Seminar for Oklahoma State Legislators March 20, 2013

INFORM+INSPIRE

The Griffith Insurance Education Foundation

Basic Principles of Insurance & Risk Management

University of Central Oklahoma

Finance – Insurance and Risk Management

Stuart MacDonald, Gerald Wilkins, Allen Arnold

Seminar for

Oklahoma State LegislatorsMarch 20, 2013

Seminar Agenda Overview of Insurance Principles Types of Insurance Regulation and Legislation


Overview of Insurance Principles

Definition of Risk The Role of Insurance Risk Pooling Adverse Selection Concept of Moral Hazard


Definition of Risk Risk refers to uncertainty An unknown or unexpected event Risk can be strategic, unintentional,

systemic, fortuitous


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).


Characteristics of Insurance

Pooling of Losses Payment of Fortuitous Losses Risk Transfer Indemnification


Risk Pooling Spreads the loss suffered by an

individual over the whole group Based on the Law of Large Numbers


Payment of Fortuitous Losses

Unforeseen Unexpected Result of Chance


Transfer of Risk Pure risk transferred from an insured

to an insurer for a fee (insurance premium)


Indemnification Restoring an insured to their

approximate pre-loss financial position


Concept of Peril and Hazard A peril is the cause of a loss

A hazard is a factor that creates or contributes to a loss


Physical Hazard Physical condition that increases the

frequency and/or severity of a loss


Moral Hazard Dishonest or deceitful statements or

behavior in order to defraud the insurer, thereby increasing the frequency and/or severity of loss claims

Insurance fraud causes increases in premium rates for everyone


Attitudinal Hazard Carelessness or indifference to a loss,

thereby increasing the frequency and/or severity of loss claims


Legal Hazard Characteristics of the legal system or

regulatory environment that increases the frequency and/or severity of loss claims


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


Characteristics of an Ideally Insurable Risk Large number of exposure units Accidental and unintentional loss Determinable and measurable Not a catastrophic loss Chance of loss must be calculable Economically feasible premium


Risk Management Matrix Low frequency and severity: Retention High frequency and low severity: Loss

Prevention and Retention Low frequency and high severity:

Transfer Risk (Insurance) High frequency and high severity:

Avoidance


INFLATION-ADJUSTED U.S. CATASTROPHE LOSSES BY CAUSE OF LOSS, 1992-2011


(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.

Why Insurers Become Insolvent


Note that Fraud outranks Catastrophe Losses.

Types of Insurance Personal Lines

Life Health Homeowners Auto

Reinsurance and Surplus Lines



Source: SNL Financial, Inc.

$502B

$576B

$175B

2011 U.S. Net Pre-miums Written

P&CLifeA&H

Personal Lines - Life Life insurance is justified if others are

financially dependent on the insured Term Insurance vs. Whole Life Insurance Ownership Clause Incontestable Period / Suicide Clause Death benefit proceeds are tax-exempt Life Income Options / Annuities


Personal Lines - Health Patient Protection and Affordable Care

Act State Health Insurance Exchanges No pre-existing conditions No lifetime or annual limits Coverage for children to age 26


2011 Life/A&H U.S. NPW by Line



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)


Personal Lines - Auto Personal Auto Policy

Liability Coverage Medical Payments Coverage Uninsured / Underinsured Motorists Collision and Comprehensive Exclusions (intentional injury or damage,

racing, road rage, business use, etc.)


2011 P&C U.S. NPW by Line



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


Reinsurance Primary insurer that writes the

insurance transfers to another insurer (the reinsurer) part or all of the potential losses associated with such insurance


Reasons for Reinsurance Increase underwriting capacity Stabilize profits Reduce 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)


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)


Surplus Lines Surplus lines carriers are registered

with the Oklahoma Insurance Department

A 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 insured


Regulation of Insurance National Association of Insurance

Commissioners (NAIC) All 50 states, Wash. D.C, 5 US Territories Maintain insurer solvency Regulate fair and reasonable rates Ensure availability of insurance Consumer protection and education


State Regulation of Insurance Oklahoma Insurance Department

Enforce insurance-related laws Protect consumers Promote competitive insurance markets License and educate insurance agents

and adjusters, funeral home directors, bail bondsmen, real estate appraisers


State Guaranty Funds Provide protection from losses if an

insurer becomes insolvent Life and Health Insurance Guaranty

Association Property and Casualty Insurance

Guaranty Association


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 carrier


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)


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, investments

Rates regulated to balance insurer profitability and prevent consumer gouging


Regulatory Methods to Ensure/Monitor Insurer Solvency

State insurance departments utilize strict methods and requirements to maintain insurer solvency

Licensing and financial requirements Risk-based capital standards Submission of financial statements In-field examinations of insurer practices


Policy Forms Insure Consistency of Product Consistency of Interpretation of

Language Set Coverage Standards


Balance between Consumers and Insurers Government Failure vs. Market Failure Bad Faith vs. Fraud State Guaranty Funds vs. Moral

Hazard Sound Underwriting vs. Red Lining


Rate Filing Interstate Insurance Compact Must Insure Solvency McCarran-Ferguson Act Prevent “Destructive” Competition


Issues in Insurance Legislation

Tag initiative uninsured drivers loss of state revenue

Workers Compensation

Captive Insurance


Questions?

Comments?


Melissa Kuhn Wheeler, The Griffith Insurance Education Foundation, (855) 288-7743, [email protected]

Dr. Stuart MacDonald, (405) 974-2152, [email protected] Wilkins, (405) 974-5566, [email protected] Arnold, (405) 974-2171, [email protected]

INFORM+INSPIRE


Thank 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/

mailto:[email protected]




Seminar for Oklahoma State Legislators March 20, 2013

Documents

insurance protection

insurance applicant

insurance association

fee insurance premium

transfer of risk pure

risk poolingspreads

american risk

risk redja