Insurer Operations and Captive Managemnet TBS

University of Iowa - second half of semester (final)

What are the three steps of rational decision making?

1. Determine the options and their characteristics

2. Define preferences/utility (objective function)

3. Choose the option that maximizes utility (payoff)

What is a utility function?

A function that represents a person’s preferences and the payoff they receive from different choices.

What does maximizing utility mean?

Choosing the option that provides the highest payoff or satisfaction.

What is game theory?

The study of multi-person decision-making problems where each person’s outcome depends on others’ decisions.

What does Ux (x’s decisions choices of all other players) mean?

Player X’s utility depends on both their own decisions and the decisions of all other players.

What is a game in economic terms?

A decision-making situation involving multiple players whose outcomes depend on each other's choices.

What are the three main components of a game?

1. Players (n > 1)

2. Strategies (possible choices for each player)

3. Payoffs for each combination of strategies

What are the assumptions of a static game of complete information?

Players are rational, decisions are made simultaneously, everyone knows the strategies and payoffs of all players, and players cannot communicate or make deals (non-cooperative)

What is equilibrium in game theory?

A stable outcome where no player has an incentive to change their strategy.

What is a Nash equilibrium?

A set of strategies where each player’s strategy is the best response to the strategies chosen by all other players.

What is the key idea behind the Prisoner’s Dilemma?

Individual rational decisions can lead to worse outcomes for both players compared to cooperating.

What must happen for a customer to accept a deal?

The deal must create value for the customer.

What makes a deal successful for both sides?

The deal creates value for both the company and the customer (win-win).

What are the main marketing systems in insurance?

Independent agents, brokers, exclusive agents, direct writers and direct mail

What are key characteristics of independent agents?

Independent contractors, own their business and expirations, represent multiple insurersand earn commissions

What services do independent agents provide?

Advice to clients, access to products from multiple insurers, claims assistance, loss control, billing and policy preparation, and adjusting small claims

What do brokers do?

They represent the client rather than the insurer.

Name major insurance brokers.

Marsh, Aon and Willis

What are the characteristics of exclusive agents?

Independent contractors, represent only one company, own expirations only during employment and receive commissions (lower on renewals)

What are direct writers in insurance?

Employees of the insurer who sell policies directly.

How are direct writers compensated?

Salary, salary plus bonus, or commissions.

Who owns the expirations for direct writers?

The insurer.

What is direct mail in insurance marketing?

A marketing system where insurers sell policies directly to consumers without using agents.

What is target marketing in direct mail insurance?

Focusing marketing efforts on specific groups of consumers likely to buy the product.

Name two companies known for direct marketing in insurance.

GEICO and USAA.

Why do direct mail insurers often have lower sales costs?

Because they do not pay commissions to agents.

What is a disadvantage of direct mail insurance systems?

Consumers receive less service since there are no agents.

What is a combination marketing system in insurance?

When insurers use multiple distribution channels instead of relying on just one.

How can insurance companies divide marketing systems by territory?

Using different distribution systems in different geographic areas.

What does dividing marketing systems by lines mean?

Using different marketing systems for different types of insurance products.

What is an important comment about direct writers?

They sell insurance directly through employees instead of independent or exclusive agents.

What are Excess and Surplus (E&S) lines?

Insurance coverage for unusual, high-risk, or hard-to-insure exposures.

What are non-admitted insurers?

Insurance companies not licensed in a state but allowed to sell certain specialized coverage there.

When do E&S insurers tend to perform well?

During hard insurance markets when coverage is limited and prices are higher.

Name a well-known non-admitted insurance market.

Lloyd's of London.

What are the two major categories of insurance?

Life insurance and Property & Casualty (P&C) insurance.

What are the main functions of insurance producers?

Sales, underwriting, claims, and risk management

What factors influence the choice of a marketing system?

Geographic location, nature of existing business, products to be offered, markets to be targeted, or other service functions required 

What is market segmentation?

Dividing a market into smaller groups based on shared characteristics.

What are common types of market segmentation?

geographic and product line

What is product differentiation?

Making a product unique to stand out from competitors.

What is cost leadership?

Competing by offering lower prices than competitors.

What are key elements of marketing management?

Product, contract, service, and producer motivation

What are alternative insurance marketing approaches?

Mass merchandising and group sales, internet sales, banks and government programs

What is underwriting?

The process of deciding which risks to insure, for how much, at what price, and under what conditions.

What is the main goal of underwriting?

Selection and classification of profitable risks.

What is the primary problem underwriting tries to avoid?

Adverse selection caused by information asymmetry.

What are the steps in the underwriting process?

1. Evaluate loss exposure

2. Determine underwriting alternatives

3. Select an alternative

4. Set the premium

5. Implement the decision

6. Monitor loss exposure

What is the purpose of selecting and classifying risks?

