Overview of Risk and Insurance

Fall 2013

Contents

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Insurance Industry Overview - Size and Performance Definition Insurance and Risk Risk Management and Insurance Types of Insurance

Property Insurance Liability Insurance Life Insurance Health Financial Planning – Disability and Retirement funding

mechanisms General Insurance Concepts Careers in Insurance Hot Topics Conclusions

Insurance Industry Overview Insurance Information Institute

http://www.iii.org/ World insurance premiums totaled $4. 6 trillion in 2012 III Fact Book:

http://www2.iii.org/assets/docs/pdf/International_Insurance_Factbook_2014.pdf

In 2007 there were: 2,723 U.S. property/casualty insurance companies with $1.3 trillion

in assets 1,190 U.S. life/health insurance companies with $3 trillion in assets The insurance industries employed over 2.3 million people in 2008

Catastrophe losses were $45 billion in 2012 (majority from Sandy) $6.7 billion in 2007 $25.6 billion in 2008 (2nd highest year on record) http://www.iii.org/media/hottopics/insurance/catastrophes/

The P/C industry had an average annual rate of return of .5 percent in 2008, down from 12.4 percent in 2007

Forty banks have failed since the financial crisis began, yet no insurance claim has gone unpaid because of the crisis.

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Profitability of the Insurance Industry 2012

http://www.iii.org/articles/2012-year-end-results.html

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Insurance

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not just transfer of risk;a device for transferring, sharing, and reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable.

Key Term

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Risk- not just uncertainty of financial loss;- possibility of deviation between actual and expected outcomes- measured in units called “exposures”

How Insurance Reduces Risk (assume 1/100 Probability of Loss) #Exposures Expected Loss Actual Loss Deviation

1 ? 100 1 2 100% 1,000 10 11 10% 10,000 100 101 1% 100,000 1,000 1,001 .1%

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What assumptions are required to make this situation work?

Assuming the exposures are houses…..

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In Homeowners Insurance Houses must be similar value Houses must be geographically disbursed Houses must be construction Houses must have similar probability of loss Must be able to value the loss ………..

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So, what are the requisites of an insurable risk? With what type of people or exposures do we

want to share losses?

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Requisites for an Insurable Risk Large Number of Exposure Units Accidental and Unintentional Loss Determinable and measurable loss No catastrophic loss Calculable Chance of Loss Economically feasible premium

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Is the Risk of Collision Insurable?Requisite: Large #s? Accidental/

Unintentional? Measurable?

Potentially catastrophic?

Calculable chance

Affordable premium

Requisite Met? Yes Yes, except for arson to

car Yes, ACV Yes, not all insured

vehicles should have collision at same time

Yes, chance can be statistically determined

Yes, rate per car value is low

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Is the Risk of Unemployment Insurable? Large #s? Accidental/

Unintentional?

Measurable?

Potentially catastrophic?

Calculable chance Affordable premium

Possibly No, may be voluntary

or involuntary No, Measurement of

loss is difficult/ambiguous

No, recession/depression could be catastrophic

No, too many types of unemployment

No, adverse selection/ moral hazard problem

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Risk Management

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The process of identifying and analyzing all possible loss exposures, selecting a method of handling the exposure, and monitoring the method and exposure regularly.

Everyone is exposed to risk management!

“Sub-prime underwriting” How feasible would it be to insure: Only those over age 75 No serious underwriting requirements Charge “insured” no premium (retroactively

taken out of benefits) Assign benefits to third party automatically

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Risk Management and Insurance Connection?

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Risk Management techniques: risk avoidance risk control

hazard or loss reduction risk retention risk transfer

Hedging and sub-contracting Insurance

Property Insurance

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Property insurance – a type of insurance designed to pay for damage or loss to property caused by direct perils Automobile vs. Homeowners Personal vs. Commercial Lines Commercial Property

Liability Insurance

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Coverage for responsibility to third parties Students are often most interested in

automobile claims: You let your roommate drive your car and she

causes an accident; who is responsible for ensuing damages?

You are stopped at a red-light and someone hits you, causing the tire tool in the back of your pickup truck to fly out and hit a pedestrian. Could you be held responsible?

You let your friend leave your apartment after a party you gave in which alcohol was served. If your friend has an accident, who is responsible?

Life Insurance

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Significance of the Life Insurance Industry Life insurers have nearly $4 trillion invested in the U.S.

economy--including $1.2 trillion in new net investments between 2002 and 2006.

To create an estate To replace funds that the insured would have been able to

accumulate had he/she lived Purpose of life insurance?

