Overview of Risk and Insurance

1. Overview of Risk and Insurance Fall 2013

2. Contents • Insurance Industry Overview - Size and Performance • Definition Insurance and Risk • Risk Management and Insurance • Types of Insurance • Property Insurance • Liability Insurance • Life Insurance • Health • Financial Planning – Disability and Retirement funding mechanisms • General Insurance Concepts • Careers in Insurance • Hot Topics • Conclusions Risk Management Introduction

3. Insurance Industry Overview • Insurance Information Institute • http://www.iii.org/ • World insurance premiums totaled $4. 6 trillion in 2012 • III Fact Book: http://www2.iii.org/assets/docs/pdf/International_Insurance_Factbook_2014.pdf • In 2007 there were: • 2,723 U.S. property/casualty insurance companies with $1.3 trillion in assets • 1,190 U.S. life/health insurance companies with $3 trillion in assets • The insurance industries employed over 2.3 million people in 2008 • Catastrophe losses were • $45 billion in 2012 (majority from Sandy) • $6.7 billion in 2007 • $25.6 billion in 2008 (2nd highest year on record) • http://www.iii.org/media/hottopics/insurance/catastrophes/ • The P/C industry had an average annual rate of return of .5 percent in 2008, down from 12.4 percent in 2007 • Forty banks have failed since the financial crisis began, yet no insurance claim has gone unpaid because of the crisis. Risk Management Introduction

4. Profitability of the Insurance Industry • 2012 • http://www.iii.org/articles/2012-year-end-results.html Risk Management Introduction

5. Insurance • not just transfer of risk; • a device for transferring, sharing, and reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable. Risk Management Introduction

6. Key Term • Risk - not just uncertainty of financial loss; - possibility of deviation between actual and expected outcomes - measured in units called “exposures” Risk Management Introduction

7. How Insurance Reduces Risk (assume 1/100 Probability of Loss) • #Exposures Expected Loss Actual Loss Deviation • 1 ? • 100 1 2 100% • 1,000 10 11 10% • 10,000 100 101 1% • 100,000 1,000 1,001 .1% Risk Management Introduction

8. What assumptions are required to make this situation work? • Assuming the exposures are houses….. Risk Management Introduction

9. In Homeowners Insurance • Houses must be similar value • Houses must be geographically disbursed • Houses must be construction • Houses must have similar probability of loss • Must be able to value the loss • ……….. Risk Management Introduction

10. So, what are the requisites of an insurable risk? • With what type of people or exposures do we want to share losses? Risk Management Introduction

11. Requisites for an Insurable Risk • Large Number of Exposure Units • Accidental and Unintentional Loss • Determinable and measurable loss • No catastrophic loss • Calculable Chance of Loss • Economically feasible premium Risk Management Introduction

12. Is the Risk of Collision Insurable? Requisite: • Large #s? • Accidental/Unintentional? • Measurable? • Potentially catastrophic? • Calculable chance • Affordable premium Requisite Met? • Yes • Yes, except for arson to car • Yes, ACV • Yes, not all insured vehicles should have collision at same time • Yes, chance can be statistically determined • Yes, rate per car value is low Risk Management Introduction

13. Is the Risk of Unemployment Insurable? • Large #s? • Accidental/Unintentional? • Measurable? • Potentially catastrophic? • Calculable chance • Affordable premium • Possibly • No, may be voluntary or involuntary • No, Measurement of loss is difficult/ambiguous • No, recession/depression could be catastrophic • No, too many types of unemployment • No, adverse selection/ moral hazard problem Risk Management Introduction

14. Risk Management • The process of identifying and analyzing all possible loss exposures, selecting a method of handling the exposure, and monitoring the method and exposure regularly. • Everyone is exposed to risk management! Risk Management Introduction

15. “Sub-prime underwriting” How feasible would it be to insure: • Only those over age 75 • No serious underwriting requirements • Charge “insured” no premium (retroactively taken out of benefits) • Assign benefits to third party automatically Risk Management Introduction

16. Risk Management and Insurance Connection? • Risk Management techniques: • risk avoidance • risk control • hazard or loss reduction • risk retention • risk transfer • Hedging and sub-contracting • Insurance Risk Management Introduction

17. Property Insurance • Property insurance – a type of insurance designed to pay for damage or loss to property caused by direct perils • Automobile vs. Homeowners • Personal vs. Commercial Lines • Commercial Property Risk Management Introduction

18. Liability Insurance • Coverage for responsibility to third parties • Students are often most interested in automobile claims: • You let your roommate drive your car and she causes an accident; who is responsible for ensuing damages? • You are stopped at a red-light and someone hits you, causing the tire tool in the back of your pickup truck to fly out and hit a pedestrian. Could you be held responsible? • You let your friend leave your apartment after a party you gave in which alcohol was served. If your friend has an accident, who is responsible? Risk Management Introduction

19. Life Insurance • Significance of the Life Insurance Industry • Life insurers have nearly $4 trillion invested in the U.S. economy--including $1.2 trillion in new net investments between 2002 and 2006. • To create an estate • To replace funds that the insured would have been able to accumulate had he/she lived • Purpose of life insurance? • Preservation of family’s economic security • Moral obligation to provide protection • Financial needs • Key person indemnification • Credit enhancement • Business continuation • Employee benefit plans • Term vs. Whole Life? Risk Management Introduction

