Transcript INFORM +INSPIRE - The Griffith Foundation

INFORM+INSPIRE
Basic Principles of Insurance & Risk Management
University of Central Oklahoma
Finance – Insurance and Risk Management
Stuart MacDonald, Gerald Wilkins, Allen Arnold
Seminar for
Oklahoma State Legislators
March 20, 2013
The Griffith Insurance Education Foundation
Seminar Agenda
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Overview of Insurance Principles
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Types of Insurance
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Regulation and Legislation
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Overview of Insurance Principles
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Definition of Risk
The Role of Insurance
Risk Pooling
Adverse Selection
Concept of Moral Hazard
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Definition of Risk
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Risk refers to uncertainty
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An unknown or unexpected event
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Risk can be strategic, unintentional,
systemic, fortuitous
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The Role of Insurance
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According to the American Risk and
Insurance Association, “insurance is the
pooling of fortuitous losses by transfer of
such risks to insurers, who agree to
indemnify insureds for such losses, to
provide other pecuniary benefits on their
occurrence, or to render services
connected with the risk” (Redja, p. 20, 2011).
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Characteristics of Insurance
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Pooling of Losses
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Payment of Fortuitous Losses
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Risk Transfer
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Indemnification
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Risk Pooling
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Spreads the loss suffered by an
individual over the whole group
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Based on the Law of Large Numbers
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Payment of Fortuitous Losses
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Unforeseen
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Unexpected
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Result of Chance
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Transfer of Risk
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Pure risk transferred from an insured
to an insurer for a fee (insurance
premium)
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Indemnification
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Restoring an insured to their
approximate pre-loss financial
position
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Concept of Peril and Hazard
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A peril is the cause of a loss
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A hazard is a factor that creates or
contributes to a loss
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Physical Hazard
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Physical condition that increases the
frequency and/or severity of a loss
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Moral Hazard
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Dishonest or deceitful statements or
behavior in order to defraud the
insurer, thereby increasing the
frequency and/or severity of loss
claims
Insurance fraud causes increases in
premium rates for everyone
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Attitudinal Hazard
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Carelessness or indifference to a loss,
thereby increasing the frequency
and/or severity of loss claims
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Legal Hazard
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Characteristics of the legal system or
regulatory environment that increases
the frequency and/or severity of loss
claims
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Adverse Selection
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Tendency for insurance applicant with
a higher than average loss potential
(sub-standard risk) to acquire
insurance protection at less expensive
(standard risk) premium rates
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Characteristics of an Ideally
Insurable Risk
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Large number of exposure units
Accidental and unintentional loss
Determinable and measurable
Not a catastrophic loss
Chance of loss must be calculable
Economically feasible premium
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Risk Management Matrix
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Low frequency and severity: Retention
High frequency and low severity: Loss
Prevention and Retention
Low frequency and high severity:
Transfer Risk (Insurance)
High frequency and high severity:
Avoidance
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INFLATION-ADJUSTED U.S. CATASTROPHE
LOSSES BY CAUSE OF LOSS, 1992-2011
(1) Estimated property losses adjusted for inflation through 2011 by ISO using the GDP implicit price deflator. Excludes
catastrophes causing direct losses less than $25 million in 1997 dollars. Does not include flood damage covered by the
federally administered National Flood Insurance Program.
(2) Excludes snow.
(3) Includes wildland fires.
(4) Includes losses from civil disorders, water damage, utility service disruptions, and any workers compensation
catastrophes generating losses in excess of PCS's threshold after adjusting for inflation.
Source: The Property Claim Services (PCS) unit of ISO, a Verisk Analytics company.
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Why Insurers Become Insolvent
 Note that Fraud outranks Catastrophe Losses.
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Types of Insurance
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Personal Lines
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Life
Health
Homeowners
Auto
Reinsurance and Surplus Lines
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2011 U.S. Net
Premiums Written
$175B
$502B
P&C
Life
A&H
$576B
Source: SNL Financial, Inc.
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Personal Lines - Life
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Life insurance is justified if others are
financially dependent on the insured
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Term Insurance vs. Whole Life Insurance
Ownership Clause
Incontestable Period / Suicide Clause
Death benefit proceeds are tax-exempt
Life Income Options / Annuities
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Personal Lines - Health
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Patient Protection and Affordable Care
Act
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State Health Insurance Exchanges
No pre-existing conditions
No lifetime or annual limits
Coverage for children to age 26
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2011 Life/A&H U.S. NPW by Line
Source: SNL
Financial, Inc.
