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Ratemaking

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113 Terms

1

Ratemaking

the pricing of insurance, done by actuaries, using past claim data from this & other insurance companies, adjusted to take into account expectations about how future claims may differ from past claim

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2

rate

the price per unit of insurance

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3

exposure unit

the unit of measurement used in insurance pricing

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4

Underwriting

Refers to the process of selecting, classifying, and pricing applicants for insurance.

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5

Actuary

An officer, of an insurance company, who calculates and states the risks and premiums

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6

Production

the sales and marketing activities of insurers

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7

Reinsurance

an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer part or all of the potential losses associated with such insurance

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8

Ceding Company

the primary insurer that initially writes the insurance

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9

Reinsurer

the insurer that accepts the insurance from the ceding company

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10

Retention Limit

the amount of insurance retained by the ceding company

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11

cession

the amount of insurance ceded to the reinsurer

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12

Retrocession

is when a reinsurer insures part or all of a risk with another insurer

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13

What is reinsurance used for?

-Increase underwriting capacity

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14

-Stabilize profits

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15

-Reduce the unearned premium reserve, which represents the unearned portion of gross premiums on all outstanding policies at the time of valuation

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-Provide protection against a catastrophic loss

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-To access the technical expertise of the reinsurer, especially in lines where the companydoes not have much experience itself

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18

Facultative Reinsurance

an optional, case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit

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19

Treaty Reinsurance

means the primary insurer has agreed to cede insurance to the reinsurer, and the reinsurer has agreed to accept the business

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20

Main Functions Inside Insurance Companies

Rating and Rate Making

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21

Underwriting

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22

Production

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23

Claims Settling

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24

Reinsurance

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25

Investments

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26

Information Systems, legal services and loss-control services

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27

Premium Formula

rate x exposure units

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28

Premium Formula 2

expected claims (if one occurs) X probability of claims X (1+λ)

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29

Rating Factors

variables that are used to divide applicants for insurance into relatively homogeneous classes for the purpose of determining the rate

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30

Underwriting Principles

-Attain an underwriting profit

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31

-Select prospective insureds according to the company's underwriting standards

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32

-Provide equity among the policyholders

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33

Main Sources of Information Available to Underwriters

Application, Agent's Report, Inspection Report, Physical Inspection, Physical examination (life insurance), MIB Report (auto insurance)

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34

Producers

agents who sell insurance

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35

Objectives of Claim Settling

Verification of a covered loss

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36

Fair and prompt payment of claims

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37

Provide personal assistance to the insured

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38

Major types of claims adjustors:

Agents, Staff Claims Representative, Independent Adjustors, Public Adjustors

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39

Steps in Settling a Claim

  1. notice of loss must be given to the company

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40
  1. the claim is investigated by the company

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41
  1. a proof of loss may be required

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42
  1. a decision is made concerning payment

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43

Two Reinsurance Alternatives

Securitization of risk, Catastrophe Bonds

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44

Securitization of Risk

insurable risk is transferred to the capital markets through creation of a financial instrument

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45

Catastrophe Bond

permits the issuer to skip or defer scheduled payments if a catastrophic loss occurs

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46

Quote Share Treaty

The ceding insurer and the re-insurer agree to share premiums and losses based on some proportion

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47

Surplus Share Treaty

the reinsurer agrees to accept insurance in excess of the ceding insurer's retention limit, up to some maximum amount

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48

excess-of-loss treaty

is designed for protection against a catastrophic loss

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49

A treaty can be written to cover a single exposure, a single occurrence, or excess losses

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50

Reinsurance Pool

organization of insurers that underwrites insurance on a joint basis

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51

Balance Sheet

summarizes what a company owns (assets), what it owes (liabilities), and the difference between these two values (owner's equity)

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52

Major assets of Insurance Companies

Investments in bonds, stocks, real estate, mortgage-backed-securities, and marketable securities, as well as cash

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53

Reserves

An insurance companies liabilities

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54

Loss Reserve

the estimated cost of settling claims

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55

Case Reserves, Reserves established using the loss ratio method, and reserves for incurred-but-not reported claims (IBNR)

Loss reserves in property and causalty insurance

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56

Unearned Premium Reserve

= unearned portion of gross premiums for outstanding policies at the time of valuation

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57

Policy Holders Surplus

Difference between an insurers total assets and total liabilities. = Paid in capital at stock companies + retained profits from insurance operations and investments over time

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58

Income Statement

measures flows of revenue and expenses

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59

Cash Basis Accounting

Reporting income when the cash is received and expenses when the cash is paid.

