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INFORM+INSPIRE The Griffith Insurance Education Foundation Risk Management Principles and The Role of Insurance David T. Russell, Ph.D. Director, CSUN.

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Presentation on theme: "INFORM+INSPIRE The Griffith Insurance Education Foundation Risk Management Principles and The Role of Insurance David T. Russell, Ph.D. Director, CSUN."— Presentation transcript:

1 INFORM+INSPIRE The Griffith Insurance Education Foundation Risk Management Principles and The Role of Insurance David T. Russell, Ph.D. Director, CSUN Center for Risk and Insurance March 14-15, 2013

2 What is Risk?  In short, Risk = Uncertainty  Two Kinds of Risk  Pure Risk: Possibility of Loss  Speculative Risk: Possibility of Profit or Loss  Example of Pure Risk: Driving a Car  Example of Spec Risk: Buying a Stock The Griffith Insurance Education Foundation

3 Risk Management  RM is Treatment of Exposure to Risk  Five Main Methods of Risk Management  Avoidance (Refrain from Activity)  Retention (Accept the Possibility of Loss)  Loss Control (Steps to Reduce Freq or Sev)  Non-Insurance Transfer (ex: Hold Harmless)  Insurance (Transfer to a Pool for Premium)  Usually, RM is a Combination of Methods The Griffith Insurance Education Foundation

4 Insurance  Insurance Transfers Risk to a Pool  “Shares” Risk with Other Similar Risks  An Insurance Policy is a Contract  Adjudicated and Regulated by State Law  Designed to Indemnify Policyholder  “Insured” Should Not Profit from a Loss  Profiting from Loss Contrary to Public Policy The Griffith Insurance Education Foundation

5 The Insurance Purchase Decision  One or More Reasons to Buy Coverage  Required by Law, Lenders or Others  Buyer is Risk Averse or Unsure About Risks  Coverage is Mispriced (Rare)  One or More Reasons NOT to Buy  Buyer Cannot Afford or Has Other Priorities  Coverage Perceived as too Expensive  Risk is Better Managed in Other Ways  Coverage Not Needed The Griffith Insurance Education Foundation

6 Insurance is NOT Gambling  Insurance Transfers Existing Pure Risk  Gambling Creates New Speculative Risk  Insurer Reduces Risk by Pooling  Like Any Contract, Consideration a Must  Aleatory: Consideration is Unequal The Griffith Insurance Education Foundation

7 Underwriting  UW is Selection/Classification of Risk  EQ Example for School  UW Uses Application, MVR, MIB, Other  Some UW Factors Illegal (Ex: Race)  Underwriters Place Risks in Right Pool  Insurer Loses $ if Many Risks Declined The Griffith Insurance Education Foundation

8 Moral Hazard  Simply Put, Ins Changes Behavior  Carelessness—Less Vigilant if Insured  Increased Utilization—Visit Doctor More  FDIC—Pursue High Rate, Despite Risk  Fraud—If Insured, Policyholder May Intentionally Cause Losses to Collect Money  Result—Higher Claims  How to Prevent MH? Law, Contract, UW The Griffith Insurance Education Foundation

9 Adverse Selection  AS is Tendency of Risks to Seek Coverage at Lower Rates  Ex: “All-You-Can-Eat” Pricing  Ex: Unisex Pricing Option  Example: “No Medical Exam”  Result: Without Underwriting, Ins Pools Tend to End Up With High Risks  Low Risks Tend to Drop Out The Griffith Insurance Education Foundation

10 The Insurance Mechanism  Pooling of Similar Risks  Ex: 10,000 Toyota Camrys  Using Historical Data, Losses Can Be Predicted and Priced  Appropriate Insurance Concepts  “Law of Large Numbers”  “In the Long Run”  “Diversified Portfolio” The Griffith Insurance Education Foundation

11 Insurable Risks  Large Number of Exposures  Losses Are Accidental and Random  Losses Are Determinable & Measurable  Chance of Loss is Calculable (Pricing)  Premium is Economically Feasible  Losses Are Not Correlated*  Gov’t May Handle Uninsurable Risks The Griffith Insurance Education Foundation

