ITS DEFINITIONS & EVALUATIONS

INSURANCE DEFINED

The world of INSURANCE involves pooling funds from many insured entities (also known as exposures) to pay for the losses that some may come across. These insured entities are therefore protected from risk for a fee, with the fee being dependent upon the frequency and harshness of the event occurring. In order to be an insurable risk, the risk insured against must meet certain characteristics. INSURANCE as a financial mediator is a commercial enterprise and a major part of the financial services industry, but individual entities can also be self-insured through saving money for possible future losses.

INSURABILITY

Risk(s) that can be insured typically shares some common features:

INCOMPLETE RISK OF DISASTROUSLY HUGE LOSSES: Principal constrains insurers' ability to sell earthquake insurance as well as wind insurance in hurricane zones. In commercial fire insurance, it is possible to find single properties whose total exposed value is well in excess of any individual insurer's capital constraint. Such properties are generally shared among several insurers, or are insured by a single insurer who syndicates the risk into the reinsurance market. Insurable losses are ideally free and non-catastrophic, meaning that the losses do not happen all at once and individual losses are not severe enough to bankrupt the insurer; insurers may prefer to limit their exposure to a loss from a single event to some small portion of their capital base.

TOO MUCH OF SIMILAR EXPOSURE UNITS: Accepted that insurance operates through pooling resources, the majority of insurance policies are provided for individual members of large classes, allowing insurers to benefit from the law of large numbers in which predicted losses are similar to the actual losses. However, all exposures will have particular differences, which may lead to different premium rates.

HUGE LOSS: The extent of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. There is hardly any point in paying such costs unless the protection offered has real value to a buyer. For small losses, these latter costs may be several times the size of the expected cost of losses.

REASONABLE PREMIUM: If the possibility of an insured event is so high, or the cost of the event so huge, that the resulting premium is large relative to the amount of protection offered, then it is not likely that the insurance will be purchased, even if on offer. In addition, as the accounting profession formally recognizes in financial accounting standards, the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, then the transaction may have the form of insurance, but not the substance.

ACCIDENTAL LOSS: This loss should in the sense that it results from an event for which there is only the opportunity for cost and above all, it should be pure. Events that contain speculative elements, such as ordinary business risks or even purchasing a lottery ticket, are generally not considered insurable. The occurrence that constitutes the generation of a claim should be accidental and unexpected, or at least outside the control of the beneficiary of the insurance.

ACCESSIBLE LOSS: Possibility of loss is generally an experiential exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.

There are two rudiments that must be at least venerable, if not properly computable: the possibility of loss, and the attendant cost.

EXACT LOSS: Job-related disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place, or cause is identifiable. The loss takes place at a known time, place, and from a known cause. The classic example is death of an insured person on a life insurance policy. Ideally, the time, place, and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory.

LEGAL RESPONSIBILITIES

At a time a corporation insures an individual entity, there are basic lawful necessities to be observed. Several normally cited legal principles of insurance comprise:

PROTECTION – the insurance company guarantees, protects & indemnifies, or compensates, the insured in the case of certain losses only up to the insured's interest.

INSURABLE CONCERN – The notion requires that the insured have a "stake" in the loss or damage to the life or property insured. the insured typically must directly suffer from the loss. Insurable interest must exist whether property insurance or insurance on a person is involved. What that "stake" is will be determined by the kind of insurance involved and the nature of the property ownership or relationship between the persons. The requirement of an insurable interest is what distinguishes insurance from gambling.

  

INDEMNIFICATION

The word "indemnify" simply means to be restored to the position that one was in, to the extent possible or to make whole again, prior to the happening of a specified event or peril. Accordingly, life insurance is generally not considered to be indemnity insurance, but rather "contingent" insurance (i.e., a claim arises on the occurrence of a specified event).

INSURERS' COMMERCIAL COPY

Underwriting and investing

The commercial copy or business model is to collect more in premium and investment income than is paid out in losses, and to also offer a competitive price which consumers will accept. Profit can be reduced to a simple equation:

    Profit = investment income + earned premium - underwriting expenses incurred loss.

v  Insurers By investing the premiums they collect from insured parties.

      can make money in two ways:

v  Through underwriting, the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks;

At the most fundamental level, initial ratemaking involves looking at the frequency and severity of insured perils and the expected average payout resulting from these perils. Thereafter an insurance company will collect historical loss data, bring the loss data to present value, and compare these prior losses to the premium collected in order to assess rate adequacy. Loss ratios and expense loads are also used. Rating for different risk characteristics involves at the most basic level comparing the losses with "loss relativities" - a policy with twice as many losses would therefore be charged twice as much.

The most complex aspect of the insurance business is the actuarial science of ratemaking (price-setting) of policies, which uses statistics and probability to approximate the rate of future claims based on a given risk. After producing rates, the insurer will use discretion to reject or accept risks through the underwriting process.

Underwriting performance is measured by something called the "combined ratio" which is the ratio of expenses/losses to premiums. A combined ratio of less than 100 percent indicates an underwriting profit, while anything over 100 indicates an underwriting loss.

Upon extinction of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's underwriting profit on that policy. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings.

CLAIMS

Claims and loss handling is the materialized usefulness of insurance; it is the actual "product" paid for. Claims may be filed by insureds directly with the insurer or through brokers or agents. The insurer may require that the claim be filed on its own proprietary forms, or may accept claims on a standard industry form.

Incoming claims are classified based on severity and are assigned to adjusters whose settlement authority varies with their knowledge and experience. The adjuster undertakes an investigation of each claim, usually in close cooperation with the insured, determines if coverage is available under the terms of the insurance contract, and if so, the reasonable monetary value of the claim, and authorizes payment. Insurance company claims departments employ a large number of claims adjusters supported by a staff of records management and data entry clerks.

Regulating liability insurance claims is particularly difficult because there is a third party involved, the plaintiff, who is under no contractual obligation to cooperate with the insurer and may in fact regard the insurer as a deep pocket. The adjuster must obtain legal counsel for the insured (either inside "house" counsel or outside "panel" counsel), monitor litigation that may take years to complete, and appear in person or over the telephone with settlement authority at a mandatory settlement conference when requested by the judge.

MARKETING

Agents can be locked up, meaning they write only for one company, or independent, meaning that they can issue policies from several companies Insurers will often use insurance agents to initially market or underwrite their customers.. The existence and success of companies using insurance agents is likely due to improved and personalized service.