Cpcu 520 Ch. 01

Front 1

Insurance

Back 1

a risk management technique that transfers some or all of the potential financial consequences (liability) for certain loss exposures from the insured to the insurer

Front 2

Law of large numbers

Back 2

a mathematical principle stating that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) also increases

Front 3

Proprietary insurers

Back 3

insurers formed to earn a profit for their owners

Front 4

Cooperative insurers

Back 4

Insurers owned by their policyholders and usually formed to provide insurance protection to their policyholders at minimum cost. Mutual insurance companies, reciprocal exchanges, and fraternal organizations are examples of cooperative insurers.

Front 5

Pool

Back 5

- A group of insurers, not otherwise related, that join together to insure loss exposures that individual insurers are unwilling to insure.
- Ex. airline crashes, nuclear power plants.
- Formed voluntarily or to meet statutory requirements
- Operate either as a syndicate (all pool members are liable to indemnify the insured in a specified capacity) or through reinsurance (one member issues the insurance, but all members pay a proportion of the insured's losses)
- ex. FAIR (Fair Access to Insurance Requirements - residual market

Front 6

Fair Access to Insurance Requirements (FAIR) plans

Back 6

An insurance pool through which private insurers collectively address an unmet need for property insurance on urban properties, especially those susceptible to loss by riot or civil commotion

Front 7

Licensed insurer (or admitted insurer)

Back 7

an insurer authorized by the state insurance department to transact business within a particular state

Front 8

Unlicensed insurer (or non-admitted insurer)

Back 8

an insurer not authorized by the state insurance department to transact business in the insured's state

Hint 8

Context: There are four ways to classify types of insurers. One of these ways is Licensing Status which includes admitted and non-admitted (unlicensed).

Front 9

Expense ratio

Back 9

- An insurer's incurred underwriting expenses for a specific period divided by its written premiums for the same period
- expenses to premiums
- underwriting expenses consist of commission expenses (sales), and other expenses but excludes loss adjustment expenses (claims and legal fee expenses)
- When rates are rising rapidly, expense ratios tend to decline because expenses do no rise as fast as rates. When competition/regulation holds insurance rates down, expense ratio tends to increase because expenses tend to rise consistently with inflation.

Front 10

Loss ratio

Back 10

- An insurer's incurred losses (including loss adjustment expenses) for a specific period divided by its earned premiums for the same period.
- incurred losses to earned premiums
- measures how well insurer can control amount of insured losses
- Insurer with lower than industry avg expense ratio can afford higher loss ratio while still earning an acceptable profit
- Pure loss ratio = loss ratio without LAE. Traditionally loss ratios include LAE in the statistic.

Front 11

Combined ratio

A combined ratio under 100 =
A combined ratio over 100 =

Back 11

The sum of an insurer's loss ratio and its (underwriting) expense ratio.

<100 = earned a profit on its insurance operations (underwriting profit)

>100 = loss in insurance operations

Front 12

Financial basis combined ratio

Back 12

One of two ways to calculate the combined ratio. A profitability ratio calculated by dividing incurred losses and incurred expenses by earned premiums.

Calculation: (Incurred losses & loss adjustment expenses + incurred UW expenses)/earned premiums

Front 13

Trade basis combined ratio

Back 13

One of two ways to calculate the combined ratio. A profitability ratio calculated by dividing incurred losses and loss adjustment expenses by earned premiums and then adding the result of dividing incurred UW expenses by net written premiums

Calculation: [(Incurred losses & loss adjustment expenses)/earned premiums] + [(incurred UW expenses)/net written premiums]

Front 14

Operating profit or loss

Back 14

The sum of underwriting profit or loss and investment profit or loss

Front 15

Explain the role of the risk transfer process in the risk management process

Back 15

Risk transfer is a part of the overall risk mgmt process and is an example of a risk financing technique

Front 16

Identify the steps in the risk management process

Back 16

1. Identify loss exposures
2. Analyze the loss exposures
3. Examine the feasibility of risk mgmt techniques
4. Select the most appropriate technique for the loss exposure
5. Implement the chosen technique
6. Monitor the results and make changes as needed

Front 17

Identify the four classifications that may be used to distinguish insurers from one another

Back 17

1. Legal form of ownership
2. Place of incorporation
3. Licensing status
4. Marketing systems used

Front 18

How do stock and mutual insurers differ

Back 18

A stock insurer is owned by its stockholders, who elect a board of directors to oversee the oeprations. Profits in stock insurers are returned to the stockholders. Mutual companies are owned by policyholders, who elect a board of directors. Profits in excess of those added to surplus are usually returned to the policyholders in the form of dividends.

Front 19

Describe the role of each of the following insurer operations
-- Lloyd's
-- Reciprocal exchanges

Back 19

Lloyd's: all of the insurance written at Lloyd's is written by or on behalf of individuals and is backed by that member's entire personal fortune.

Reciprocal exchanges: reciprocal insurers are owned by their members, and the risk is then transferred to the other members of the exchange.

Front 20

Describe the internal constraints an insurer might face when trying to achieve its goals.

Back 20

Internal constraints include efficiency, and some insurers are more efficient than others because of superior mgmt, advanced technologies, or other reasons. Another constraint is lack of needed expertise ina ll coverages in which the insurer is involved. Size and financial resources might also constrain an insurer from meeting its objectives.

Front 21

Describe the environmental constraints an insurer might confront when trying to achieve its goals.

