Chapter 4:
Insurance Company Operations
Insurance Company Functions
• Underwriting
• Reinsurance
• Claims adjusting
• Rate making
• Investing
• Other functions
• Selection, classification and pricing of insurance
applications offered to an insurer
• Accept applicants who will have loss experience
comparable to insurer’s expected loss experience
• Minimize adverse selection
• Achieve mass (large numbers) and homogeneity
• Agent is field underwriter – first step – face contact
• Performed by employees in insurer’s home office
Sources of Underwriting Information
Applicant- signed statements
Agent – signed statements
– First Step in Underwriting (“A Field Underwriter”)
Insurer’s inspection or claims department
Insurer bureaus and associations (MIB)
Outside agencies - D&B, Credit Agencies, Motor
Vehicle, Court records, Inspection companies,
Medical companies (paramedical and medical
Most UW is by salaried EEs in Home
Purposes of Reinsurance
Reinsurance – transfer portion of all risk to another
– Primary company issues policy and pays
– Usually transparent to policyowner (P/O DOES
• Primary insurer can write higher limits – retention
limits – maximum on one life
• Spreading losses enhances insurers’ financial
strength and stabilizes mortality experience
• Reinsurers provide technical advice and specialty
Types of Reinsurance
Treaty (Automatic) Reinsurance
– Primary insurer agrees in advance to cede
(transfer) a portion of some types of loss
exposures covered by the primary insurer
– Reinsurer agrees to accept them automatically
Facultative Reinsurance
– Optional for both primary insurer and reinsurer
– Handled on case-by-case basis
– Each party retains “faculty” or privilege of
accepting or rejecting reinsurance
Types of Insurance Adjusters
• Insurance agents (property-liability for small losses)
• Insurance company employees- staff adjuster,
claims examiner or claims analyst
• Independent adjusters
– Work for INSURERS to handle claims
• Public adjusters
– Represent the policyowner for a fee. Help
through process and defend policyowner
Claims Process
1. Policyowner furnishes notice of loss
2. Insurer investigates claim
3. Policyowner files proof of loss
4. Insurer pays, denies, negotiates
Details vary by line of insurance.
Rate vs. Premium
– Price charged for each unit of coverage (cost of
– Establishing price to be charged for insurance based
on prediction of future loss costs plus margins for
expenses (loading) and profit
– Gross premium- Price charged for coverage
provided by policy
– Determined by multiplying rate times number of units
of coverage
– Net Premium - no expense loading - the amount
needed to pay future claims
Pure (Net) Rate
• Portion of the rate that is designed to
cover future losses (without loading for
expenses, profit, etc.)
Risk of
AGE (yrs)
Rate Making
• Property and liability
- Advisory Organization assists insurers by collecting
loss statistics or submitting rating recommendations.
Example: ISO- Insurance Services Office
– Loss ratios - adjustment of premium for experience
(actual losses vs. assumed losses. Losses/ premium
• Life uses mortality tables and experience.
• Health uses morbidity tables and experience
Class Rate vs. Specific Rate
• Class rate - group rate with average price
that applies to each category of similar
– Example: personal auto insurance
• Specific (schedule) rate - rate for specific
situation based on schedule that evaluates
unique hazards
– Example: property insurance on factory building,
World Trade Center
Life Insurance Rate Making
• Net single premium per $1000
– Amount needed today to pay all claims within
a class of insureds. Calculated by discounting
timing and amount of assumed future claims
and interest.
• Net level annual premium per $1000
– Net single premium spread over policy’s
premium-paying period.
– Gross premium adds loading for
commissions, taxes, expenses,
contingencies, and profit
Funds not immediately needed for operating
expenses or claims are invested
•Investment earnings lower the premiums
•Generates profit for insurer
•Provides competitive return for cash value life
insurance policyowner
•Investment objective is safety of principal and
– Life insurers use long-term, highly rated
government and corporate bonds.
– Stocks about 32%. Table 4-1
Insurance Company Investments
(Table 4-1)
• Life Insurers > Non-life Insurers
• Non-life > Cash & Cash Equivalents (to
pay frequent claims)
• Non-Life > Bonds
• Life > Stocks (longer time until claims
Other Insurer Functions
• Legal
• Actuarial
• Public relations
• Education and training
• Accounting
• Information technology
• Personnel management
• Purchasing
Self-Test Questions – Chapter 4
1. The purpose of underwriting is to select only those
insureds who are expected to have no losses.
2. Among other things, reinsurance can help insurers
spread large losses and reduce the surplus drain
associated with writing new business.
3. Under facultative reinsurance, the insurer agrees in
advance to transfer some types of risks, and the
reinsurer agrees to accept those risks.
4. The purpose of the claims settlement process is to
determine the insurer’s liability for a given loss and to
reach agreement with respect to the amount of loss or
damage payable under the insurance contract.
5. Most life insurance agents have their companies’
authority to settle claims.