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Personal Lines - Homeowners
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Homeowners 3 (Special Form)
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All-Risks Coverage, except named
exclusions (Earthquake, Flood, War,
Nuclear Radiation)
Homeowners 6 (Condominiums)
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Same as above
Homeowners 4 (Renters Insurance)
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Named Perils (NOT All-Risks)
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Personal Lines - Auto
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Personal Auto Policy
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Liability Coverage
Medical Payments Coverage
Uninsured / Underinsured Motorists
Collision and Comprehensive
Exclusions (intentional injury or damage,
racing, road rage, business use, etc.)
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2011 P&C U.S. NPW by Line
Source: SNL
Financial, Inc.
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State Trends in Auto and
Homeowners Pricing
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2011 report by the Insurance
Research Council indicates a rapid
increase in the severity of claims, and
a slow but steady increase in the
frequency of non-severe claims.
Commercial Auto most stable
underwriting
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Reinsurance
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Primary insurer that writes the
insurance transfers to another insurer
(the reinsurer) part or all of the
potential losses associated with such
insurance
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Reasons for Reinsurance
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Increase underwriting capacity
Stabilize profits
Reduce the unearned premium reserve
Protection against catastrophic losses
(e.g. reinsurers paid a large part of the
$41 billion insured losses arising from
Hurricane Katrina which significantly
reduced losses paid by primary insurers)
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Surplus Lines
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Surplus lines refers to any type of
insurance for which there is no insurer
licensed by the State of Oklahoma that
will write the type and amount of
insurance requested by the insured
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Coverage must be placed by a surplus
lines broker with a nonadmitted insurer
which is not licensed to do business in
Oklahoma (e.g. Lloyd’s of London)
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Surplus Lines
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Surplus lines carriers are registered
with the Oklahoma Insurance
Department
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A 6% surplus lines tax is levied on
insurance premiums for surplus lines
coverage; tax is paid by the surplus
lines broker placing the coverage for
the insured
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Regulation of Insurance
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National Association of Insurance
Commissioners (NAIC)
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All 50 states, Wash. D.C, 5 US Territories
Maintain insurer solvency
Regulate fair and reasonable rates
Ensure availability of insurance
Consumer protection and education
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State Regulation of Insurance
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Oklahoma Insurance Department
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Enforce insurance-related laws
Protect consumers
Promote competitive insurance markets
License and educate insurance agents
and adjusters, funeral home directors,
bail bondsmen, real estate appraisers
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State Guaranty Funds
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Provide protection from losses if an
insurer becomes insolvent
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Life and Health Insurance Guaranty
Association
Property and Casualty Insurance
Guaranty Association
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Oklahoma Guaranty Associations
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When a licensed insurer fails, other
licensed insurance carriers are
assessed according to the % of
premiums they write in the State to pay
the claims of the failed carrier
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Oklahoma Guaranty Associations
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Each insurer who pays an assessment
is permitted to take the amount they pay
as a credit against their premium taxes
(licensed insurance carriers pay a
2.25% premium tax on all premiums
they bill their insureds)
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Solvency, Pricing, Rate Adequacy
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Insolvency result of catastrophic losses,
inadequate reserves and rates,
mismanagement, bad investments, etc
Premium pricing function of expected
losses, expense loading, investments
Rates regulated to balance insurer
profitability and prevent consumer gouging
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Regulatory Methods to
Ensure/Monitor Insurer Solvency
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State insurance departments utilize
strict methods and requirements to
maintain insurer solvency
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Licensing and financial requirements
Risk-based capital standards
Submission of financial statements
In-field examinations of insurer practices
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Policy Forms
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Insure Consistency of Product
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Consistency of Interpretation of
Language
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Set Coverage Standards
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Balance between Consumers
and Insurers
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Government Failure vs. Market Failure
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Bad Faith vs. Fraud
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State Guaranty Funds vs. Moral Hazard
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Sound Underwriting vs. Red Lining
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Rate Filing
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Interstate Insurance Compact
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Must Insure Solvency
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McCarran-Ferguson Act
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Prevent “Destructive” Competition
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Issues in Insurance Legislation
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Tag initiative uninsured drivers loss of
state revenue
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Workers Compensation
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Captive Insurance
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Questions?
Comments?
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INFORM+INSPIRE
Thank you for allowing us to present this seminar
on Insurance and Risk Management. Please
contact us if we can be of further assistance.
This presentation can be downloaded at:
www.griffithfoundation.org/public-policy/resources/
Melissa Kuhn Wheeler, The Griffith Insurance Education
Foundation, (855) 288-7743, [email protected]
Dr. Stuart MacDonald, (405) 974-2152, [email protected]
Gerald Wilkins, (405) 974-5566, [email protected]
Allen Arnold, (405) 974-2171, [email protected]
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