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  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 1

    Insurance Risk 101

    Pat Teufel, FSA, MAAA

    Timothy J. Tongson, FSA, MAAA

    James E. Rech, MBA, ACAS, ASA, MAAA

    July 9, 2001

    RHOB 2220

  • Life Insurance Risk 101

    Timothy J. Tongson, FSA, MAAA

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 2

  • Overview

    Principles of insurance

    Life insurance products and pricing

    Risks a life insurer faces

    Mortality risk and underwriting

    Other risks

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 3

  • Principles of Insurance

    Gambling vs. Insurance Gambling creates a risk that did not previously

    exist

    Insurance transfers the financial consequencesof an existing risk for a known dollar amount(premium)

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 4

  • Principles of Insurance

    Law of Large Numbers Statistics (Bernoullis Theorem)

    The greater the number of similar exposurers,the more predictable the outcome

    Used to develop reliable assumptions forpricing and risk management

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 5

  • Principles of Insurance

    Risks insured (life insurance) Premature death

    Outliving accumulated savings

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 6

  • Life Insurance Products

    Term Life - Pure death protection Permanent Life - Term + Savings

    Whole, Universal and Variable

    Deferred Annuities - Tax deferredsavings product (SPDA, VA)

    Payout Annuities - income for life with aperiod certain

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 7

  • Considerations in SettingPremium Rates

    Premium rate adequacy Premiums charged must in aggregate, cover the

    benefits promised and expenses associated withpaying the benefits

    Inadequate premiums can lead to severefinancial problems including insolvency

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 8

  • Considerations in SettingPremium Rates

    Premiums must be equitable Insureds who have similar risk profiles should

    be charged the same premium

    No unfair subsidies - for example, nonsmokersvs. smokers

    Equity is a goal

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 9

  • Considerations in SettingPremium Rates

    Premiums should be fair The amount charged should not be excessive in

    relation to the benefits

    Market competition is a major factor toensuring fairness

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 10

  • The Pricing Process

    Probability of event occurring

    Time value of money

    The benefit promised

    Expenses

    Contingencies (risks)

    Profit

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 11

  • Insurance Company Risks

    Some examples Legal - litigation

    Operational - mistakes, errors, etc.

    Pricing - inadequate premiums

    Regulatory - new requirements

    Reputation - negative press

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 12

  • Life Insurance Pricing Risks

    Mortality - when death occurs

    Persistency - how long the customer keeps thepolicy

    Expenses - how efficient the company operates

    Investment - return of and on invested cashflows

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 13

  • Mortality Risk

    Historical perspective The bedrock in the growth and development of

    the life insurance industry

    Based on a single-wage earning family model

    Premature death of breadwinner haddevastating financial consequences

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 14

  • Mortality Risk

    Trends Improvement in life expectancy at virtually

    every age

    Traditional model has changed, but the basicconcerns regarding the prudent management ofmortality risk still exist

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 15

  • Mortality Risk

    Insured vs. Population Data Insured life mortality reflects a selection

    process (underwriting) to determine theappropriate premium rate classification for thebenefit being insured against

    Population mortality reflects the generalpopulation and does not reflect any selectionprocess (eg. census data). Many that would notqualify for insurance

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 16

  • Mortality Risk

    The Adverse Selection Problem The buyer usually knows more than the insurer

    about their own health and other riskcomponents

    Adverse Selection is when a buyer uses thisinformation to gain an advantage on the insurer

    Underwriting is used to deter and detectadverse selection

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 17

  • Underwriting

    Selection The process by which insurers decide whether

    to issue insurance according to specific termsand prices

    Classification The process of assigning a proposed insured to

    a group (class) of insureds with approximatelythe same expected loss probabilities

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 18

  • Underwriting

    Major factors considered Age

    Gender

    Physical condition

    Family history

    Personal history and habits (eg. tobacco, alcohol and drug use, hazardous

    avocations, financial status)

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 19

  • Underwriting

    Classification Methods Method should accurately measure each factor

    affecting risk on an equitable, yet relativelysimple basis

    Judgement Method - Requires highly skilled andexperienced personnel

    Numerical Method - Point system where debits andcredits are applied to risk factors

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 20

  • Underwriting

    Classification Categories Standard

    Preferred, smoker, nonsmoker, other

    Substandard Multiple or flat extra premium

    Decline Not eligible for coverage

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 21

  • Other Risks

    The traditional model has changed

    Concern for outliving retirement assets isbecoming a greater concern than premature death

    This has caused growth in asset accumulationproducts

    Investment risks and competition with banks andsecurities firms is significant for insurers

    Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 22

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 23

    James E. Rech, MBA, ACAS, ASA, MAAA

    An Overview of Property &Casualty Insurance

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 24

    Property & Casualty InsuranceOutline of Discussion

    Insurance Value Chain

    Risk Aggregation Activities

    Risk Spreading Activities

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 25

    Insurance Value Chain

    Distribution UnderwritingRisk

    Classification

    Claims Reinsurance Investment

    RiskAggregation

    Activity

    RiskSpreadingActivity

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 26

    Insurance Value ChainP&C Lines of Business (LOB)

    Personal Lines

    Commercial Lines

    Reinsurance

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 27

    Insurance Value ChainPersonal Lines

    Personal Automobile

    Homeowners

    Fire, Allied Lines, Earthquake

    Inland Marine

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 28

    Insurance Value Chain

    Commercial Auto Commercial Multiple

    Peril Workers

    Compensation Other Liability Fidelity Surety Boiler & Machinery

    Medical Malpractice Professional Liability Other Accident &

    Health Fire, Allied Lines, EQ Farm-owners Multiple

    Peril Ocean Marine Aircraft

    Commercial Lines

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 29

    Insurance Value Chain

    Risk Aggregation ActivitiesDistribution Channels

    Underwriting Services

    Claims Services

    Risk Spreading ActivitiesReinsurance Services

    Investment Services

  • Copyright 2001 by the American Academy ofActuaries

    All Rights ReservedInsurance Risk 101 30

    Risk Aggrega

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