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The Business of Insurance, Reinsurance, Regulation of Insurance, Risk Management and Public Policy

The Business of Insurance, Reinsurance, Regulation of Insurance, Risk Management and Public Policy. Dr. John F. Fitzgerald, Jr CLU, CPCU, CIC. The Business of Insurance. Business of Insurance. #1 Concern- 28% of Small Business Satisfied Consumers. Structure Types. Life Health

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The Business of Insurance, Reinsurance, Regulation of Insurance, Risk Management and Public Policy

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  1. The Business of Insurance, Reinsurance, Regulation of Insurance, Risk Management and Public Policy Dr. John F. Fitzgerald, Jr CLU, CPCU, CIC

  2. The Business of Insurance

  3. Business of Insurance • #1 Concern- 28% of Small Business • Satisfied Consumers

  4. Structure Types • Life • Health • Property-Liability

  5. Forms & Insurers • Form • Stock • Mutual • Insurers • Life-Health 1200 • Property- Liability 2700

  6. Distribution System • Independent Agents • Agent, broker, solicitor, surplus lines • Exclusive Agents • Direct Writers • Direct Response • Web • Internet • Mail

  7. Market Share • Personal Lines • Agencies 30% • Direct 70% • Commercial Lines • Agency 70% • Direct 30%

  8. Investments

  9. 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)

  10. 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

  11. 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

  12. Reinsurance

  13. What is Reinsurance? • Defined: • Insurance for insurance companies • Retrocession • Insurance for reinsurers

  14. Why is Reinsurance Purchased? • Several “Needs” May Exist • Capacity • Stability • Catastrophe Protection • Premium Growth • Enter/Exit Classes of Insurance

  15. 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

  16. Capacity • Unusual risk or “large line” • Regulations affecting insurers • The 10% rule • Management of line size (limits) within insurance portfolio

  17. 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

  18. Catastrophe Protection • Protect against adverse affects of a catastrophic event natural or man-made • Multiple policies involved in single loss or event

  19. 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

  20. Other Functions • Entry into new classes/ territories • Exit from classes/ territories • Underwriting expertise • Protect insurer against punitive or “bad faith” damages

  21. In/Reinsurance Distribution Broker Market Direct Market

  22. 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)

  23. Types of Reinsurance • Facultative • Treaty • Other (Hybrid/Financial)

  24. Facultative Reinsurance • Individual risk review/underwriting • Certificate issuance • Treaty protection/Hazardous risks • Hybrid agreements • Advantages/Disadvantages

  25. Treaty Reinsurance • Groups of policies, class/line of business, or entire portfolio • Obligatory reinsurer acceptance • Pooling effect • One agreement

  26. 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

  27. Proportional Reinsurance • Sharing Concept- QS (%) & SS($) $1M Primary Insurer Retention Limits of insurance Reinsurance Cession Percentage of premiums & losses shared 0% or ($) 100% or ($)

  28. Comparing: QS & SS

  29. 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

  30. 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

  31. “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

  32. 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

  33. 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.

  34. Alternative to Traditional Reinsurance • Finite risk reinsurance • Capital market alternatives to traditional and non-traditional reinsurance

  35. 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

  36. 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

  37. Factors Affecting Reinsurance Limit Selection • Maximum policy limit • Extra-contractual obligations • Loss adjustment expenses • Clash cover • Catastrophe exposure

  38. Many More Reinsurance Issues • Basis of “Attaching” Coverage • Contract Wording/Documentation • Pricing Issues (Primary & Reinsurance) • Trends and Emerging Issues • And much more…

  39. Reinsurance Regulation • Contract certainty • Credit for reinsurance transactions

  40. Finally: What do Reinsurance Underwriters Really Do?

  41. Regulation of Insurance

  42. Federal Regulation • Advantages of Federal Regulation • Uniformity of laws • Greater efficiency • More competent regulation

  43. 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

  44. 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

  45. 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

  46. 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)

  47. 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)

  48. 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)

  49. Insurance Regulatory Activities: Regulating Insurance Rates • Insurance rate regulation goals • Adequate • Not excessive • Not unfairly discriminatory • Types of rating laws

  50. 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%

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