Preservation of family’s economic security Moral obligation to provide protection Financial needs Key person indemnification Credit enhancement Business continuation Employee benefit plans

Term vs. Whole Life?

Uses of Life Insurance

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Uses of Term Temporary need for protection Lack of finances for permanent insurance Danger of relying solely on group term insurance

Uses of Whole Life A way to provide death benefit protection for the

entire span of life Enables insured to build retirement fund Allows “permanent” protection Accounts for the great bulk of total assets of life

insurers and the economy

Present Value Example

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How much life insurance does it take to provide dependents $40,000 per year for 30 years? Assume 7% interest could be earned during this time.

Is the answer $40,000 times 30? [$1,200,000]

No! One must consider the Time Value of Money benefit.

$496,362

Health Insurance Facts

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Morbidity rates higher than mortality rates At age 40, there is a 50% chance of becoming disabled

while working Health care costs average $7,868/year per person in the

U.S. (Kaiser Foundation, October 08) The share of the economy (GDP) devoted to health care

spending has gone from 7.2% in 1970 to 16.6% in 2008; Costs have risen 700% in last 20 years 85% of people in the U.S. have some type of health

insurance; the 15% uninsured are typically self-employed or work for someone self-employed

The indigent population typically have health insurance through a government-sponsored plan like Medicaid or a state managed plan

90% of private health insurance is through a group plan

Health Insurance History

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Initially health insurance was only short-term disability income coverage became obsolete during depression

In 1929, first group formed agreement with hospital (teachers/hospital in Dallas) would pay monthly fee for hospital costs if

needed; members only First Blue Cross arrangement Physicians later formed Blue Shield plans

Health Insurance History (cont.)

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Medical expense coverages began in 1940s Premiums became tax deductible for

employers Group policies were the most popular conduit

as employers needed to attract employees Often included life and disability ins. Experience rating began through idea that

different groups incurred different types/amounts of losses

By the 1950s, more medical expense policies than BC/BS policies

Typical Types of Health Plans

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PPO providers service members and non-members smaller co-pay/deductible if insured selects provider on list insured may go to provider of choice

HMO Cost containment lead to the development of HMOs “insurance company” actually provides medical

services managed care focuses on preventive care and treatment

POS Hybrid between HMO and PPO The best of both worlds?

Disability Income Insurance

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Insure one’s income Payment made typically as frequent as

paycheck was received Elimination period serves as deductible Static costs therefore more predictable

Social Security

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Old Age, Survivors, and Disability Insurance Act of 1935

SS Benefits Retirement, survivor, and disability

Medicare - health and hospitalization exp. Tax

6.2% SS, up to $113,700 for 2013 1.45% Medicare; no limit Matched by employer

15.3 percent of all income under $113,700 is paid into the social security system

Workers Compensation

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Benefits prescribed by different laws in each state

Typically includes Medical care benefits Disability income Death benefits Rehabilitation benefits

Still necessary?

Financial Planning

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If you were to be unable to work after today, how much money would your family need to replace your income?

If you retired today, how much money would you like to have each month to live on for rest of your life?

Basic Insurance Terminology

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Indemnification Very important to having many

insurance products succeed! Policies enforcing indemnity:

property, business income and extra expense, and liability

Policies not contracts of indemnity: life insurance

Exclusions in Insurance

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Why do we have or need exclusions?

May result in catastrophic loss Should be covered elsewhere Not fortuitous (unexpected and unforeseen) To control moral or morale hazards To eliminate duplicate coverage To eliminate coverage not needed by the average

insured

How Indemnity is Enforced

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Insurable Interest Subrogation ACV Loss Measurement (versus valued/face

amount contracts) Other Insurance Clause

Pro Rata Clause Other Restrictive Clauses

Insurance Related Laws

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COBRA - 1985 allows portability/continuation of benefits for

specified reasons 18 or 36 months

HIPAA (Health Ins. Portability and Accountability Act – 1996) requires new group insurer to accept new

member even with preexisting

Current Hot Insurance Topics

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Health Care Reform Financial Crisis and Bankruptcies Social Security Funding Long-Term Care Funding STOLI (Stranger-originated life insurance) and

other Senior issues Federal Charters for Insurers Tort Reform Ponzi Schemes

Examples of Careers in Insurance

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Underwriters Claims Adjusters Actuaries Agents Brokers Reinsurance Insurance Law Financial Services Estate Planning Employee Benefit Management

For Further Information…

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Insurance Information Institute http://www.iii.org/

American Council of Life Insurers http://www.acli.com

Social Security Administration www.ssa.gov