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3 Insurance contract and insurance
company’s operations
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Indemnification for loss which enables
maintaining financial security
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Reduction of worry and fear
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Source of investment funds
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Loss prevention
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Enhancement of credit
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Regulation of the business of insurance,
Regulation of the content of insurance
policies, especially with regard to consumer
policies,
Regulation of claim handling.
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Insurance is a contract based upon money for
a promise. The policyholder’s premium is
consideration for the insurer’s agreement to
pay a covered claim that may occur months,
years or even decades in the future and where
the amount of the claim is likely to be
significantly greater than the premium
collected. Once the premium is paid, the
policyholder is dependent on the insurer’s
ongoing ability and willingness to pay the
claim should an insured loss occur.
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To have a valid insurance contract following
requirements must be met:
1.
2.
3.
4.
There must be offer and acceptance
There must be an exchange of consideration
There must be intention to create legal relationship
The parties to the contract must be legally
competent
5. The contract must be for a legal purpose (contract
that encourages something illegal is contrary to
public interest and cannot be enforced)
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Insurance contracts are unilateral contracts.
That means that only one party, in this case
insurer, makes a legally enforceable promise.
By the contract of insurance the insurer
undertakes to pay a claim or provide other
services to the insured. After the first
premium is paid the insurance is in force, but
the insured cannot be legally forced to pay
the premiums or to comply with the policy
provisions.
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Insurance contract is a conditional contract.
The insurer’s obligation to pay depends on
whether the insured or the beneficiary has
complied with all policy conditions.
Conditions are provisions inserted in the
policy that qualify or place limitations on the
insurer’s promise to perform.
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In property insurance, insurance is a personal
contract, which means that the contract is
between the insured and the insurer. Strictly
speaking, a property insurance contract does
not insure property, but insures the owner of
property against loss.
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Insurance policies sold to individuals are virtually
all ‘contracts of adhesion’, as are most of the
insurance contracts purchased by a commercial
and public entities.
Adhesion contracts are characterized by the use
of standard form agreements drafted exclusively
by one party and for which there is little or no
bargaining over terms other than price; the
discretion or choice is whether to agree to the
contract as written or forgo it altogether.
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The great majority of consumers will neither
read nor necessarily understand the contract.
Policyholders may only become aware of
important terms in their contract when an
insurer denies a claim.
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An insurance contract is an aleatory contract
where the values exchanged may not be
equal and depend on the occurence of an
uncertain event.
In contrast, other commercial contracts are
commutative. The values exchanged by both
parties are theoretically equal.
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Declarations
Definitons
Insuring agreement
Exclusions
Consitions
Miscellaneous provisions
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Courts and legislatures have long recognized
that a pure freedom of contract approach to
insurance regulation would often lead to unjust
results and damage confidence in insurance
market.
◦ therefore
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Insurance is governed by a mix of statutes,
administrative agency regulations and court
rulings in order to control premium rates,
prevent unfair practices by insurers and guard
against the financial insolvency to protect
assureds.
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In recent years insurance, like most other
business endeavors has been globalized.
Since existing international norms necessarily
leave much of insurance regulation to the
discretion of each country, each jurisdiction
must decide what level of intervention into
the insurance market is most beneficial to its
citizens.
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One of insurance characteristics is that it may
be mandated by government or required as a
condition
of
engaging
in
particular
professional
services
or
commercial
transactions, e.g. car owner’s liability
insurance, attorney’s professional insurance
or medicine practice insurance.
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What do you think?
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Alternatives range from exclusive government
or publicly-run insurers, to a purely freemarket
regulatory
system
where
government’s role is limited largely to
solvency review.
1.
Solvency and Prudential Regulation
2.
Insurance Markets
3.
Consumer Protection and Market Conduct
Regulation
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Solvency regulation includes mandating and
enforcing
capital
requirements,
claim
reserves and investment restrictions, as well
as insolvency administration.
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Insurance
Markets
includes
regulating
corporate structure, mergers and acquistions,
market entry and withdrawal, underwriting
and risk classifiaction requirements and
restrictions, reinsurance and the regulation of
insurance intermediaries.
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Consumer Protection can be considered as
both the regulatory tools to enforce insurance
laws (e.g. licensing of insurers and insurance
intermediaries, regulating the terms of the
insurance contract, and market conduct
exams) as well as government entities
interdeciding directly on behalf of consumers,
which can range from mediating individual
insurer/policyholder disputes to regulatory
action
and
litigation
against
specific
insurance market participants.
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There are various types of insurance
companies as well as several methods of
marketing their product.
The companies are generally classified by the
type of corporate structure under which they
operate.
Private insurance companies
Public insurance companies
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Stock companies
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Mutual companies
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Reciprocal insurance exchanges
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Corporations chartered by a state to conduct
an insurance business. To start te business,
individuals buy shares and these funds are
used to fund the insurance company’s
operations until the organization generates
enough business to pay operating costs out
of current income. The paid-in capital also
serves as the surplus fund guaranteeing the
fulfillment of policy obligations during the
early days of the organization.
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The characteristics of a stock insurance
company are:
 paid-in capital appears in its financial
statement,
 the board of directors is elected by the
stockholders,
 some portion of earnings may be paid to
stockholders as dividends on their stock
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Mutual insurance companies are owned by their
policyholders. Before they can receive authority
to operate they must meet a statutory
requirement on the amount of premium and
number of policies that it can immediately issue
upon authorization.
