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This comprehensive book provides an in-depth exploration of the business of insurance and reinsurance, covering topics such as regulation, risk management, and public policy. It includes discussions on various forms of insurance, distribution systems, investments, liabilities, functional areas, reinsurance, and different types of reinsurance agreements.
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The Business of Insurance, Reinsurance, Regulation of Insurance, Risk Management and Public Policy Dr. John F. Fitzgerald, Jr CLU, CPCU, CIC
Business of Insurance • #1 Concern- 28% of Small Business • Satisfied Consumers
Structure Types • Life • Health • Property-Liability
Forms & Insurers • Form • Stock • Mutual • Insurers • Life-Health 1200 • Property- Liability 2700
Distribution System • Independent Agents • Agent, broker, solicitor, surplus lines • Exclusive Agents • Direct Writers • Direct Response • Web • Internet • Mail
Market Share • Personal Lines • Agencies 30% • Direct 70% • Commercial Lines • Agency 70% • Direct 30%
Liabilities • Unearned premium reserves (UPR) • Loss reserves (2/3 of liabilities) • Reserve for accidents or events that have already occurred • Three types of loss reserves: • Settled but not yet paid • Reported but not yet settled • Incurred but not yet reported (IBNR)
Statutory Accounting Principles (SAP) (Insurance Accounting) • GAAP v. SAP • Going concern v. liquidation • Expenses recognized immediately while revenues must be accrued • Admitted v. non-admitted assets • Conservative securities valuation • Assets – Liabilities = Net worth
Functional Areas • Sales and marketing • Underwriting- selection of risks • Claims- paying and reserving for losses • Product development • Ratemaking (actuarial) – pricing of policies • Investments • Risk management services- loss control, data management, etc. • Accounting, Legal, IT
What is Reinsurance? • Defined: • Insurance for insurance companies • Retrocession • Insurance for reinsurers
Why is Reinsurance Purchased? • Several “Needs” May Exist • Capacity • Stability • Catastrophe Protection • Premium Growth • Enter/Exit Classes of Insurance
Reinsurance and Its Function • Basic terms and concepts • Reinsurance functions: • Increase large-line capacity • Provide catastrophe protection • Stabilize loss experience • Provide surplus relief • Facilitate withdrawal from a market segment • Provide underwriting guidance
Capacity • Unusual risk or “large line” • Regulations affecting insurers • The 10% rule • Management of line size (limits) within insurance portfolio
Stability • Desire to limit the fluctuation in results due to random variation in losses • Predictability in loss ratio • Need to comfort shareholders, policyholders, regulators, and investors
Catastrophe Protection • Protect against adverse affects of a catastrophic event natural or man-made • Multiple policies involved in single loss or event
Premium Capacity • Also referred to as “Surplus Relief” • Arises from conservative nature of insurance accounting principles (SAP) • New/Growing insurers need to “finance” the premiums they write • Measure = Leverage Ratio • Net Premiums Written: Policyholders’ Surplus
Other Functions • Entry into new classes/ territories • Exit from classes/ territories • Underwriting expertise • Protect insurer against punitive or “bad faith” damages
In/Reinsurance Distribution Broker Market Direct Market
Reinsurance Sources • Professional reinsurers • Reinsurance departments of primary insurers • Reinsurance pools, syndicates, and associations • Reinsurance professional and trade associations • Intermediaries and Reinsurance Underwriters Association (IRU) • Brokers & Reinsurance Markets Association (BRMA) • Reinsurance Association of America (RAA)
Types of Reinsurance • Facultative • Treaty • Other (Hybrid/Financial)
Facultative Reinsurance • Individual risk review/underwriting • Certificate issuance • Treaty protection/Hazardous risks • Hybrid agreements • Advantages/Disadvantages
Treaty Reinsurance • Groups of policies, class/line of business, or entire portfolio • Obligatory reinsurer acceptance • Pooling effect • One agreement
Forms of Reinsurance Agreements • Proportional (Pro Rata) • Principal of sharing- premium, limits, and losses • Reinsurance applications: • Quota Share- Fixed percentage sharing • Surplus Share- Fixed dollar amount retained, yielding variable percentages • Variations
Proportional Reinsurance • Sharing Concept- QS (%) & SS($) $1M Primary Insurer Retention Limits of insurance Reinsurance Cession Percentage of premiums & losses shared 0% or ($) 100% or ($)
Types of Reinsurance • Pro Rata Reinsurance • Quota share reinsurance • Surplus share reinsurance • Excess of Loss Reinsurance • Per risk excess of loss • Catastrophe excess of loss • Per policy excess of loss • Per occurrence excess of loss • Aggregate excess of loss
Forms of Reinsurance Agreements • Non-Proportional (Excess of loss – XOL) • Principal of indemnification • Reinsurance applies: • Per risk/Per occurrence/Per claim • Per policy • Catastrophe- Property • Clash- Casualty • Aggregate or Stop Loss
