The Griffith Insurance Education Foundation Basic Principles of Insurance amp Risk Management University of Central Oklahoma Finance Insurance and Risk Management Stuart MacDonald Gerald Wilkins Allen Arnold ID: 288975
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INFORM+INSPIRE
The Griffith Insurance Education Foundation
Basic Principles of Insurance & Risk ManagementUniversity of Central Oklahoma Finance – Insurance and Risk Management Stuart MacDonald, Gerald Wilkins, Allen Arnold
Seminar for
Oklahoma State Legislators
March 20, 2013Slide2
Seminar Agenda
Overview of Insurance Principles Types of InsuranceRegulation and Legislation
The Griffith Insurance Education FoundationSlide3
Overview of Insurance Principles
Definition of RiskThe Role of InsuranceRisk PoolingAdverse Selection
Concept of Moral HazardThe Griffith Insurance Education FoundationSlide4
Definition of Risk
Risk refers to uncertaintyAn unknown or unexpected event Risk can be strategic, unintentional, systemic, fortuitous
The Griffith Insurance Education FoundationSlide5
The Role of Insurance
According to the American Risk and Insurance Association, “insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risk” (
Redja, p. 20, 2011).The Griffith Insurance Education FoundationSlide6
Characteristics of Insurance
Pooling of LossesPayment of Fortuitous LossesRisk Transfer
IndemnificationThe Griffith Insurance Education FoundationSlide7
Risk Pooling
Spreads the loss suffered by an individual over the whole groupBased on the Law of Large Numbers
The Griffith Insurance Education FoundationSlide8
Payment of Fortuitous Losses
UnforeseenUnexpected
Result of ChanceThe Griffith Insurance Education FoundationSlide9
Transfer of Risk
Pure risk transferred from an insured to an insurer for a fee (insurance premium)
The Griffith Insurance Education FoundationSlide10
Indemnification
Restoring an insured to their approximate pre-loss financial position
The Griffith Insurance Education FoundationSlide11
Concept of Peril and Hazard
A peril is the cause of a lossA hazard is a factor that creates or contributes to a loss
The Griffith Insurance Education FoundationSlide12
Physical Hazard
Physical condition that increases the frequency and/or severity of a lossThe Griffith
Insurance Education FoundationSlide13
Moral Hazard
Dishonest or deceitful statements or behavior in order to defraud the insurer, thereby increasing the frequency and/or severity of loss claimsInsurance fraud causes increases in premium rates for everyone
The Griffith Insurance Education FoundationSlide14
Attitudinal Hazard
Carelessness or indifference to a loss, thereby increasing the frequency and/or severity of loss claims
The Griffith Insurance Education FoundationSlide15
Legal Hazard
Characteristics of the legal system or regulatory environment that increases the frequency and/or severity of loss claims
The Griffith Insurance Education FoundationSlide16
Adverse Selection
Tendency for insurance applicant with a higher than average loss potential (sub-standard risk) to acquire insurance protection at less expensive (standard risk) premium rates
The Griffith Insurance Education FoundationSlide17
Characteristics of an Ideally Insurable Risk
Large number of exposure unitsAccidental and unintentional lossDeterminable and measurableNot a catastrophic
lossChance of loss must be calculableEconomically feasible premiumThe Griffith Insurance Education FoundationSlide18
Risk Management Matrix
Low frequency and severity: RetentionHigh frequency and low severity: Loss Prevention and Retention
Low frequency and high severity: Transfer Risk (Insurance)High frequency and high severity: AvoidanceThe Griffith Insurance Education FoundationSlide19
INFLATION-ADJUSTED U.S. CATASTROPHE LOSSES BY CAUSE OF LOSS, 1992-2011
The Griffith Insurance Education Foundation
(1) Estimated property losses adjusted for inflation through 2011 by ISO using the GDP implicit price deflator. Excludes catastrophes causing direct losses less than $25 million in 1997 dollars. Does not include flood damage covered by the federally administered National Flood Insurance Program.(2) Excludes snow.(3) Includes wildland fires.(4) Includes losses from civil disorders, water damage, utility service disruptions, and any workers compensation catastrophes generating losses in excess of PCS's threshold after adjusting for inflation.
