10 slide
TRANSCRIPT
10-1
Nature & Functions of Insurance
In its simplest aspect, insurance has two fundamental characteristics:
1. Transfer of risk from the individual to the group.
2. Sharing of losses on some equitable basis.
10-2
Operation of Insurance Illustrated
1. 1,000 dwellings valued at $100,000 each.
2. Each owner faces risk of a $100,000 loss.
3. Owners agree to share losses that occur.
4. If one house burns (total loss) each owner pays $100 ($100 X 1,000 = $100,000).
5. This is a pure assessment mutual insurance plan.
10-3
Operation of Insurance (continued)
6. Potential difficulty: some members might refuse to pay their assessment.
7. This problem can be overcome by requiring advance payment for predicted future losses (based on past experience).
8. If 2 total losses are predicted, each owner’s cost is $200.
9. If we add $100 for a cushion and for operating expenses, the cost is $300.
10-4
Insurance Defined: Individual Perspective
Insurance is an economic device whereby the
individual substitutes a small certain cost (the
premium) for a large uncertain financial loss
(the contingency insured against) which
would exist if it were not for the insurance.
10-5
Risk Reduction Through Pooling
1. The risk an insurer faces is not merely a summation of risks transferred to it by individuals.
2. Insurer can predict within narrow limits the amount of losses that will occur.
3. If insurer could predict future losses with absolute precision, it would have no risk.
4. Accuracy of insurer’s prediction is based on the law of large numbers.
10-6
Dual Application of Law of Large Numbers in Insurance
1. To estimate the underlying probability accurately, insurer must have a large sample of experience.
2. Once the estimate of probability has been made, it must be applied to a large number of exposure units to permit the underlying probability “to work itself out.”
10-7
Insurance Defined Social Perspective
Insurance is an economic device for reducing and eliminating risk through the process of combining a sufficient number of homogeneous exposures to make the losses predictable for the group as a whole.
10-8
Insurance: Transfer or Pooling?
1. The view that the essence of insurance is risk transfer emphasizes the individual’s substitution of a small small certain cost for large uncertain loss.
2. Emphasis on pooling or risk sharing emphasizes the role of reducing risk in the aggregate.
3. Insurance can exist without pooling, but not without transfer.
10-9
Insurance and Gambling
1. In gambling, there is no chance of loss (and therefore no risk) prior to the wager.
2. In the case of insurance, the chance of loss exists whether or not insurance is purchased.
3. Gambling creates risk, while insurance provides for the transfer of existing risk.
10-10
Economic Contribution of Insurance
1. Creates certainty about burden of loss.
2. Spreading losses that do occur.
3. Provides for an optimal utilization of capital.
10-11
Elements of an Insurable Risk
1. Large numbers of exposure units
2. Definite and measurable loss
3. The loss must be fortuitous
4. The loss must not be catastrophic
10-12
Other Facets of Insurable Risk
1. Randomness-adverse selection
2. Economic feasibility
10-13
Self-Insurance
1. Definitional impossibility
2. Acceptable operational definition
• enough exposures for predictability
• financially dependable
• geographic dispersion
10-14
The Fields of Insurance
1. Private insurance
voluntary programs designed to protect individual against financial loss
2. Social Insurance
compulsory insurance programs generally operated by government
3. Public Benefit Guarantee Programs
quasi-social coverages usually associated with regulation
10-15
Private (Voluntary) Insurance
1. Usually (but not always) voluntary
2. Usually (but not always) offered by private insurers
10-16
Monoline Organization in the U.S.
State laws restricted the lines of insurance an insurer could write, compartmentalizing underwriting power.
Three distinct classes of insurance developed
1. Life insurance
2. Fire and marine insurance
3. Casualty insurance
10-17
Reasons for Monoline Organization
1. It was supposed that specialization would promote proficiency.
2. Segregation of insurance by class would simplify financial regulation.
3. Fear of danger in combining fire insurance (which seemed subject to catastrophes) with life insurance.
10-18
Multiple-Line Transition
1. Individual states began to change their laws in the 1940’s to permit multiple-line underwriting (writing of fire and marine and casualty by a single company).
2. New York permitted multiple-line underwriting in 1949.
3. Compartmentalization still exists between life insurers and property and casualty insurers.
10-19
Modern Classification of Insurance Coverages
1. Life insurance
2. Accident and health insurance
3. Property and liability insurance
10-21
Casualty Insurance
• accident and health insurance• automobile• liability• workers compensation• boiler and machinery• plate glass• burglary, robbery, theft• credit insurance• title insurance
10-22
Classification of Insurers
Insurers may be classified according to
• place of incorporation
• place of licensing
• legal form of ownership
• distribution system
10-23
Classification by Place of Incorporation
• A domestic insurer in a given state is one incorporated in that state.
• A foreign insurer is one incorporated in another state.
