Finance 431: Property-Liability Insurance Lecture 2: Overview of Insurance Operations

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Finance 431Property-Liability
InsuranceLecture 2 Overview of Insurance
Operations
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Overview of Insurance Operations

• Types of Insurers
• Risk Transfer Process
• Objectives of Insurers
• Constraints of Achieving Objectives
• Measurement of Insurer Performance
• Functions Required to Meet Needs
• Interdependence Among Functions

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Types of Insurers

• Legal Form of Ownership
• Proprietary Insurers
• Stock Insurance Companies
• Lloyds
• Insurance Exchanges
• Cooperative Insurers
• Mutual Insurance Corporations
• Reciprocal Exchanges
• Captive Insurers
• Risk Retention Groups and Purchasing Groups
• Fraternal Organizations

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Types of Insurers

• Other Insurers
• Health Maintenance Organizations (HMOs)
• Blue Cross-Blue Shield
• Banks
• Pools and Associations
• Governmental Insurers
• Workers Compensation
• Mine Subsidence
• Federal Insurance Programs

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Place of Incorporation and Licensing Status

• Domestic - incorporated in that state
• Foreign - incorporated in another state
• Alien - incorporated in another country
• Admitted - licensed to provide insurance in a
  state
• Nonadmitted - operating without a license
• Surplus lines brokers can place business with
  nonadmitted insurers if admitted insurers will
  not write the coverage

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Principal Steps in Risk Management

1. Identify and analyze loss exposure
2. Select technique(s) to handle loss exposure
3. Implement the chosen technique(s)
4. Monitor results and implement necessary changes

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Risk Transfer Process

• Risk Manager
• Consultants
• Insurance Agents and Brokers
• Insurers

• Insurance Functions
• Policy contract development
• Pricing
• Marketing
• Underwriting
• Loss adjustment
• Loss control
• Reinsurance
• Investments

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Objectives of Insurers

• Profit Objective
• Customer Needs Objective
• Determinants of Insurance Cost
• 1. Losses
• 2. Expenses
• 3. Profit
• Legal Requirement Objective
• Humanitarian and Societal Objectives
• Contributions
• Employee benefits

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Constraints on Achieving Objectives

• Internal
• Efficiency
• Expertise
• Size
• Financial Resources
• Miscellaneous
• Market recognition
• Poor reputation

• External
• Regulation
• Public Opinion
• Competition
• Economic Conditions
• Recession
• Inflation
• Investment results
• Distribution Systems
• Miscellaneous
• Catastrophes

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Measurement of Insurer Performance

• Profit Measurement
• Problems in Measuring Profitability
• Catastrophes
• Loss Reserve Inaccuracy
• Premium Volume
• Impact of Growth

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Components of Profit Measurement

• Expense Ratio
• Loss Adjustment Expenses/Earned Premium
• Other Expenses/Written Premium
• Loss Ratio
• Incurred Losses/Earned Premium

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Components of Profit Measurement

• Combined Ratio
• Statutory
• Incurred Losses LAE Incurred Expenses
• Earned Premiums Earned Premiums
• Trade Basis
• Incurred Losses LAE Incurred Expenses
• Earned Premiums Written Premiums

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Combined Ratio Example

• Written Premium 100 million
• Earned Premium 95
• Incurred Losses and LAE 76
• Underwriting Expenses 19
• Statutory Combined Ratio
• 76 19 100
• 95 95
• Trade Basis Combined Ratio
• 76 19 99
• 95 100

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Components of Profit Measurement

• Investment Earnings
• Investment Income
• Interest
• Dividends
• Rents
• Realized Capital Gains or Losses
• Unrealized Capital Gains or Losses
• Operating Ratio
• Combined Ratio - Investment Earnings/Earned
  Premium

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Property-Liability Industry Profitability

• Combined Operating
• Year Ratio NII/EP Ratio
• 1995 106.4 14.5 91.9
• 1996 105.8 14.4 91.4
• 1997 101.6 15.3 86.3
• 1998 106.0 14.6 91.4
• 1999 108.0 14.0 94.0
• 2000 110.4 14.0 96.4
• 2001 115.9 12.2 103.7
• 2002 107.4 11.2 96.2
• 2003 100.1 10.2 89.9
• 2004 98.1 9.7 88.4
• Source Bests Aggregates and Averages
  Property/Casualty Edition 2005 U.S. Industry
  Ratios pp. 397-398

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Measurement of Insurer Performance

• Meeting Customers Needs
• Meeting Legal Requirements
• Meeting Social Responsibilities

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Functions Required to Meet Needs

• Marketing
• Underwriting
• Claims
• Loss Control
• Reinsurance
• Actuarial
• Investments

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Interdependence Among Functions

• Marketing and Underwriting
• Underwriting and Loss Control
• Loss Control and Marketing
• Claims and Other Departments
• Actuarial and Other Departments