There is no capital stock outstanding, the
members of the board of directors are elected by
the policyholders and the funds remaining after
paying all costs of operations (including
additions to all surplus and contigency funds) are
distributed to the policyholders as policy
dividends.
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Reciprocal insurance exchange firms are also
called inter-insurance exchange. They are similar
to a mutual insurance company as they are
owned by their members. The policyholders,
called subscribers, establish an exchange and
insure one another. They also contract with an
attorney-in-fact to operate the exchange under
the control of an advisory board.
Each policyholder is both an insured and an
insurer since the contracts are exchanged on a
reciprocal basis. A premium called a deposit is
paid in advance. Dividends may be paid to the
subscribers based on operating results.
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Captive insurers - a company that provides riskmitigation services for its parent company or for
a group of related companies. A captive
insurance company may be formed if the parent
company is unable to find an outside firm to
insure against a particular business risk if the
parent company determines that the premiums it
pays to the captive insurance company may
create a tax savings or if the insurance the
captive insurance company provides is more
affordabor offers better coverage for the parent
company's risks.
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Savings bank life insurance - a type of life
insurance only allowed in certain states,
Massachusetts, New York and Connecticut.
This insurance is sold by a savings bank.
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There are insurance programs that are
underwritten by both federal governemnt as
well as state governments. Some of theme are
voluntary while others are compulsory.
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Insurance business is specific as the insurer
does not know in advance what its actual
costs are going to be. It is very hard to
reliably estimate them. The total premiums
charged for given line of insurance may be
inadequate for paying all claims and
expenses during the policy period. It is only
after the period of protection has expired that
an insurer can determine its actual losses and
expenses.
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Rate making
Underwriting
Production
Claims settlement
Reinsurance
Investments
Accounting
Legal services
Loss control
Information systems
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Rate making refers to the pricing of insurance
and the calculation of insurance premiums. It is
done by actuaries, usually mathematicians
involved in all phases of insurance company
operations, including planning, pricing and
research.
The premium paid by the insured is the result of
multiplying a rate determined by actuaries by the
number of exposure units, and adjusting the
premium by various rating factors.
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Underwriting refers to the process of selecting,
classifying, and pricing applicants for insurance.
Underwriter is a person who decides whether to
accept or to reject an application.
Underwriting management of an insurance
company establishes guidelines which cover the
types of policies, procedures and exposures that
an underwriter uses in selecting insureds, so
called underwriting policy.
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If the underwriting standards are not met, the
insurance is denied, or an extra premium
must be paid, or the coverage offered may be
more limited.
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Attain an underwriting profit
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Select prospective insureds according to the
company’s underwriting standards
 Adverse selection – the tendency of people with the
higher-than-average chance of loss to seek insurance
at standard (average) rates, which if not controlled by
underwriting, will result in higher-than-expected loss
levels
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Provide equity among policyholders
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C-O-P-E
C stands for Construction (wood, brick,
concrete, combustible/non-combustible)
O stands for Occupancy (single, multi-tenat,
manufacturing, retail)
P stands for Protection (fire, theft, public,
private)
E stands for Exposure (neighborhood,woods,
water, other properties)
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Inspection report of the property may be
required.
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Age
Gender
Weight
Occupation
Personal and family health history
Hazardous hobbies
Amount of insurance requested
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Physical examination by a doctor may be
needed.
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Production refers to the sales and marketing
activities of insurers.
People who sell insurance are frequently
referred to as producers.
No business is produced until a policy is sold.
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Agent – someone who legally represents the principal
(insurance company) and has the authority to act on
the principal’s behalf. The principal is legally
responsible for the acts of an agent whenever the the
agent is acting within the scope of his or her
authority granted or implied by the principal.
Broker – someone who legally represents the insured
even though he or she receives a commission from
the insurer. A broker legally does not have the
authority to bind the insurer.
Brokers usually enter into separate agency contracts
with few insurers.
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From the insurer’s viewpoint , there are
several basic objectives of settling claims:
◦ Verifications of covered loss
◦ Fair and prompt payment of claims
◦ Provision of personal assistance to the insured
1.
2.
3.
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5.
Notice of loss
Investigation of the claim.
Filing a proof of loss.
Decision concerning payment.
Possible dispute over the amount to be
paid.
Failure of the insured to cooperate with the
insurance company usually results in denial
of the claim.
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Reinsurance is an arrangement by which the
primary insurer that initially writes the insurance
transfers to another insurer part or all the
potential losses associated with insurance.
Reinsurance is insurance that is purchased by
an insurance company from one or more
insurance companies (the "reinsurer") as a means
of risk management, sometimes in practice
including tax mitigation and other reasons.
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The ceding company and the reinsurer enter into
a reinsurance agreement which details the
conditions upon which the reinsurer would pay a
share of the claims incurred by the ceding
company. The reinsurer is paid a "reinsurance
premium" by the ceding company, which issues
insurance policies to its own policyholders.
The amount of insurance retained by the ceding
company for its own account is called the
retention limit, or net retention. The amount of
insurance ceded to the reinsurer is known as the
cession.
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Facultative reinsurance
Treaty reinsurance
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Alternatives to traditional reinsurance:
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◦ Securitization of risk – insurable is transferred to
the capital markets through the creation of a
financial instrument, such as a catastrophe bond,
futures contract, options contract, or other financial
instrument.
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Due to the fact that premiums are paid in
advance, they can be invested until needed to
pay claims and expenses.