CPCU 520- Overview of Insurance Operations

Educational Objectives
1. Explain how insurers have organized to provide property-casualty insurance.
2. Describe the major goals of an insurer.
3. Describe the internal and external constraints that impede insurers from achieving their major goals.
4. Describe the measurements used to evaluate how successful an insurer is at meeting its established goals.
5. Describe the core and supporting functions performed by insurers.
Outline
What is the principle function of insurers?
Acceptance of risks that other transfer to it through insurance.
1. Classifications of Insurers How can insurers be classified?
A. Legal Form of Ownership 1. 4
i. Proprietary Insurers that are formed for the purpose of earning a profit.
1. Stock Insurance Companies: owned by stockholders, who elect a board of directors
to oversee the company’s operations. This board then appoints officers who make
the day-to-day decisions and hire employees to operate the company
2. Lloyd’s: Consists of Lloyd’s of London and American Lloyd’s organizations: Lloyd’s is
not an insurance company, but a marketplace. Similar to a stock exchange. Offers
location and means to get others to contribute. Marine insurance for ships.
3. Insurance Exchanges: Acts as an Insurance Marketplace INEX
ii. Cooperative Insurers that are formed to provide insurance at a minimum cost to policyholders,
who own the insurer.
1. Mutual Insurance Companies: Corporations owned by their own policyholders and
formed to provide low cost insurance to those policyholders. In a mutual, the
potential financial consequences for certain loss exposures are transferred to the
insurer. New Jersey Manufactures
2. Reciprocal Exchanges: (Also called interinsurance exchanges) usually formed to
provide insurance at a lower cost and are owned by their members. In a reciprocal,
the liability is transferred to the other members of the exchange. Captives, Risk
Retention groups
3. Fraternal Organizations: Resemble a mutual insurance company but they combine a
lodge or social function with their insurance. They write primarily life and health
insurance.
iii. Other Insurers include pools and government insurers.
1. Pool: consists of several insurers, not otherwise related, that join together to
insure loss exposures that individual insurers are unwilling to write
2. Government Insurers- not otherwise insurable
a. Fair- WC
b. National Flood
c. TRIPRA

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 B. Place of Incorporation
1. Domestic- state of incorporation
2. Foreign- other states
3. Alien- other countries
C. Licensing Status
1. Minimum requirements for stability
2. Surplus lines broker- places business with insurers not licensed (non-admitted) in that srate
in which the transaction occurs but that is permitted to write insurance because coverage in
not available through standard market insurers
D. Insurance Distribution Systems and Channels-
1. Independent agency
2. Direct writer
3. Exclusive agency
2. Insurer Goals 1.10
A. Earn a Profit- stay in business, have surplus and capital, return on investment
1. Premium, Underwriting profit, investments, loans
B. Meet Customer Needs- timeliness, service
C. Comply With Legal Requirements- to stay viable, to help market grow
D. Diversify Risk- spread
E. Fulfill Their Duty to Society- WC, charity
3. Constraints on Achieving Insurer Goals 1.13
A. Internal Constraints
1. Efficiency- expense ratio- larger has more economy of scale
2. Expertise- skills and ability to generate underwriting profit, niche ( L Chubb-middle market,
high end personal lines versus large ARM accounts- L Ace)
3. Size-scale, diversification of risk, geography, etc.
4. Financial Resources-
5. Other Internal Constraints- new insurers no brand recognition, damaged reputation
B. External Constraints
1. Regulation- solvency, rates, coverage, forms
2. Rating Agencies-AM Best, Standard & Poor’s, Moody’s, etc.
3. Public Opinion- of industry as a whole,
4. Competition
a. Hard cycle- little capacity, higher rates
b. Soft cycle- more capacity, lower rates
5. Economic Conditions
a. Inflation costs rise

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 b. Lower investment profits
6. Insurance Marketing and Distribution
a. Internet
b. banks
7. Other External Constraints
4. Measuring Insurer Performance 1.19
A. Meeting Profitability Goals
1. Premiums and Investment Income
a. Revenue- premium and investments
b. Growth- must be profitable. NB costs more. Can start to relax standards.
c. Retention
2. Underwriting Performance- 1.22 and 1.23 charts
a. Underwriting profit- Loss ratio + expense ratio
b. Investment income ratio- net investment income/earned premium
c. Overall operating ratio- combined- investment income
d. ROE- net income/owners’ equity
3. Overall Operating Performance-
a. Net operating income- after losses, expense, taxes and reserves
4. Estimation of Loss Reserves- IBNR
B. Meeting Customer Needs
1. Complaints and Praise
2. Customer Satisfaction Data
3. Insurer's Retention Ratio and Lapse Ratio- total number lapsed during year/total policies
written at beginning of year
4. Insurer-Producer Relationships
5. State Insurance Department Statistics
6. Consumer Reports
C. Meeting Legal Requirements-1.26
1. Suits
2. Market Conduct Exams
3. Rating agencies
D. Meeting Social Responsibilities
1. Website to depict stewardship, awards, etc
2. Employee benefits
3. Green initiatives
5. Functional View of Insurance 1.27
A. Core Functions
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 1. The three core functions are Marketing, Underwriting, and Claims.
a. Marketing involves knowing the customers’ need and also informing those effectively
about the product. This relates with underwriting because than those that know about
the product will come to the insurer and hopefully will meet those guidelines.
b. The Underwriting will show how effective the marketing was
c. Claims shows how effective the underwriting was which ultimately ties back to
marketing
d. Book of business
e. Adverse selection
B. Supporting functions:
1. Risk control
2. Premium Auditing
3. Actuarial
4. Reinsurance
5. IT
2. Other Common Functional Areas
a. Investments
b. Accounting and finance
c. Customer service
d. Legal and compliance
e. HR
f. Special investigations

