Insurance

Section 5

Prepared by

Eman Abdelrahim Shehata

Assistant lecture at Statistics, Mathematics and Insurance Department
Faculty of Commerce, Assiut University
 Section 5
Chapter 3 (continued)
Types of Insurance

Private insurance Government Insurance

Personal Commercial
lines lines Social Government
Insurance Insurance
 Life insurance Programs Programs
 Health insurance
 Disability plans
 Property insurance
 Liability insurance
 Casualty insurance
 Types of Insurance
Private insurance
Private insurance coverages can be grouped into
two major categories:

1- Personal lines
That insure on the life, real estate and personal
property of individuals and families or provide
protection against legal liability.

2- Commercial lines
For business firms, nonprofit organizations, and
government agencies
private insurance can be divided as follows:
 Life insurance pays death benefits to
beneficiaries when the insured ‫ المؤمن عليهم‬dies.

 Health insurance covers: pays medical

expenses because of sickness or injury.

 Disability plans pay income benefits, disability

income insurance provides benefits to replace
lost income when an insured unable to work
because of illness and/or injury.

 Property insurance indemnifies property

owners against the loss or damage of property.
 Liability insurance covers the insured’s legal
liability arising out of property damage or
bodily injury to others.

 Casualty insurance refers to insurance that

covers whatever is not covered by fire,
marine, and life insurance
 Government Insurance
1- Social Insurance Programs:
Financed by contributions from employers and/or
employees. Benefits are heavily weighted in favor of
low-income groups.

Examples:
- Social Security
- Unemployment
- Workers Compensations
2- Government Insurance Programs:
Found at both the federal and state level.

Examples:
- Federal flood insurance, and
- state health insurance pools
 Social Benefits and costs of Insurance
1- Social Benefits of Insurance:
• Indemnification for Loss: Contributes to family
and business stability
• Reduction of Worry and Fear: Insureds are less
worried about losses
• Source of Investment Funds: Premiums may be
invested, promoting economic growth
• Loss Prevention: Insurers support loss-prevention
activities that reduce direct and indirect losses.
• Enhancement of Credit: Insured individuals are
better credit risks than individuals without
insurance.
2- Social Costs of Insurance:
• Cost of Doing Business. Insurers consume
resources in providing insurance to society.

An expense loading is the amount needed to

pay all expenses, including commissions, general
administrative expenses, state premium taxes,
acquisition expenses, and an allowance for
contingencies and profit.
εpremiums = net premium + an expense loading
• Fraudulent and Inflated Claims: Payment of
fraudulent or inflated claims results in higher
premiums to all insureds, thus reducing
disposable income and consumption of other
goods and services
All of the following are benefits to society that
result from insurance EXCEPT
(A) Less worry and fear
(B) Elimination of moral hazard
(C) Indemnification for loss
(D) Loss prevention

All of the following are social costs associated with

insurance EXCEPT
(A) Insurance company operating expenses
(B) Fraudulent claims
(C) Inflated claims
(D) Increased cost of capital
Insurance company operations

Rate making

Underwriting and
investment

Production

Claim Settlement

Reinsurance
 Rate making
• Rate making refers to the pricing of insurance
so that total premiums charged must be
adequate for paying all claims and expenses
during the policy period.

• Rates and premiums are determined by an

actuary, using the company’s past loss
experience and industry statistics.
 Underwriting and investment
Underwriting refers to the process of selecting,
classifying, and pricing applicants for insurance. The
objective of underwriting is to produce a profitable
book of business.

A statement of underwriting policy establishes policies

that are consistent with the company’s objectives, such
as:
- Acceptable classes of business.
- Amounts of insurance that can be written.
An underwriter makes daily decisions concerning
the acceptance or rejection of business. There are
three important principles of underwriting:

- The underwriter must select prospective insureds

according to the company’s underwriting
standards.

- Underwriting should achieve a proper balance

within each rate classification.

- In class underwriting, exposure units with similar

loss-producing characteristics are grouped
together and charged the same rate.
Information for underwriting comes from:
– The application
– The agent’s report
– An inspection report
– Physical inspection
– A physical examination and attending physician’s report
– MIB report

After reviewing the information, the underwriter can:

Accept the application or Accept the application subject
to restrictions or modifications or Reject the application.
The business model can be reduced to a simple equation

Profit = earned premium + investment income – incurred

loss - underwriting expenses.

Insurers make money in two ways:

1) Through underwriting, the process by which insurers
select the risks to insure and decide how much in
premiums to charge for accepting those risks.
2) By investing the premiums they collect from insured
parties.
insurers use actuarial science to quantify the risks they are
willing to assume and the premium they will charge to assume
them, Actuarial science uses statistics and probability to analyze
the risks associated with the range of perils covered.

Upon termination of a given policy, the amount of premium

collected and the investment gains thereon minus the amount
paid out in claims is the insurer's underwriting profit on that
policy.
Of course, from the insurer's perspective, some policies are
"winners" (i.e., the insurer pays out less in claims and expenses
than it receives in premiums and investment income) and some
are "losers" (i.e., the insurer pays out more in claims and
expenses than it receives in premiums and investment income);
insurance companies use actuarial science to attempt to
underwrite enough "winning" policies to pay out on the "losers"
while still maintaining profitability
Investments
Because premiums are paid in advance, they can be
invested until needed to pay claims and expenses.

