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Chapter 6: The Insurance Market:

Chapter 6: The Insurance Market:. The Economic Problem. Buyers, Sellers, and Regulators. Regulation. Insurance Companies. Individuals. Agents and Brokers. Business Firms. Regulation. Economic Theory. Normal market Two parties - buyers and sellers

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Chapter 6: The Insurance Market:

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  1. Chapter 6:The Insurance Market: The Economic Problem

  2. Buyers, Sellers, and Regulators Regulation Insurance Companies Individuals Agents and Brokers Business Firms Regulation

  3. Economic Theory • Normal market • Two parties - buyers and sellers • Insurance - add regulators for the third party • Reports of the market having problems occur regularly • Inability to afford or find coverage • Heath care costs and insurance availability • Attorney Generals’ suit against Insurance Industry • Attack on McCarran Ferguson Act

  4. Insurance Industry Critics • Critics of the Industry Charged • Collusion • Bad business practices • Inadequate rate regulation • Irresponsible investment practices

  5. Insurance Industry Response Costs have gone up due to: • Increased medical costs, automobile repair costs, and legal expenses • More thefts, accidents, and insurance fraud • Courts imposing more frequent and higher awards as well as punitive awards • “Catastrophic” losses – windstorm, water damage, hail – weather related events, risk of terrorism • Social inflation - due to liberal legal conclusions • Investment rates of return are historically low

  6. The Insurance Consumer • The insurance consumer is not well informed • Cost of obtaining information is high • Feel that the insurance product is a commodity • Legal complexity of the contract • The more informed the consumer the more information producers will provide • Consumers do not ask the right technical questions and understand the answers • Consumers need to protect his/her self • First level of defense - Education

  7. The Company Financial Strength Service and loss settlement practices The Agent Trust and understand Professional designations and education The Policy Meets needs Proper amount of coverage The right price Lowest price not necessarily the best price Consumer Choices

  8. Insurance and Consumer Protection • Three levels of Consumer External Protection • The Courts • The Insurance Code • The Insurance Commissioner

  9. Consumer Protection:The Courts • The Role is to determine the “Facts” and apply the appropriate law • “Stare decisis” • Reasonable expectations doctrine • Reasons for denying claims

  10. Consumer Protection:The Insurance Code • The Law (Insurance Code) • Massive amount of consumer protection • Financial solvency • Fair claims practices • Standardized insurance policies • Approval of wording • Approves rates and forms • Disclosure requirements • Investment requirements

  11. Consumer Protection: The Insurance Commissioner • Chief Insurance Regulator • Interpretation of insurance code • Enforcement of the insurance code • Suggests legislation • Member of National Association of Insurance Commissioners (NAIC)

  12. Further Consideration of The Law of Supply and Demand Demand P2 Supply P1 Price P3 Q3 Q2 Q1 Quantity

  13. Supply of Insurance is Regulated and Limited: Some Concepts • Loss Ratio • Losses and loss adjustment expenses / Earned Premium • Expense Ratio • Other Expenses / Written Premium • Combined Ratio • Loss ratio + Expense Ratio

  14. Supply of Insurance is Regulated and Limited: P/S ratio • Premium Written to Surplus Ratio Example 1 (Target: 2 or 3 to 1) • Surplus $10,000 • P/S Ratio 2:1 • Premium Volume Company can Write • $20,000 If premium per policy goes up, fewer polices can be sold If premium per policy goes down, rates could be inadequate i.e.., Can’t sell unlimited number of polices

  15. Supply of Insurance is Regulated and Limited: P/S ratio • Example 2 • If P/S is 3 to 1 • Combined Ratio is 1.05 • 15% of Surplus is wiped out in one year. • Surplus $10,000 • Premium $30,000 • Combined Loss $31,500 • Out of Surplus $ 1,500 • Loss as % of Surplus 15% • At 10:1 & 1.05 combined, 50% of surplus gone in one year • At 5:1 & 1.10 combined, 50% of surplus gone in one year • At 10:1 & 1.10 combined, 100% gone in one year • Surplus may also shrink due to investment results • If premiums remain the same and surplus shrinks, • P/S ratio increases

  16. Supply and Demand for Insurance: Hypothetical D C Price Supply B Demand A Quantity

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