CHAPTER 4: INSURANCE COMPANY’S OPERATION
OUTLINE
• Rate making
• Underwriting
• Production
• Claim settlement
• Reinsurance
• Investment
Rating and rate making
• Ratemaking refers to the pricing of insurance and the calculation of
insurance premiums. Actuary
• A rate is the price per unit of insurance
• An exposure unit is the unit of measurement used in insurance
pricing
Premium = rate exposure units
Underwriting
• Underwriting refers to the process of selecting, classifying, and pricing
applicants for insurance
• The basic principles of underwriting include:
• Attain an underwriting profit
• Select prospective insureds according to the company’s underwriting
standards
• Provide equity among the policyholders
Steps in underwriting
• Underwriting starts with the agent
• Information for underwriting comes from:
• The application
• The agent’s report
• An inspection report
• Physical inspection
• A physical examination and attending physician’s report
Steps in underwriting
• After reviewing the information, the underwriter can:
• Accept the application and recommend that the policy be issued
• Accept the application subject to restrictions or modifications
• Reject the application
• Many insurers now use computerized underwriting for certain
personal lines of insurance that can be standardized
Production
• Production refers to the sales and marketing activities of insurers
• Agents are often referred to as producers
• Life insurers have an agency or sales department
• Property and liability insurers have marketing departments
• The marketing of insurance has been characterized by a trend toward professionalism
• An agent should be a competent professional with a high degree of technical
knowledge in a particular area of insurance and who also places the needs of his or
her clients first
Claim settlement
• The objectives of claims settlement include:
• Verification of a covered loss
• Fair and prompt payment of claims
• Provide personal assistance to the insured
Types of claims adjustors
• Major types of claims adjustors include:
• An insurance agent often has authority to settle small first-party claims up to some
limit
• A staff claims representative is usually a salaried employee who will investigate a
claim, determine the amount of loss, and arrange for payment.
• An independent adjustor is an organization or individual that adjusts claims for a fee
• A public adjustor represents the insured and is paid a fee based on the amount of the
claim settlement
Steps in claim settlement
• The claim process begins with a notice of loss, typically immediately or as soon as
possible after a loss has occurred.
• Next, the claim is investigated
• An adjustor must determine that a covered loss has occurred and determine the
amount of the loss
• The adjustor may require a proof of loss before the claim is paid
• The adjustor decides if the claim should be paid or denied
• Policy provisions address how disputes may be resolved
Reinsurance
• Reinsurance is an arrangement by which the primary insurer that initially writes the
insurance transfers to another insurer part or all of the potential losses associated
with such insurance
• The primary insurer is the ceding company
• The insurer that accepts the insurance from the ceding company is the reinsurer
• The retention limit is the amount of insurance retained by the ceding company
• The amount of insurance ceded to the reinsurer is known as a cession
• Retrocession is when a reinsurer insures part or all of a risk with another insurer
Reinsurance
• Reinsurance is used to:
• Increase underwriting capacity
• Stabilize profits
• Reduce the unearned premium reserve, which represents the unearned portion of
gross premiums on all outstanding policies at the time of valuation
• Provide protection against a catastrophic loss
• Retire from business or from a line of insurance or territory
• Obtain underwriting advice on a line for which the insurer has little experience
Types of reinsurance agreements
• There are two principal forms of reinsurance:
• Facultative reinsurance is an optional, case-by-case method that is used when the
ceding company receives an application for insurance that exceeds its retention limit
• Often used when the primary insurer has an application for a large amount of
insurance
• Treaty reinsurance means the primary insurer has agreed to cede insurance to the
reinsurer, and the reinsurer has agreed to accept the business
• All business that falls within the scope of the agreement is automatically reinsured
according to the terms of the treaty
Investments
• Because premiums are paid in advance, they can be invested until needed to pay claims
and expenses
• Investment income is extremely important in reducing the cost of insurance to
policyowners and offsetting unfavorable underwriting experience
• Life insurance contracts are long-term; thus, safety of principal is a primary consideration
• In contrast to life insurance, property insurance contracts are short-term in nature, and
claim payments can vary widely depending on catastrophic losses, inflation, medical
costs, etc
Other insurance company functions
• Information systems are extremely important in the daily operations of insurers.
• Computers are widely used in many areas, including policy processing,
simulation studies, market analysis, and policyholder services.
• The accounting department prepares financial statements and develops budgets
• In the legal department, attorneys are used in advanced underwriting and estate
planning
• Property and liability insurers also provide many loss control services