• An alien insurer is one incorporated in another country.
10-24
Classification by Licensing
• An admitted insurer with regard to any given state is a company that has been granted a license to operate in that state.
• An unlicensed (or nonadmitted) insurer is one that has not been granted a license.
• Nonadmitted insurers may write insurance in states in which they are not licensed under specific conditions.
10-25
Types of Insurers by Form of Ownership
1. Capital stock companies
2. Mutual companies
3. Reciprocals: attorney-in-fact
4. Lloyd's associations
5. Health Expense Associations
10-26
Capital Stock Insurers
1. Organized as profit-making ventures with stockholders who assume the risk that is transferred by insureds.
2. Premium charged by insurer is final--there is no form of contingent liability for policyholders.
3. Board of directors is elected by stockholders.
4. Earnings are distributed to stockholders as dividends on their stock.
10-27
Mutual Insurers
1. Owned by policyholders.
2. Distinguishing characteristic is distribution of earnings. Any money left after costs is returned to policyholders as a dividend.
3. Broadly speaking, mutuals are divided into three classes• pure assessment mutual• advance premium mutuals with
assessable policies• advance premium nonassessable
mutuals
10-28
Reciprocal Insurers
1. Also called “interinsurance exchange.”
2. Unincorporated aggregation of individuals, called subscribers, who exchange risks.
3. Each member is both insured and insurer.
4. In a mutual, policyholders assume liability collectively; in a reciprocal, subscribers assume liability severally.
5. Administrator of the program is known as the attorney-in-fact.
10-29
Lloyd’s Associations
1. Named after London coffee house where modern marine insurance originated.
2. Lloyds does not write insurance, but is like the New York Stock Exchange, where buyers and sellers transact business.
3. Innsurance is written by 40,000 members of underwriting syndicates, who individually assume liability for risks insured.
4. American Lloyds are U.S. organizations whose operations are patterned after Lloyds of London.
10-30
Insurance Exchanges
States of Florida, Illinois, and New York enacted legislation authorizing “insurance exchanges” patterned after Lloyds in 1979.
Florida and New York exchanges encountered financial difficulty and failed.
Illinois exchange continues to operate successfully.
10-31
Health Expense Associations
1. Originally, Blue Cross and Blue Shield organizations organized to provide for prepayment of hospital and physicians services respectively.
2. Now include Health Maintenance Organizations which provide a wide range of health care services in return for an annual membership fee.
3. Physician-Hospital Organizations are provider- owned delivery systems now being formed in many areas.
10-32
Health Expense Associations
1. Terminology in this area is changing due to the various proposals for reform in health care delivery system.
2. Physician Hospital Organizations (PHOs) also sometimes called Integrated Delivery Systems.
3. Medicare reform proposal in Balanced Budget Act of 1995 introduced the term “Provider Sponsored Organization.”
10-33
Government Insurers Defined
1. Direct provision by the government
2. Government reinsurance
3. Does not include self-insurance of government exposures
10-35
The Agent
Agent:an individual authorized by an insurer to create, modify, and terminate contracts of insurance.
Broker:a representative of the insured who solicits business from insurance buyers but who is compensated by the insurer.
The agent can “bind” an insurer to a risk.A broker does not have binding authority.
10-36
Life Insurance Distribution Systems
1. General Agents
2. Branch Office System
10-37
General Agent System
1. General agent is empowered by company to operate in a given territory and to appoint subagents.
2. G.A. receives an overriding commission on business produced by subagents, out of which it pays expenses.
3. Most general agents receive some additional financial support from the insurer.
10-38
Branch Office System
1. Branch office manager is an employee of the insurance company.
2. Expenses of branch office are paid by insurer, since branch office is simply an extension of the home office.
3. Branch manager may receive additional compensation based on production of agents supervised.
10-39
Property & Liability Distribution Systems
1. American Agency System• Agency represents multiple companies• Agent is said to “own the expirations”
2. Direct Writing System operates through • exclusive agents (State Farm)• captive agents (Allstate)
3. Direct response distribution• mass media advertising• direct mail
10-40
Corporate Combinations in Insurance
Insurance company groups or fleets
Originally formed in monoline era to combine property and casualty coverages.
About 290 groups, comprising 1100 insurers, write about 90% of property and liability coverage.
10-41
Corporate Combinations in Insurance
Underwriting syndicates
1. Associated Factory Mutual Insurance Companies
2. Industrial Risk Insurers
3. Improved Risk Mutuals
4. Nuclear Energy Pools
10-42
Reinsurance
1. Nature of reinsurance
2. General approaches• facultative • treaty
3. Types of treaties• facultative• automatic
10-43
Reinsurance in Property & Liability Insurance
1. Proportional reinsurance
• quota share
• surplus line
2. Excess loss reinsurance
10-44
Functions of Reinsurance
1. Spreading of risk
2. Financing function - surplus relief