RMI 640 midterm

the transfer and pooling of risk where individuals pay a premium now in exchange for a promise to pay a larger amount later if a loss occurs                

what is insurance

it is based on trust because the consumer is at an information disadvantage        

why do we say insurance is a relationship business

customer, needs, assets

it all starts with a ________ that has ____ to protect their ____

reduce financial uncertainty, protect assets, allow businesses to take risks, stabilize the economy, gives a sense of resilience

purpose of insurance

defined and measurable, predictable, able to be pooled, random, pure risk

what makes a risk insurable

reduce financial uncertainty for their customers, be profitable, comply with regulators, stay solvent, diversify risk

insurer goals    

global risks    

debt, infectious diseases, extreme weather events, cyberattacks    

underwriting function

decide whether to insure and sets prices

agents/brokers function

the person who listens to you as the consumer and tells you what plan would be right for you

• sells insurance and advises customers

claims function    

investigate and pay claims

agents: represent insurance companies, have contracts with insurers, fiduciary duty to insurer

brokers: represent customers, find best insurer for client, no contract with insurer

what is the difference between agents and brokers

KPI (key performance indicator)    

uses number to define performance rather than saying it was ‘good’    

loss ratio, expense ratio, combined ratio        

examples of KPI’s

combined ratio, tells us if the company makes money on underwriting

what is “the” KPI  & why

the losses + expenses > premium

what does a combined ratio of over 100% mean    

net investment income / earned premium

investment ratio formula

assets - liabilities

policyholder surplus or shareholders equity formula

net income / shareholders equity

return on equity formula

if you’re effective with your money (you make more money using your money)

what does ROE tell us

expense ratio + loss ratio

combined ratio formula

independent agents

sell policies from multiple insurers

• customers get more choices    

exclusive agents    

sell policies from one insurer only, ex: StateFarm agents    

direct writers  

salespeople employed by the insurance company, ex: GEICO

stock insurers    

owned by shareholders, publicly traded, raise capital in stock market

mutual insurers    

owned by policyholders, not publicly traded, profits benefit policyholders

admitted insurers    

regulated by state, file rates + policy forms, state monitors solvency

• high protection, state pays claims if insurer fails

non-admitted insurers    

less regulated, more flexible, can insure unusual risks, no protection if insurer fails, growing quickly

• ex: event cancellation

underwriting + investments

how do insurance companies make money

underwriting profit/loss

premium - losses - expenses

(losses + LAE) / earned premium    —     measures claims cost

loss ratio    

expenses / earned premium — underwriting, IT, marketing, etc

expense ratio

<100% = underwriting profit, >100% = underwriting loss but doesn’t mean the company isn’t making money as they could be making money from investments

what is important about the combined ratio

solvency    

what does policyholder surplus measure

company is impaired, regulators may intervene or take over operations

what happens if policyholder surplus is negative

<1 too conservative, 1-2.5 healthy, >3 solvency risk

premium-to-surplus ratios

paid losses, case reserves, IBNR, LAE

loss components

paid losses

claims already paid

case reserves

estimated cost of known claims

IBNR

incurred but not reported, claims that occurred but haven’t been reported yet (largest liability for insurers)

LAE

cost of handling claims

ALAE

allocated LAE, specific claim expenses (ex: lawyer fees) - can tie to a specific claim

ULAE

unallocated LAE, general claim expenses (ex: claims department salaries)

agent/broker role

find customers, assess risks, prepare submissions, present quotes, service policies

typically 15% commission on premium

agents/broker compensation

submission   

the info sent to insurers to request coverage (risk details, loss history, financial info)    

• allows underwriters to evaluate risk and price policy

diversification

what is the key to solvency

internal constraints  

efficiencies, current sales network, brand and reputation, expertise, size

external constraints

regulation environment, rating agencies, reputation and public opinion, competition, economic conditions

which customers/markets to service

• farmers, truckers, personal insurance, small businesses, etc

strategic choice (who)

what products/services to sell    

• property insurance, auto insurance, cyber insurance, etc

• admitted vs non-admitted products

strategic choice (what)

geographic location or size of business

• local, regional, national, etc

strategic choice (where)

how insurance is distributed

• independent agents, exclusive agents, brokers, etc

• how do we sell the insurance

strategic choice (how)

reduce the frequency + severity of losses

risk control role

reduce losses but increases expense —> net improvement in CR

how does risk control impact the combined ratio

losses (claims)

what is the biggest cost for insurers

ROI, risk, cost vs benefit, does it solve a real problem

decision framework for AI investment

compare this year’s premium to last years’s - tells if you are increasing your premium over the last year or if it’s going down (doesn’t have to increase every year)

how does premium growth work

underwriting income + investment income - taxes

net operating income    

net income / shareholders’ equity

ROE formula

IBNR

what is the biggest liability on a company’s balance sheet