To ensure profitability and proper pricing of insurance policies.

What is field underwriting?

Initial risk evaluation performed by producers in the field.

Why is insurance fraud important in underwriting?

It increases losses and must be identified and prevented.

What are key underwriting principles?

Proper classification of insureds, avoid adverse selection, ensure equity among policyholders and maintain statistical validity

What makes a good rating factor?

Separates risk classes, creates homogeneity, is reliable and verifiable, is admissible (causal relationship), and has incentive value

What does “homogeneity” mean in rating factors?

Risks within a group are similar in expected loss.

What is admissibility in rating factors?

The factor should have a logical or causal connection to risk (not just a proxy).

What is a controversial example of a rating factor?

Gender

What factors are commonly used in auto insurance rating?

Territory, type of vehicle, age, gender, marital status, mileage, and driving record

What are common rating factors for life insurance?

Age

Gender

Medical condition (including genetic testing)

What are common rating factors for homeowners insurance?

Location 

Construction 

Age of property  

Credit rating

Why is fairness important in rating factors?

Because rating factors impact how much policyholders pay and must be justified and non-discriminatory.

What do some states (like Florida) require regarding underwriting?

Insurers must file underwriting guidelines with regulators.

What is a market conduct examination?

A regulatory review to ensure insurers follow their filed classification and rating plans.

What is redlining?

The unfair practice of denying or limiting insurance based on location, often targeting certain neighborhoods.

What are common sources of underwriting information?

Application, Producer report, Photos, Inspection report, Bureaus (e.g., MIB, MVR), Physical inspection, Loss history, Credit report

What is a physical hazard?

A condition that increases the chance of loss (e.g., faulty wiring).

What is a moral hazard?

Dishonesty or intent to cause a loss for financial gain.

What is a morale hazard?

Carelessness or indifference to risk because of insurance coverage.

What is a legal hazard?

Characteristics of the legal system that increase the likelihood or size of claims.

What is adverse selection?

When higher-risk individuals are more likely to purchase insurance.

What does policy wording include?

Terms and conditions

Exclusions

Deductibles

What is an important note about reinsurance?

It rarely makes an unacceptable risk acceptable.

What are the main underwriting alternatives?

Accept as is

Reject

Make a counteroffer with modifications

What are common modifications in underwriting?

Require loss control measures

Change rating plans or policy limits

Amend terms and conditions

Use facultative reinsurance

What factors influence the final underwriting decision?

Amount of underwriting authority required

Presence of supporting business

Mix of business

Producer relationship

Regulatory restrictions

What is the purpose of evaluation and review in underwriting?

To assess past underwriting decisions and improve future risk selection and profitability.

Why is claim history important in evaluation and review?

It helps determine whether past underwriting decisions were accurate and predicts future risk.

What is the role of audits in underwriting?

To verify that underwriting guidelines were properly followed.

Why must underwriters evaluate information sources?

To ensure decisions are based on accurate, reliable, and relevant data.

What is the underwriting cycle?

The cyclical pattern of rising and falling profitability in the insurance industry.

What is a hard market?

A period with high premiums, strict underwriting, and limited availability of coverage.

What is a soft market?

A period with low premiums, relaxed underwriting, and more available coverage.

What is cash-flow underwriting?

Accepting lower underwriting profits (or losses) to generate investment income from premiums.

What factors influence the underwriting cycle?

Interest rates

Competition

Loss experience

Economic conditions

What are “developments” in the underwriting cycle?

Changes or trends that impact insurance markets and underwriting practices.

What are alternative markets in insurance?

Non-traditional sources of insurance used when standard markets are unavailable.

When are alternative markets most commonly used?

During hard markets when coverage is expensive or difficult to obtain.

Why is understanding the current underwriting cycle important?

It helps insurers adjust pricing, risk selection, and overall strategy.

What is reinsurance?

The shifting of part or all of insurance risk from one insurer to another

Who are the main customers of reinsurance?

Other insurers (primary insurers)

What are professional reinsurers?

Companies that specialize in accepting reinsurance

What is direct reinsurance?

Reinsurance placed directly between insurer and reinsurer

What is the broker market in reinsurance?

Reinsurance arranged through intermediaries

What are reinsurance departments?

Units within insurers that handle reinsurance activities

What is a ceding company (cedent)?

The primary insurer that transfers risk

What is a reinsurer (cessionnaire)?

The insurer that assumes the transferred risk

What is net retention?

The amount of risk the insurer keeps

What is a cession?

The portion of risk transferred to a reinsurer

What is a retrocession?

Reinsurance purchased by a reinsurer

What is a retrocedent?

A reinsurer that transfers risk to another reinsurer

What is a retrocessionnaire?

A reinsurer that assumes retroceded risk