20. Uses of Life Insurance • Uses of Term • Temporary need for protection • Lack of finances for permanent insurance • Danger of relying solely on group term insurance • Uses of Whole Life • A way to provide death benefit protection for the entire span of life • Enables insured to build retirement fund • Allows “permanent” protection • Accounts for the great bulk of total assets of life insurers and the economy Risk Management Introduction

21. Present Value Example • How much life insurance does it take to provide dependents $40,000 per year for 30 years? Assume 7% interest could be earned during this time. • Is the answer $40,000 times 30? [$1,200,000] • No! One must consider the Time Value of Money benefit. • $496,362 Risk Management Introduction

22. Health Insurance Facts • Morbidity rates higher than mortality rates • At age 40, there is a 50% chance of becoming disabled while working • Health care costs average $7,868/year per person in the U.S. (Kaiser Foundation, October 08) • The share of the economy (GDP) devoted to health care spending has gone from 7.2% in 1970 to 16.6% in 2008; • Costs have risen 700% in last 20 years • 85% of people in the U.S. have some type of health insurance; the 15% uninsured are typically self-employed or work for someone self-employed • The indigent population typically have health insurance through a government-sponsored plan like Medicaid or a state managed plan • 90% of private health insurance is through a group plan Risk Management Introduction

23. Health Insurance History • Initially health insurance was only short-term disability income coverage • became obsolete during depression • In 1929, first group formed agreement with hospital (teachers/hospital in Dallas) • would pay monthly fee for hospital costs if needed; members only • First Blue Cross arrangement • Physicians later formed Blue Shield plans Risk Management Introduction

24. Health Insurance History (cont.) • Medical expense coverages began in 1940s • Premiums became tax deductible for employers • Group policies were the most popular conduit as employers needed to attract employees • Often included life and disability ins. • Experience rating began through idea that different groups incurred different types/amounts of losses • By the 1950s, more medical expense policies than BC/BS policies Risk Management Introduction

25. Typical Types of Health Plans • PPO • providers service members and non-members • smaller co-pay/deductible if insured selects provider on list • insured may go to provider of choice • HMO • Cost containment lead to the development of HMOs • “insurance company” actually provides medical services • managed care • focuses on preventive care and treatment • POS • Hybrid between HMO and PPO • The best of both worlds? Risk Management Introduction

26. Disability Income Insurance • Insure one’s income • Payment made typically as frequent as paycheck was received • Elimination period serves as deductible • Static costs therefore more predictable Risk Management Introduction

27. Social Security • Old Age, Survivors, and Disability Insurance Act of 1935 • SS Benefits • Retirement, survivor, and disability • Medicare - health and hospitalization exp. • Tax • 6.2% SS, up to $113,700 for 2013 • 1.45% Medicare; no limit • Matched by employer • 15.3 percent of all income under $113,700 is paid into the social security system Risk Management Introduction

28. Workers Compensation • Benefits prescribed by different laws in each state • Typically includes • Medical care benefits • Disability income • Death benefits • Rehabilitation benefits • Still necessary? Risk Management Introduction

29. Financial Planning • If you were to be unable to work after today, how much money would your family need to replace your income? • If you retired today, how much money would you like to have each month to live on for rest of your life? Risk Management Introduction

30. Basic Insurance Terminology • Indemnification • Very important to having many insurance products succeed! • Policies enforcing indemnity: property, business income and extra expense, and liability • Policies not contracts of indemnity: life insurance Risk Management Introduction

31. Exclusions in Insurance • Why do we have or need exclusions? • May result in catastrophic loss • Should be covered elsewhere • Not fortuitous (unexpected and unforeseen) • To control moral or morale hazards • To eliminate duplicate coverage • To eliminate coverage not needed by the average insured Risk Management Introduction

32. How Indemnity is Enforced • Insurable Interest • Subrogation • ACV Loss Measurement (versus valued/face amount contracts) • Other Insurance Clause • Pro Rata Clause • Other Restrictive Clauses Risk Management Introduction

33. Insurance Related Laws • COBRA - 1985 • allows portability/continuation of benefits for specified reasons • 18 or 36 months • HIPAA (Health Ins. Portability and Accountability Act – 1996) • requires new group insurer to accept new member even with preexisting Risk Management Introduction

34. Current Hot Insurance Topics • Health Care Reform • Financial Crisis and Bankruptcies • Social Security Funding • Long-Term Care Funding • STOLI (Stranger-originated life insurance) and other Senior issues • Federal Charters for Insurers • Tort Reform • Ponzi Schemes Risk Management Introduction

35. Examples of Careers in Insurance • Underwriters • Claims Adjusters • Actuaries • Agents • Brokers • Reinsurance • Insurance Law • Financial Services • Estate Planning • Employee Benefit Management Risk Management Introduction

36. For Further Information… • Insurance Information Institute • http://www.iii.org/ • American Council of Life Insurers • http://www.acli.com • Social Security Administration • www.ssa.gov Risk Management Introduction