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Insurance

Insurance

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Published by Rahim Ejaz

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Categories:Types, Business/Law
Published by: Rahim Ejaz on Jan 11, 2011
Copyright:Attribution Non-commercial

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08/21/2012

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Insurance
Inlawandeconomics,
insurance
is a form of risk management primarily used tohedgeagainst theriskof a contingent,uncertainloss. Insurance is defined as the equitable transfer of the risk of a loss, fromone entity to another, in exchange for payment. An
insurer
is acompany selling the insurance; an
insured
or
policyholder
is theperson or entity buying the insurance policy. The
insurance rate
is afactor used to determine the amount to be charged for a certainamount of insurance coverage, called the
premium
.Riskmanagement, the practice of appraisingand controlling risk, has evolved as a discrete field of study and practice. The transaction involves the insured assuming a guaranteed andknown relatively small loss in the form of payment to the insurer inexchange for the insurer's promise to compensate (indemnify) theinsured in the case of a large, possibly devastating loss. The insuredreceives acontractcalled theinsurance policywhich details the conditions and circumstances under which the insured will becompensated.
Insurers' business model 
Underwriting and investing
 The business model can be reduced to a simple equation: Profit =earned premium+ investment income - incurred loss - underwritingexpensesInsurers make money in two ways:
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1.
 Throughunderwriting, the process by which insurers select therisks to insure and decide how much in premiums to charge foraccepting those risks;
2.
Byinvestingthe premiums they collect from insured parties. The most complicated aspect of the insurance business is theunderwritingof policies. Using a wide assortment of data, insurerspredict the likelihood that a claim will be made against their policiesand price products accordingly. To this end, insurers useactuarialscienceto quantify the risks they are willing to assume and thepremium they will charge to assume them. Data is analyzed to fairlyaccurately project the rate of future claims based on a given risk.Actuarial science usesstatisticsandprobabilityto analyze the risks associated with the range of perils covered, and these scientificprinciples are used to determine an insurer's overall exposure. Upontermination of a given policy, the amount of premium collected and theinvestment gains thereon minus the amount paid out in claims is theinsurer'sunderwriting profiton that policy. Of course, from theinsurer's perspective, some policies are "winners" (i.e., the insurerpays out less in claims and expenses than it receives in premiums andinvestment income) and some are "losers" (i.e., the insurer pays outmore in claims and expenses than it receives in premiums andinvestment income); insurance companies essentially use actuarialscience to attempt to underwrite enough "winning" policies to pay outon the "losers" while still maintaining profitability.An insurer's underwriting performance is measured in its combinedratio
which is theratio of lossesand expenses to earned premiums. Acombined ratio of less than 100 percent indicates underwritingprofitability, while anything over 100 indicates an underwriting loss. A
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company with a combined ratio over 100% may nevertheless remainprofitable due to investment earnings.Insurance companies earninvestmentprofits on “float”. “Float” oravailable reserve is the amount of money, at hand at any givenmoment that an insurer has collected in insurance premiums but hasnot paid out in claims. Insurers start investing insurance premiums assoon as they are collected and continue to earn interest or otherincome on them until claims are paid out. TheAssociation of BritishInsurers(gathering 400 insurance companies and 94% of UK insuranceservices) has almost 20% of the investments in theLondon StockExchange.
In theUnited States, the underwriting loss of propertyandcasualty insurancecompanies was $142.3 billion in the five years ending 2003.But overall profit for the same period was $68.4 billion, as the result of float. Some insurance industry insiders, most notablyHank Greenberg,do not believe that it is forever possible to sustain a profit from floatwithout an underwriting profit as well, but this opinion is notuniversally held.Naturally, the “float” method is difficult to carry out in an economicallydepressed period.Bear marketsdo cause insurers to shift away frominvestments and to toughen up their underwriting standards. So a pooreconomy generally means high insurance premiums. This tendency toswing between profitable and unprofitable periods over time iscommonly known as the "underwriting" orinsurance cycle.
Property and casualty insurers currently make the most money fromtheir auto insurance line of business. Generally better statistics areavailable on auto losses and underwriting on this line of business hasbenefited greatly from advances in computing. Additionally, property
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