Life insurance contracts are long-term and property

insurance contracts are short-term in nature and
claim payments can vary widely depending on
catastrophic losses, inflation, medical costs, etc

Insurance companies also earn investment profits

on available reserve is the amount of money, at
hand at any given moment, that an insurer has
collected in insurance premiums but has not been
paid out in claims
 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.

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 includes:
– Verification of a covered loss
– Fair and prompt payment of claims
– Personal assistance to the insured
Some laws prohibit unfair claims practices, such as the
following:
a) Refusing to pay claims without conducting a
reasonable investigation.
b) Not attempting to provide prompt, fair, and
equitable settlements
c) Offering lower settlements to compel insureds to
institute lawsuits to recover amounts due
Claims may be filed by insureds directly with the
insurer or through brokers or agents.

A claims adjustor determines if a covered loss has

occurred and 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.

The adjuster undertakes a thorough investigation of

each claim, usually in close cooperation with the
insured, determines its reasonable monetary value,
and authorizes payment
fraudulent insurance practices are a major
business risk that must be managed and
overcome. Disputes between insurers and
insureds over the validity of claims or claims
handling practices occasionally escalate into
litigation
 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 and The amount of insurance ceded
to the reinsurer is known as a cession
Reinsurance is used to:
⁻ Increase underwriting capacity.
⁻ Stabilize profits.
⁻ Reduce the unearned premium reserve.
⁻ 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.
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.

• Treaty reinsurance means the primary insurer

has agreed to cede insurance to the reinsurer,
and the reinsurer has agreed to accept the
business.
- Under a quota-share treaty, the ceding insurer
and the reinsurer agree to share premiums and
losses based on some proportion
- Under a surplus-share treaty, the reinsurer
agrees to accept insurance in excess of the
ceding insurer’s retention limit, up to some
maximum amount.
- An excess-of-loss treaty is designed for
catastrophic protection.
A reinsurance pool is an organization of insurers
that underwrites insurance on a joint basis
Reinsurance Alternatives
- Some insurers use the capital markets as an
alternative to traditional reinsurance
- Securitization of risk means that an insurable
risk is transferred to the capital markets through
the creation of a financial instrument, such as a
futures contract
- Catastrophe bonds are corporate bonds that
permit the issuer of the bond to skip or reduce
the interest payments if a catastrophic loss
occurs
The function of an actuary is to:
(A) Adjust claim
(B) Determine premium rates
(C) Negotiate reinsurance treaties
(D) Preparer financial reports

All of the following are classified as casualty

insurance EXCEPT
(A) Life insurance
(B) General liability insurance
(C) Workers compensation insurance
(D) Burglary and theft insurance
Apex insurance company wrote a large number of
property insurance policies in an area where earthquake
losses could occur. When the president of apex was asked
if she feared that a severe earthquake might put the
company out of business, she responded not a chance.
We transferred most of the risk to other insurance
companies. An arrangement by which an insurer that
initially writes insurance transfers to another insurer part
or all of the potential losses associated with such
insurance is called:

(A) hedging
(B) speculative
(C) reinsurance
(D) loss avoidance
Which of the following statement about the insurance
industry as a source of investment funds is (are) true:
I. These funds result in a lower cost of capital than
would exist in the absence of insurance
II. These funds tend to promote economic growth and
full employment

(A) I only (B) II only

(c) Both I and II (D) Neither I nor II

Which of the following types of risks best meets the

requirements for being insurable by private insurers:
(A) Market risks (B) property risks
(c) Financial risks (D) political risks
Which of the following is a form of casualty insurance
(A) Fire insurance
(B) general liability insurance
(C) Inland marine insurance
(D) Ocean marine insurance

An insurable risk is transferred to the capital markets

through the creation of a financial instrument (is):
(A) contracts
(B) reinsurance
(C) Securitization
(D) Hold-harmless agreement
Under this a treaty, the ceding insurer and the reinsurer agree
to share premiums and losses based on some proportion:
(A) quota-share treaty
(B) surplus-share treaty
(C) An excess-of-loss treaty
(D) reinsurance pool

Under a treaty, the reinsurer agrees to accept insurance in

excess of the ceding insurer’s retention limit, up to some
maximum amount.
(A) quota-share treaty
(B) surplus-share treaty
(C) An excess-of-loss treaty
(D) reinsurance pool
an optional, case-by-case method that is used when the
ceding company receives an application for insurance that
exceeds its retention limit.

(A) quota-share treaty

(B) Treaty reinsurance
(C) Facultative reinsurance
(D) reinsurance pool

means the primary insurer has agreed to cede insurance to

the reinsurer, and the reinsurer has agreed to accept the
business.
(A) An excess-of-loss treaty
(B) Treaty reinsurance
(C) Facultative reinsurance
(D) reinsurance pool