12 The Insurance Mechanism  Critical: Losses Cannot Be Correlated  Correlated Risks: EQ, Flood, Unemploy Ins  Capital Required to Back Promises  Losses Can Exceed Expectations  Usually, Capital is Called Equity or Net Worth  Insurer Capital is Called “Surplus”  Surplus is Cushion Against Unexpected  Surplus Expects a Return in Normal Times The Griffith Insurance Education Foundation

13 Simplified Pricing Example  10,000 Toyota Camrys  Assume Avg Claim is $250 per 6 Months  Insurer Must Add Expenses and Profit  Assume 15% for Corporate/Underwriting  Assume 15% for Commission  Assume 5% for Profit  $250 + 35% = $337.50 Avg Per Six Months (Some Drivers Pay More, Less) The Griffith Insurance Education Foundation

14 Other Pricing Considerations  Claims or Expenses May Come in High  Owners Lose Money in “Bad” Periods  Insurers May Purchase Reinsurance  Insurer Receives Investment Income  Premiums Received Before Claims Paid  Investment Holdings Regulated  Investment Risks Can Affect Solvency The Griffith Insurance Education Foundation

15 Rate Regulation  CA Requires Prior Approval for Auto, HO  Market Forces Also Keep Rates Low  Mature Mkt Means Fierce Competitors  Consumers Benefit from Competition  Inadequate Rates Threaten Everyone  Insolvency Costs Spread to Other Cos.  State Guaranty Fund Assessments The Griffith Insurance Education Foundation

16 Rate Regulation  Pricing Reflects Costs and Market Structure  Ins “Cost” is a Forecast, Rather than Known  Pricing Should Not Be Unfairly Discriminatory  Rates Should Be Adequate, But Not Excessive  Cover Claim Costs, Overhead and Profit  Capital Will Go Elsewhere Without Profit  Profit Should Be Commensurate with Risk The Griffith Insurance Education Foundation

17 Solvency Surveillance  Solvency = Sufficient to Pay Claims  Surplus is Cushion Against Unexpected  Surplus Does Not Mean “Too Much” $  Reserves Mean $ for Expected Claims  Policyholders Trust Claims Will Be Paid  DOI Actuaries Review Reserves  Reserves Reflect Estimated Claim Costs The Griffith Insurance Education Foundation

18 Solvency Surveillance: What Can Go Wrong? The Griffith Insurance Education Foundation AssetsLiabilities Cash 1,000,000Unearned Premiums 500,000 Investments 9,000,000Reserves 7,500,000 Surplus 2,000,000 Total10,000,000Total10,000,000 Note: Insurance companies use different, more “stable” accounting rules called Statutory Accounting.

19 US Insurance Market  Very Large and Mature; Little Growth  Divided into Two Main Sectors  Property/Casualty Insurance  Life/Health (Includes Annuity Products)  Larger Organizations May Self Insure to Avoid Profit and Expense Loadings The Griffith Insurance Education Foundation

20 Source: SNL Financial, Inc.

21 2011 P&C U.S. NPW by Line The Griffith Insurance Education Foundation

22 2011 Life/A&H NPW by Line The Griffith Insurance Education Foundation

23 The California Insurance Market  CA Represents About 11.29% of US Mkt  $124.5b in Premiums Written (2011)  Roughly 200,000 Agents Licensed in CA  Roughly $2.3b in Premium Taxes Paid The Griffith Insurance Education Foundation

24 Policy Forms  Standardized Contracts of Insurance  Vetted Over Decades of Litigation  Changes Require Approval by State  Interpreted in State Courts  Ambiguities Interpreted Against Insurer  Smaller Insurers License Forms from ISO (Insurance Services Office), etc. The Griffith Insurance Education Foundation

25 Policy Forms  Policies Include Insuring Agreement, Definitions, Conditions, Exclusions, Etc.  Can Be Amended with Endorsements  Policy Provisions Designed to Reduce Moral Hazard, Adverse Selection, Fraud  Ex: Mold Exclusion  Ex: Suicide Clause  Ex: Must Cooperate w/Investigators The Griffith Insurance Education Foundation

26 Feel free to contact me: David T. Russell, Ph.D. California State University, Northridge (818) 677-2438 David.Russell@csun.edu INFORM+INSPIRE The Griffith Insurance Education Foundation Any Questions?


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