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60

Accrual Basis Accounting

reporting income when it is earned and expenses when they are incurred but not when they are actually paid

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61

Premiums and Investments Income

The major sources of revenue for an insurance company

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62

Major Expenses

loss payments, loss-adjustment expenses, commissions, premium taxes, general insurance company expenses

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63

Net Income Equation

Revenues - Expenses

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64

Expense Ratio

The ratio of the insurers underwriting expenses to written premiums. calculated on a cash flow basis

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Loss Ratio

(incurred losses + loss adjustment expenses) / premiums earned. The ratio of a property and causaltys insurer's incurred losses and loss-adjustment expenses to earned premiums

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Combined Ratio

A profitability ratio that indicates whether an insurer has made an underwriting loss or gain. If it is greater than one it suggests an underwriting loss, but if it is less than 1 it suggests an underwriting profit. = Loss Ratio + Expense Ratio

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67

Policy Reserve

the amount of money allocated specifically for the fulfillment of policy obligations by a life insurance company; reserves are in place to safeguard that the company is able to pay all future claims.

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A life insurer's net gain from operations

equals total revenues less total expenses, policyowner dividends, and federal income taxes

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69

Principle of Indemnity

The insurer agrees to pay no more than the actual amount of the loss, the insured should not profit from a covered loss

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70

Exceptions to the Principle of Indemnity

valued policy, valued policy laws, replacement cost insurance, life insurance

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71

Principle of Insurable Interest

The insured must be in a position to lose financially if a covered loss occurs

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72

Three Purposes of Insurable Interest

To prevent gambling, To reduce moral hazard, To measure the amount of loss in property insurance

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73

Insurable Interest Requirements for Life Insurance

Close family ties, blood relationship, marriage, or a pecuniary (financial) interest

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74

Principle of Subrogation

the insurer is entitled to recover from a negligent third party any loss payments made to the insured. Does not apply to life insurance contracts.

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Principle of Subrogation

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Purpose:

-To prevent the insured from collecting twice for the same loss

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-To hold the negligent person responsible for the loss

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-To hold down insurance rates

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79

Principle of Utmost Good Faith

A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts

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80

Representations

Statements made by the applicant on the insurance application that are believed to be true, but are not guaranteed to be true.

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81

Misrepresentation

A false statement or lie that can render the contract void.

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82

Voidable Contract Requirements

the misrepresentation is (1) material, (2) false, and (3) relied on by the insurer

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warranty

a statement of fact or a promise made by the insured, which is part of the insurance contract and must be true if the insurer is to be liable under the contract

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84

Requirements for a Valid Insurance Contract

-There must be an offer and acceptance.

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85
  • There must be an exchange of consideration.

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86
  • The parties to the contract must be legally competent.

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87
  • The contract must be for a legal purpose

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88

Aleatory Contract

a contract where the values exchanged may not be equal but depend on an uncertain event.

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89

Property Insurance Contract

The insurer agrees to pay for loss sustained to the insured's covered property. Cannot be validly assigned to another party without the insurers consent.

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90

Contract of Adhesion

the insured must accept the entire contract with all of its terms and conditions; and if there is an ambiguity in the contract, it will be construed against the insurer

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91

Four General Rules of Agency

  • There is no presumption of an agency relationship

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92
  • An agent must have the authority to represent the principal

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  • A principal is responsible for the actions of agents acting within the scope of their authority

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94
  • Limitations can be placed on the powers of agents

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95

An agent can bind the principal based on

Express authority

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96

Implied authority

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97

Apparent authority

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98

Express Authority

authority declared in clear, direct, and definite terms

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99

Implied Authority

Authority that is not expressed or written into the contract, but which the agent is assumed to have in order to transact the business of insurance for the principal.

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100

Apparent Authority and Estoppel

Third party reasonably believes (based on actions of principal) that agency relationship exists between principal and another individual

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