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

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

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

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

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

Principal Steps in Risk Management Identify and analyze loss exposure Select technique(s) to handle loss exposure Implement the chosen technique(s) Monitor results and implement necessary changes

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

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

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

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

Components of Profit Measurement Expense Ratio Loss Adjustment Expenses/Earned Premium Other Expenses/Written Premium Loss Ratio Incurred Losses/Earned Premium

Components of Profit Measurement Combined Ratio Statutory Incurred Losses + LAE + Incurred Expenses Earned Premiums Earned Premiums Trade Basis Earned Premiums Written Premiums

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

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

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: Best’s Aggregates and Averages Property/Casualty Edition 2005 U.S. Industry Ratios pp. 397-398

Measurement of Insurer Performance Meeting Customers’ Needs Meeting Legal Requirements Meeting Social Responsibilities

Functions Required to Meet Needs Marketing Underwriting Claims Loss Control Reinsurance Actuarial Investments

Interdependence Among Functions Marketing and Underwriting Underwriting and Loss Control Loss Control and Marketing Claims and Other Departments Actuarial and Other Departments