“Excess of Loss” Non-Proportional Reinsurance • Indemnification Concept Limits of insurance $1M Reinsurance reimbursement for the amount of loss in “excess of” the retention Reinsurance indemnifies for a loss in excess of the primary retention Attachment Point Primary Reinsurance Amount • Remember- reinsurance “attachment” may apply on one of many bases
Example: Excess of Loss (XOL) Dr. A, an orthopedic surgeon, failed to properly treat a fracture of the left femur. The patient was a high school athlete and suffered permanent injury to his leg. Dr. A had a $1,000,000 policy limit (claims-made) at the time of the medical incident and the insurer was able to settle the case for $1,000,000. The insurer had an Excess of Loss Reinsurance agreement in place for $750,000 “excess of” $250,000 per claim. $1,000,000 Policy Limit Reinsurer pays (indemnifies) $750,000 of the settlement “in excess of” $250,000 Retained by the insurer
Example: Clash Coverage Dr. A was involved in another case with two of his associates that was settled for a total of $3,000,000, with fault apportioned equally among the three doctors ($1M each). Each doctor was covered under a $1,000,000 policy limit at the time of the medical incident. The insurer had in place a Per Occurrence Clash reinsurance agreement for $5,000,000 “excess of” $500,000 per medical incident.
Alternative to Traditional Reinsurance • Finite risk reinsurance • Capital market alternatives to traditional and non-traditional reinsurance
Reinsurance Program Design • Factors affecting reinsurance needs • Growth plans • Types of insurance sold • Geographic spread of loss exposures • Insurer size • Insurer structure • Insurer financial strength • Senior management’s risk tolerance
Factors Affecting Retention Selection • Maximum amount the primary insurer can retain • Maximum amount the primary insurer wants to retain • Minimum retention sought by the reinsurer • Co-participation provision
Factors Affecting Reinsurance Limit Selection • Maximum policy limit • Extra-contractual obligations • Loss adjustment expenses • Clash cover • Catastrophe exposure
Many More Reinsurance Issues • Basis of “Attaching” Coverage • Contract Wording/Documentation • Pricing Issues (Primary & Reinsurance) • Trends and Emerging Issues • And much more…
Reinsurance Regulation • Contract certainty • Credit for reinsurance transactions
Federal Regulation • Advantages of Federal Regulation • Uniformity of laws • Greater efficiency • More competent regulation
State Regulation • Advantages of State Regulation • Greater responsiveness to local needs • Uniformity of laws by the NAIC • Greater opportunity for innovation • Unknown consequences of federal regulation • Decentralization of political power
Evolution of Insurance Regulation • Paul v. Virginia • Sherman Antitrust Act • South-Eastern Underwriters Association Decision • McCarran-Ferguson Act • ISO and the Attorneys General Lawsuit • Gramm-Leach-Bliley Act
Reasons for Insurance Regulation I • Maintain Insurer Solvency • Nature of the insurance promise • Ripple effect of insolvencies • Protect Consumers/Inadequate Consumer Knowledge • Complex contracts • Difficult to compare and determine monetary value • Important to maintain consumer impact and competitive incentive
Reasons for Insurance Regulation II • Prevent Destructive Competition • Insure Reasonable Rates • Adequate, not excessive, not unfairly discriminatory • Make Insurance Available • Essential coverages (auto) • Government insurance programs (unemployment)
Financial Regulation • Minimum capital and surplus requirements • Admitted assets- those that state law allows an insurer to who on its statutory balance sheet in determining its financial condition • Reserves- liabilities (state prescribes methods for calculating) • Surplus- difference between assets & liabilities (determines amount of business allowed)
Rate Regulation I • All states (except Illinois) have laws requiring rates to be adequate, reasonable (not excessive), not unfairly discriminatory • Types of rating laws (Property/Casualty): • State-made rates- state determines and all insurers in state must use (Texas and Massachusetts for auto rates) • Mandatory bureau rates- rating bureau determines and all insurers must use some deviations (North Carolina)
Insurance Regulatory Activities: Regulating Insurance Rates • Insurance rate regulation goals • Adequate • Not excessive • Not unfairly discriminatory • Types of rating laws
Rate Regulation II • Types of rating laws: • Prior approval- rates must be filed and approved by the state insurance department before they can be used (majority use, but problem of delays) • File-and-use- companies are required only to file the rates with state officials (who may later disapprove) & and use immediately • Open competition- no filing laws though may have to furnish schedules and supporting data to state officials • Flex rating laws- prior approval only required if rate change exceeds a predetermined range—e.g., 5%