Functions of Insurers

1. Functions of Insurers • 1. Ratemaking • 2. Production • 3. Underwriting • 4. Loss Settlement • 5. Investment

2. Basic Concepts in Ratemaking • Rate Price charged per unit of protection • Premium Determined by multiplying rate by units of protection purchased • Gross Rate Composed of two parts, designed to pay losses and expenses • Pure Premium Portion of the Gross Rate designed to pay losses • Loading Portion of Gross Rate designed to cover expenses of operation

3. Pure Premium • Total Losses . Exposure Units= Pure Premium • $3,000,000 . 100,000 = $30

4. Converting Pure Premium to Gross Rate • Expense part of the rateExpense Ratio: expressed as percentage of the final rate • Permissible Loss Ratio: 1 minus expense ratio • Pure Premium .Gross Rate: 1 _ expense ratio • $ 30 = 30 = $50 1 - .40 60

5. Types of Rates • 1. Class rates • 2. Individual rates • judgment rating • schedule rating • experience rating • retrospective rating

6. Adjusting the Level of Rates • Actual - ExpectedLoss Ratio Loss Ratio X Credibility Expected Loss Ratio Factor = Adjustment • .90 - .60 X .50 = +.25 .60

7. Underwriting • 1. Basic purpose: avoid adverse selection • 2. Relationship of underwriting to adequacy of rates • 3. Exposure that is unacceptable at one rate may be acceptable at another

8. Life Insurance Underwriting Classes • Standard • Preferred • Substandard (rated) • Uninsurable

9. Sources of Underwriting Information • 1. The application • 2. Information from the agent or broker • 3. Investigations • 4. Information bureaus • 5. Physical examinations or inspections

10. Postselection Underwriting • 1. Postselection underwriting (or renewal underwriting) occurs when the insurer decides whether to continue insurance. • 2. Insurer may decline to renew insurance or may offer narrower coverage. • 3. Because cancellation or nonrenewal can impose hardship on insured, some states limit the insurer’s right to exercise these options. • 4. When the option of postselection underwriting is limited, insurers may be more selective in initial underwriting.

11. Adjusters • 1. Staff adjusters • 2. Adjusting bureaus • 3. Independent adjusters • 4. Public adjusters

12. Adjustment Process • 1. Notice • 2. Investigation • 3. Proof of loss • 4. Payment or denial

13. Composition of Insurers’ Investments • Life Property Type of Investment Insurers & Liability • Corporate Stocks 20.6% 21.2% • Corporate Bonds 41.0% 18.3% • Government Bonds 17.1% 51.2% • Mortgages 8.9% 0.4% • Real Estate 2.1% 1.3% • Policy Loans 4.3% • Miscellaneous 6.0% 7.6% • 100.0% 100.0%

14. Miscellaneous Insurer Functions • Legal • Accounting • Engineering

15. Retrospective Rating • 1. A cost-plus approach to pricing in which the premium is determined after the policy period based on actual losses incurred • 2. Retrospective rating formula computes a premium based on • actual losses incurred • loss adjustment expense • premium taxes • allowance for insurer expenses and profit • charge for the “insurance” element

16. Retrospective Formula • [Basic Premium + (Losses X Loss Conversion Factor)] X Tax Multiplier • Standard Premium = $100,000 • Basic Premium = .20 of standard premium • Loss Conv. factor = 1.14 • Tax Multiplier = 1.03

17. Retrospective Rating Illustration • (1) (2) (3) (4) (5)------------------------------------------------------------------------------Incurred Converted Basic (2) + (3) (4) X Losses Losses Premium X 1.03 1.03------------------------------------------------------------------------------ • $20,000 $22,800 $20,000 $42,800 $50,000 • 40,000 45,600 20,000 65,000 66,950 • 60,000 68,400 20,000 88,400 91,052 • 80,000 91,200 20,000 111,200 114,536 • 100,000 114,000 20,000 134,000 138,020 • 120,000 136,800 20,000 156,800 150,000