INSURANCE

OPERATIONS
 Insurance companies provide various forms of
Background insurance and investment services to individuals and
charge a fee (called a PREMIUM) for this financial
service.

In general, the insurance provides payment to the

insured (or a named beneficiary) under conditions
specified by the insurance policy contract. These
conditions typically result in expenses or lost income,
so the insurance is a means of financial protection. It
reduces the potential financial damage incurred by
individuals or firms due to specified conditions.

2
Types of
INSURANCE  Life Insurance
 Property and Casualty Insurance
 Health Insurance
 Business Insurance

*** Many insurance companies offer multiple types of insurance

3
Insurance industry faces an ADVERSE SELECTION
PROBLEM, meaning that those who are most likely to
need insurance are most likely to purchase it.

Insurance can cause the insured to take more risks

because they are protected. This is known as MORAL
HAZARD PROBLEM in the insurance industry.

Insurance companies employ underwriters to calculate

the risk of specific insurance policies. The companies
decide what types of policies to offer based on the
potential level of claims to be paid on those policies
and the premiums that they can change.
4
Determinants The premiums charged by an insurance
of Insurance company for each insurance policy is based on
Premiums the probability of the condition under which the
company will have to provide a payment to the
insured (or the insured’s beneficiary) and the
potential size of the payment.

The premium may also be influenced by the

degree of competition within the industry for
the specific type of insurance offered.

5
Determinants Insurance companies can estimate the
of Insurance present value of a payment that they will
Premiums have to make for a specific insurance policy.
(cont.) The premium charged for that insurance is
influenced by the present value of the
expected payment. The premium will also
contain a markup to cover overhead expenses
and to provide a profit beyond expenses.

6
 The insurance premium is higher when there is
Determinants more uncertainty about the size of the payment
of Insurance that may ultimately have to be made. Insurance
Premiums companies recognize that the timing of the
(cont.) payout of any particular policy may be difficult to
predict, but they are more concerned with the
total flow of payments in any particular period.
That is, if an insurance company has 20,000
policies, it may not know which policies will
require payment this month but it may be able to
predict the typical amount of payment per
month.
7
Determinants Insurance companies tend to charge
of Insurance lower premiums when they provide
Premiums service to all employees of a
(cont.) corporation through group plans. The
lower premium represents a form of
quantity discount in return for being
selected to provide a particular type
of insurance to all employees.

8
Dilemma When insurance companies assess the
When probability of a condition that will
Setting result in a payment to the insured (or
Insurance the insured’s beneficiary), they rely on
Premiums
statistics about the general population.
Individuals, however, have private
information about themselves that is
not available to the insurance company.

9
Investment Insurance companies invest the
by Insurance
insurance premiums and fees
Companies
received from other services until
the funds are needed to pay
insurance claims.

10
 The insurance industry is highly regulated by state
Regulation agencies or government agencies, although the
of Insurance degree of regulation varies among
Companies countries/states. Each country/state attempts to
make sure that insurance companies are providing
adequate services, and the country/state also
approves the rates insurers may charge.

Insurance company agents must be licensed. In

addition, the forms used for policies must be
approved by the country/state to ensure that they
do not contain misleading wording.

11
Regulation The National Association of
of Insurance Insurance Commissioners (NAIC)
Companies facilitates cooperation among the various
(cont.) state agencies whenever an insurance issue
is national concern. It attempts to maintain
the degree of uniformity in common
reporting issues. It also conduct research on
insurance issues and participates in
legislative discussions.

12
Assessment The regulatory system is
System
designed to detect any
problems in time to search for
a remedy before the company
deteriorates further.

13
 The more commonly used financial ratios assess a
Assessment variety of relevant characteristics, including the
System following:
 The ability of the company to absorb either
losses or a decline in the market value of its
investments
 Return on investment
 Relative size of operating expenses
 Liquidity of the asset portfolio

Regulators monitor these characteristics to ensure that insurance

companies do not become overly exposed to credit risk, interest,
rate risk, or liquidity risk.
14
 Insurance companies are required to report a risk-
Regulation
based capital ratio to insurance regulators. The
of Capital
ratio was created by the NAIC and is intended to
force those insurance companies with a higher
exposure to insurance claims, potential losses on
assets, and interest rate risk to hold a higher level
of capital. The application of risk-based capital
ratios not only discourages insurance companies
that take high risks to back their business with a
large amount of capital. Consequently, there is less
likelihood of failures in the insurance industry.

