Chapter 4: Insurance Company Operations Insurance Company Functions • Underwriting • Reinsurance • Claims adjusting • Rate making • Investing • Other functions Underwriting • 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 exams) Most UW is by salaried EEs in Home Office Purposes of Reinsurance Reinsurance – transfer portion of all risk to another insurer – Primary company issues policy and pays claims • PRIMARY IS PAID BY REINSURURER – Usually transparent to policyowner (P/O DOES NOT HAVE TO BE NOTIFIED) • 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 risks 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 interests. 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 Rate – Price charged for each unit of coverage (cost of insurance) – Establishing price to be charged for insurance based on prediction of future loss costs plus margins for expenses (loading) and profit Premium – 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 Death 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 insureds – 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 Investing 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 income. – 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 paid) 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.