Source: The Property Claim Services (PCS) unit of ISO, a
Verisk
Analytics company.Slide20
Why Insurers Become Insolvent
The Griffith Insurance Education Foundation
Note that Fraud outranks Catastrophe Losses. Slide21
Types of Insurance
Personal Lines LifeHealthHomeowners
AutoReinsurance and Surplus LinesThe Griffith Insurance Education FoundationSlide22
The Griffith Insurance Education Foundation
Source: SNL Financial, Inc.Slide23
Personal Lines - Life
Life insurance is justified if others are financially dependent on the insured Term Insurance vs. Whole Life Insurance
Ownership ClauseIncontestable Period / Suicide ClauseDeath benefit proceeds are tax-exemptLife Income Options / AnnuitiesThe Griffith Insurance Education FoundationSlide24
Personal Lines - Health
Patient Protection and Affordable Care Act State Health Insurance ExchangesNo pre-existing conditions
No lifetime or annual limitsCoverage for children to age 26The Griffith Insurance Education FoundationSlide25
2011 Life/A&H U.S. NPW by Line
The Griffith Insurance Education Foundation
Source: SNL Financial, Inc.Slide26
Personal Lines - Homeowners
Homeowners 3 (Special Form)All-Risks Coverage, except named exclusions (Earthquake, Flood, War, Nuclear Radiation) Homeowners 6 (Condominiums)
Same as above Homeowners 4 (Renters Insurance)Named Perils (NOT All-Risks)The Griffith Insurance Education FoundationSlide27
Personal Lines - Auto
Personal Auto Policy Liability CoverageMedical Payments CoverageUninsured / Underinsured Motorists
Collision and ComprehensiveExclusions (intentional injury or damage, racing, road rage, business use, etc.)The Griffith Insurance Education FoundationSlide28
2011 P&C U.S. NPW by Line
The Griffith Insurance Education Foundation
Source: SNL Financial, Inc.Slide29
State Trends in Auto and Homeowners Pricing
2011 report by the Insurance Research Council indicates a rapid increase in the severity of claims, and a slow but steady increase in the frequency of non-severe claims.Commercial Auto most stable underwriting
The Griffith Insurance Education FoundationSlide30
Reinsurance
Primary insurer that writes the insurance transfers to another insurer (the reinsurer) part or all of the potential losses associated with such insurance
The Griffith Insurance Education FoundationSlide31
Reasons for Reinsurance
Increase underwriting capacityStabilize profitsReduce the unearned premium reserve
Protection against catastrophic losses (e.g. reinsurers paid a large part of the $41 billion insured losses arising from Hurricane Katrina which significantly reduced losses paid by primary insurers)The Griffith Insurance Education FoundationSlide32
Surplus Lines
Surplus lines refers to any type of insurance for which there is no insurer licensed by the State of Oklahoma that will write the type and amount of insurance requested by the insured
Coverage must be placed by a surplus lines broker with a nonadmitted insurer which is not licensed to do business in Oklahoma (e.g. Lloyd’s of London)The Griffith Insurance Education FoundationSlide33
Surplus Lines
Surplus lines carriers are registered with the Oklahoma Insurance DepartmentA 6% surplus lines tax is levied on insurance premiums for surplus lines coverage; tax
is paid by the surplus lines broker placing the coverage for the insuredThe Griffith Insurance Education FoundationSlide34
Regulation of Insurance
National Association of Insurance Commissioners (NAIC)All 50 states, Wash. D.C, 5 US TerritoriesMaintain insurer solvency
Regulate fair and reasonable ratesEnsure availability of insuranceConsumer protection and educationThe Griffith Insurance Education FoundationSlide35
State Regulation of Insurance
Oklahoma Insurance Department Enforce insurance-related lawsProtect consumersPromote competitive insurance markets
License and educate insurance agents and adjusters, funeral home directors, bail bondsmen, real estate appraisersThe Griffith Insurance Education FoundationSlide36
State Guaranty Funds
Provide protection from losses if an insurer becomes insolvent Life and Health Insurance Guaranty AssociationProperty and Casualty Insurance Guaranty Association
The Griffith Insurance Education FoundationSlide37
Oklahoma Guaranty Associations
When a licensed insurer fails, other licensed insurance carriers are assessed according to the % of premiums they write in the State to pay the claims of the failed
carrierThe Griffith Insurance Education FoundationSlide38
Oklahoma Guaranty Associations
Each insurer who pays an assessment is permitted to take the amount they pay as a credit against their premium taxes (licensed insurance carriers pay a 2.25% premium tax on all premiums they bill their insureds
)The Griffith Insurance Education FoundationSlide39
Solvency, Pricing, Rate Adequacy
Insolvency result of catastrophic losses, inadequate reserves and rates, mismanagement, bad investments, etc
Premium pricing function of expected losses, expense loading, investmentsRates regulated to balance insurer profitability and prevent consumer gougingThe Griffith Insurance Education FoundationSlide40
Regulatory Methods to Ensure/Monitor Insurer Solvency
State insurance departments utilize strict methods and requirements to maintain insurer solvency Licensing and financial requirementsRisk-based capital standards
Submission of financial statementsIn-field examinations of insurer practicesThe Griffith Insurance Education FoundationSlide41
Policy Forms
Insure Consistency of ProductConsistency of Interpretation of LanguageSet Coverage Standards
The Griffith Insurance Education FoundationSlide42
Balance between Consumers and Insurers
Government Failure vs. Market FailureBad Faith vs. Fraud
State Guaranty Funds vs. Moral HazardSound Underwriting vs. Red LiningThe Griffith Insurance Education FoundationSlide43
Rate Filing
Interstate Insurance CompactMust Insure SolvencyMcCarran-Ferguson Act
Prevent “Destructive” CompetitionThe Griffith Insurance Education FoundationSlide44
Issues in Insurance Legislation
Tag initiative uninsured drivers loss of state revenueWorkers Compensation
Captive InsuranceThe Griffith Insurance Education FoundationSlide45
Questions?
Comments?
The Griffith Insurance Education FoundationSlide46
Melissa Kuhn Wheeler, The Griffith Insurance Education Foundation, (855) 288-7743,
mwheeler@griffithfoundation.orgDr. Stuart MacDonald, (405) 974-2152,
smacdonald@uco.eduGerald Wilkins, (405) 974-5566, gwilkins@uco.eduAllen Arnold, (405) 974-2171, aarnold1@uco.eduINFORM+INSPIREThe Griffith Insurance Education FoundationThank you for allowing us to present this seminar on Insurance and Risk Management. Please contact us if we can be of further assistance.This presentation can be downloaded at: www.griffithfoundation.org/public-policy/resources/