Back 21

Insurers might be constrained by several external sources, including regulation, public opinion, competition, economic conditions, or even the type of marketing system used to teach potential customers.

Front 22

What are the indicators that insurers can use to gauge their success in meeting customers' needs?

Back 22

Customer complaints made either directly to the insurer or through the insurance dept can indicate customer satisfaction. Consumer surveys and feedback from producers are also useful.

Front 23

Describe the operations of the "marketing" function

Back 23

Marketing involves determining what products or services customers want or need and delivering them to those customers

Front 24

Describe the operations of the "underwriting" function

Back 24

Underwriting determines which applicants the insurer will accept

Front 25

Describe the operations of the "claims" function

Back 25

Claim personnel fulfill the promises outlined in the policy by providing payment for covered losses

Front 26

Describe the operations of the "loss control" function

Back 26

The loss control dept assists policyholders in preventing accidents and in minimizing the losses resulting from accidents that do happen.

Front 27

Describe the operations of the "reinsurance" function

Back 27

The reinsurance function facilitates the risk transfer process by spreading loss exposures among insurers.

Front 28

Describe the operations of the "investment" function

Back 28

The investment function determines how best to invest premium and loss reserve funds to provide cash flow to pay for future losses

Front 29

What are the usual sources of investable funds that insurers use to generate investment earnings?

Back 29

Premium and loss reserve funds.

Front 30

Substantial interdependance exists among the various organizational functions within a property-casualty insurer. Provide two examples of interdependencies for the "marketing and underwriting" functions.

Back 30

The UW dept works with marketing to find ways to make unacceptable insurance applications acceptable. The mkg dept can provide UW with valuable information from policyholders, prospective policyholders and producers.

Front 31

Substantial interdependance exists among the various organizational functions within a property-casualty insurer. Provide two examples of interdependencies for the "underwriting and loss control" functions.

Back 31

The loss control dept completes surveys and premises inspections for underwriters. As part of this process, loss control can share information gathered in the course of the survey that is important to the underwriting process

Front 32

Substantial interdependance exists among the various organizational functions within a property-casualty insurer. Provide two examples of interdependencies for the "claims and marketing" functions.

Back 32

The claim department assists the marketing dept by providing good claim services to customers and claimants. The claim dept can notify the mkg dept before denying coverage on an outstanding claim.

Front 33

Substantial interdependance exists among the various organizational functions within a property-casualty insurer. Provide two examples of interdependencies for the "actuarial and underwriting" functions.

Back 33

The actuarial dept calculates the rating plans for the underwriters to use. This dept also prepares statistical information used for the evaluation of the underwriting department's performance.

Front 34

What are the 4 ways to classify types of insurers?

Back 34

1. Legal form of ownership
2. Place of incorporation
3. Licensing Status
4. Marketing System

Front 35

What are the three legal forms of ownership and the subcategories of those?

Back 35

1. Proprietary (purpose is to earn a profit) - Stock Insurance Companies, Lloyd's, Insurance Exchanges

2. Cooperative (formed to provide insurance at a minimum cost to policyholders) - Mutual Insurance Companies, Reciprocal Exchanges, Fraternal Organizations

3. Other - Pools, Government Insurers

Front 36

Stock insurance companies

Back 36

- most prevalent type of proprietary insurer
- Owned by stockholders
- elect a board of directors to oversee company operations
- Board appoints officers and hires employees

Front 37

Lloyd's

Back 37

- Consists of Lloyd's of London and American Lloyd's orgs
- Not an insurance company, but a marketplace (like stock exchange)
- Members belong to syndicates and delegate day-to-day ops to syndicate mgr
- Insurance is backed by individual members and liability is limited to their own fortunes

Front 38

Mutual Insurance Companies

Back 38

- Corporations owned by the policyholders (not stockholders)
- PHs elect board of directors that elects officers to run company
- Excess profit returned to PHs in form of dividends

Front 39

Reciprocal Exchanges

Back 39

- a.k.a. interinsurance exchanges
- formed to provide lower cost insurance to members/owned by members
- Unlike mutuals, liability is transferred to the other members not the insurer member
- Unlike mutuals, managed by attorney-in-fact, not officers elected by a board
- is a non-profit

Front 40

Other examples of cooperative insurers

Back 40

Captive insurers - formed to insure loss exposures of captive's owners. Purpose is to fund the losses of owners

Risk retention groups and Purchasing Groups are organized so that only a limited group or type of insured can purchase insurance from them

Front 41

Difference between earned premiums and written premiums in the ratios

Back 41

- Written premiums count at the time the policy is written regardless of when they are earned. Earned premiums are realized over time.
- Since underwriting costs (cost of marketing, selling and evaluating risk of a policy - own def.) are all incurred before writing the premium, they more closely match the written premium rather than the earned premium which lags behind the actual UW cost until the policy period ends
- key point is that ins companies that are growing have earned premiums that lag behind written premiums (it takes longer for new customers to become profitable than existing customers)

Front 42

Difference between financial basis combined ratio and trade basis combined ratio

Back 42

- the financial basis combined ratio uses an expense ratio with earned premium in the denominator, whereas trade-basis combined ratio uses written premium in the denominator
- Financial basis tends to understate profitability (earned premium is lower than written = lower denominator = greater ratio = greater expense ratio) in growing insurers whereas trade basis uses written premium in the expense ratio thus providing a slightly more accurate number.