Key Words and Phrases for the assignment

 Insurance: is a risk management technique that transfers some of all of the potential financial
consequences for certain loss exposures from the insured to the insurer
 Law of Large Numbers: a math principle stating that as the number of similar but
independent exposure units increases, the relative accuracy of future predictions about future
outcomes also increases
 Cooperative Insurers: see above
 Pool: association of person or orgs that combine its resources to economically finance
recovery from accidental losses
 Fair Access to Insruance Requirements: (FAIR) An insurance pool through which private
insurers collectively address an unmet need for property insurance on urban properties, esp.
those susceptible to loss by riot or civil commotion.
 Licensed (admitted) Insurer: an Insurer authorized by the state insurance department to
transact business within a particular state
 Unlicensed (nonadmitted) insurer: An insurer not authorized by the state insurance
department to transact business in the insured’ state
 Expense Ratio: Insurer’s incurred underwriting expenses for a specific period divided by its
written premiums for the same period. Expenses/Written Premium

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  Loss Ratio: Insurer’s incurred losses (including Loss Adjustment Expense) for a specific
period, divided by its Earned premium for the same period. (Losses incurred + Loss
adjustment Expense)/Earned Premium
 Combined Ratio: Sum of the Expense Ratio and Loss Ratio
 Financial Basis Combined Ratio: A Profitability ratio found by (Incurred losses + Incurred
Expenses)/Earned Premium
 Trade Basis Combined Ratio: A profitability ratio found by [(incurred losses + loss
adjustment expense)/earned premiums] + [Underwriting expenses/Net written Premium]
 Operating Profit or Loss: The sums of the underwriting profit or loss and investment profit or
loss

Question during class:

Hard versus soft market

From an insurance company perspective, hard is a sellers market. We can raise rates because
it is hard for buyers to find a market

Soft market is when there are many markets- buyers market- and insurance companies can
not raise rates and often have to lower them,

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 Session Quiz- Chapter 1 Overview of Insurance Operations
1. Property- Casualty insurers can be classified in a number of ways. Which of the following is NOT a
means of classification?1.3
a. Legal form of ownership
b. Place of incorporation
c. Licensing status
d. Industry rating
2. Stock insurers are a common form of ownership of insurance companies. Which of the following is
NOT true about stock insurers? 1.4
a. They are owned by stock holders
b. Board members raise capital and funding
c. Stock companies are expected to provide a return on equity (ROE) for stockholders
d. Board of directors oversees corporate goals and appoints Chief executive officer
3. Exchanges are characterized by: 1.6
a. Exchanges are only used for reinsurance
b. Syndicates operate in consort underwriting business on a share basis only
c. Members can be individuals, partnerships, or corporations and have limited liability
d. Members are involved in the day to day operations of the exchange
4. Insurers formed to provide insurance protection to its policyholders, who are the owners, are: 1.5
a. Mutual insurers
b. Reciprocal Trust arrangements
c. National pool syndicates
d. Government insurers
5. Insurance companies are regulated at the state level. Those incorporated within a specific state are
considered:1.9
a. Domestic
b. State carrier
c. Reciprocal
d. Aligned
6. Distribution channels include all but which of the following? 1.10
a. Independent agency or brokerage
b. Direct writer
c. Exclusive agency
d. Regional carrier
7. Which of the following is NOT a major goal for ALL insurance companies? 1.10
a. Meet customer needs
b. Comply with legal requirements
c. Earn a profit
d. Fulfill their duty to society
Note: While all companies want to earn a profit, for mutual’s and reciprocal’s primary
goals

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8. Insurers face numerous constraints in achieving their goals. Internal constraints include: 1.13
a. Efficiency, Expertise, and size
b. Regulation, rating agencies, and financial market
c. Competition, marketing and distribution challenges, rating agencies
d. Public opinion, Diversification, and distribution
9. For proprietary insurers, meeting profitability goals in critical to ongoing success of the organization.
Which of the following is NOT true about premiums and investment income? 1.20
a. Premiums are the amount charged for insurance coverage
b. Insurance operations generate investable funds for loss reserves, loss adjustment
expenses, and unearned premium reserves
c. Measures of profitability consider growth and retention of book of business
d. Investment income, always positive, adds to the income of the organization
10. Overall operating performance is calculated by which of the following? 1.22
a. Earned premiums – (incurred losses + underwriting expenses)
b. Net underwriting gain or loss + investment gain or loss
c. Loss ratio + expense ratio (note: this is combined ratio or net UW gain or loss)
d. Losses incurred + loss adjustment expense + no reported but incurred losses
11. Ratio of expiring insurance policies over total policies to renew is: 1.24
a. Growth ratio
b. Submission ratio
c. Retention ratio
d. Loss business ratio
12. State insurance departments monitor the treatment of insureds, applicants for insurance and
claimants and oversee which of the following operational areas? 1.25
a. Sales and advertising, underwriting, rate making, and claims
b. Marketing, statistics, claims, and underwriting
c. Actuarial, marketing, underwriting, and claims
d. Policy processing, Underwriting, Claims and accounting
13. Functional areas in support of the core operational areas of the organization include all but one of
the following areas? 1.29
a. Risk Control
b. Premium Auditing
c. Reinsurance
d. Marketing
14. Fair access to insurance requirements (FAIR) are what type of organization?
a. Reciprocal exchange
b. Insurance pool
c. Mutual insurer
d. Proprietary

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