation to a third party
Examples of liability insurance
- Employers’ liability
- Motor third party liability
- Product liability
Property damage
Indemnity to the insured for loss of, or damage to, the policyholder’s own property
Examples of property damage insurance
- motor insurance
- buildings insurance (includes both residential and commercial buildings)
- contents insurance
Financial loss insurance
Indemnifies the insured against financial losses arising from certain causes.
Examples of financial loss insurance
- creditor insurance
- business interruption cover
Creditor insurance
Where the policy will make regular loan repayments if the policyholder becomes disabled (so that they can’t work) or otherwise unemployed
Business interruption cover
Where the policy will pay out to compensate the policholder for not being able to conduct their business, e.g. as a result of a fire in the building
Fixed benefit insurance
Benefits are specified, fixed amounts, payable on certain losses occuring, which may or may not be enough to compensate the policyholder for the full loss incurred.
Example: personal accident insurance, where insured receives fixed amount on suffering a specified injury.
Personal lines business
Insurance products sold to individuals. Include private motor, domestic household, personal accident and travel insurance.
Commercial lines business
Insurance products sold to businesses. AKA group business
Supported policies
Policies for small businesses that ofetn include all types of cover the business needs apart from motor.
Main feature considerations of insurance products
- benefits
- insured perils
- basis for cover
- measures of exposure to which premiums are related
- claim characteristics
- risk factors and rating factors
Peril
A type of event that may cause a loss that may or may not be covered by an insurance policy. An insured peril is one for which insurance cover is provided as opposed to an excluded peril for which insurance cover is not provided.
Types of basis for cover
- Losses-occurring policy
- Claims-made policy
- Risks-attaching basis
Losses-occurring policy
A policy providing cover for losses occuring in the defined period no matter when they are reported. Cover is provided if the loss occurs while the insurance policy is active
AKA claims-occurring policy
Claims-made policy
Covers all claims reported to an insurer within the policy period irrespective of when they occured. Even if claim event happened when policy was not active, it will still be paid if the policy is in force when the claim is reported.
AKA claims-reported policy
Exposure measure
An indication of the level of risk a policy presents to the insurer.
Pure risk premium
The premium required to cover the expected claim amount only. No allowance is made for expenses or profit.
Key criteria of a measure of exposure
- Should be a good measure of the amount of risk, allowing for expected frequency and severity of claim. Total expected claim amount should be proportional to exposure
- Should be practical:
- objectively measurable
- easily obtainable
- easily verifiable
- not open to manipulation.
Things that need to be confirmed before a claim can be settled
- whether or not there has been a loss
- whether the insurer is liable (and whether the insurer is liable)
- amount of the loss (and claim settlement amount)
Claim characteristics
Refer to the amount that becomes payable for a given claim and the ways in which and the speed with which the claims:
- originate
- are notified
- are settled and paid
- are reopened (on occasion)
Also refer to the frequency with which claims are made
Things to consider when assessing claim characteristics
- delays (reporting and settlement) and whether claims are short-tailed or long-tailed
- claim frequency
- claim severity/amount (allowing for accumulations, catastrophes etc.)
Risk factors
A factor that is expected, possibly with the support of statistical evidence, to have an influence on the intensity of risk of an insurance factor.
A factor that is expected—potentially supported by statistical evidence—to affect the level of risk associated with an insurance variable
Rating factor
A factor used to determine the premium rate for a policy which is measurable in an objective way and relates to the intensity of the risk. it must be a risk factor or a proxy for a risk factor(s)
Underwriting factor
Any factor that is used to determine the premium, terms and conditions of a policy. It may be a rating factor or some other risk factor that is accounted for in a subjective manner by an underwriter.
Combining exposure measures, risk factors and rating factors
- More heterogenous a class of business and types of risks covered, the greater the number of risk factors needed to identify/define amount of risk
- Better the measure of exposure in identifying the amount of risk, the lesser the importance of other rating factors to quantify the risk not accounted for by the exposure measure
- Choice of rating factors depend on the choice of exposure measure
Factors that affect the level of risk and uncertainty in a class of business
- homogeneity of risks
- non-independence of risks
- changing risks
- numbers of claims
- claim cost
- claim inflation
- delay patterns
- variability of experience
- accumulations
- fraudulent claims
Solvency capital
Capital held over and above a general insurer’s technical reserves