15
 If an insurance company files for bankruptcy, the
Regulation insurance commissioner proposes a plan within the
of Failed court system on how the assets should be distributed
to the creditors. If the company is to be liquidated,
Insurance
property insurance policies are cancelled and state
Companies
guaranty funds, which are funded by solvent insurers,
are used to cover claims based on limits set by state
laws. The limits can vary among states. The states
insurance depart will typically assume management of
the failed insurance company to preserve the
remaining assets and ensure that policyholders’ right
are maintained. Owners of the life insurance, health
insurance, or annuities can have their policies
assumed by other insurance companies. 16
 Before 1999, insurance operations were mostly
Regulation separated from other types of financial services. In
of Financial 1998, Citicorp merge with Traveler’s Insurance
Company, resulting in the financial conglomerate
Services
name Citigroup. This merger forced congress to deal
Offered
with issue of whether insurance operations can be
offered along with all other types of financial services.
In 1999, Congress passed the Financial Services
Modernization Act, which allowed insurance
companies to merge with commercial banks and
securities firms. Some banks acquired insurance
companies, which then marketed their insurance
services under the bank’s brand name to the bank’s
existing customer base. 17
 Some life insurance companies based in
International
Insurance the United States have expanded their
Regulations business internationally to areas where
insurance services have been very
limited. These companies must comply
with foreign regulations regarding
services offered in the respective
countries. The difference in regulations
countries increase the information costs
of entering foreign markets.
18
Life Since life insurance companies are a
Insurance dominant force in the insurance
Operations
industry. In aggregate, they generate
more than $100 billion in premiums
each year and serve as key financial
intermediaries by investing their funds
in financial markets.

19
 Life insurance companies compensate
Life
Insurance (provide benefits to) the beneficiary of a
Operations policy upon the policyholder’s death.
They charge policyholders a premium
that should reflect the probability of
making a payment to the beneficiary as
well as the size and timing of the
payment.

20
 Life insurance companies compensate
Life
Insurance (provide benefits to) the beneficiary of a
Operations policy upon the policyholder’s death.
They charge policyholders a premium
that should reflect the probability of
making a payment to the beneficiary as
well as the size and timing of the
payment.

21
 Life insurance companies also commonly
Life
Insurance offer employees of a corporation a
Operations group life policy. This service has
become quite popular and has generated
a large volume of business in recent
years. Group policies can be provided at a
low cost because of the high volume.
Group life coverage now makes up about
40 percent of total life insurance
coverage, up from only 26 percent.
22
 There are about 1,000 life insurance
Ownership
companies, classified as having either
stock and mutual ownership. A stock-
owned company is owned by its
shareholders, whereas a mutual life
insurance company is owned by its
policyholders.

23
 Some of the more common types of life
Types of Life
Insurance insurance are described here.

1. Whole Life Insurance

2. Term Insurance
3. Variable Life Insurance
4. Universal Life Insurance

24
 From the perspective of insured
Whole Life
policyholders, whole life insurance protects
Insurance
them until death or as long as the premiums
are promptly paid.

In addition, a whole life policy provides a form

of savings to the policyholders. It builds cash
value that the policyholder is entitle to even if
the policy is cancelled.

25
 Is temporary, providing insurance only over a
Term specified term, and does not build a cash value for
Insurance policyholders. The premiums paid represent only
insurance, not savings.

Term insurance, however, is significantly less

expensive than whole life insurance. Policy
holders must compare the cash value of whole life
insurance to the additional cost to determine
whether it is preferable to term insurance. Those
who prefer to invest their savings themselves will
likely opt for term insurance.
26
Variable The benefits awarded by the life
Insurance insurance company to a beneficiary
vary with the assets backing the
policy. Flexible-premium variable
life insurance policies are available,
allowing flexibility on the size and
timing of payments.

27
 Combines the features of terms and whole
Universal
life insurance. It specifies a period of time
Life
over which the policy will exist but also builds
Insurance
a cash value for the policyholder over time.
Interest is accumulated from the cash value
until the policyholders uses those funds.

Universal life insurance allows flexibility

regarding the size and timing of the
premiums.

28
29
Life Life insurance companies are financial
Insurance intermediaries that sell life insurance
Companies policies.

POLICY HOLDERS pay regular

insurance premium. These premiums
are used to purchase investments so
that the company can pay cash as
needed (e.g. when an insured dies).
30
 Life insurance companies provide
Life
protection over a contracted period or
Insurance
Companies term, which may be a year, five years,
or for life.

If the insured person dies during the

term of the policy, the insurance
company pays the beneficiaries the
agreed-upon sum, called the FACE
VALUE of the insurance policy.
31
 If the insured person outlives the term of the
Life policy, the insurance company pays nothing.
Insurance That is the reason why these policies have what
Companies is termed as loan value and cash value.

LOAN VALUE of a policy is the amount that can

be borrowed against the policy during the term
of the policy. The CASH SURRENDER VALUE is
the amount that will be given to the insured or
beneficiary if the insured or beneficiary decides
to surrender the policy before the term ends,
which means the policy is discontinued.
32