Insurance Company Selection

1. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Property and casualty companies • Stock and mutual companies • Most prevalent type of traditional insurance mechanism • Stock companies • Owned by stockholders • Organized as for-profit corporations • Capital derived from stockholders • Profits and losses enjoyed by or borne by stockholders • Mutual insurance companies • Owned by policyholders • Profits returned to policyholders in the form of dividends • Cannot sell shares of stock – more difficult to raise capital • Demutualization • Conversion of a mutual company to a stock company

2. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Property and casualty companies (cont’d) • Reciprocal exchanges • Unincorporated arrangements • One policyholder agrees to participate in the insuring of all other policyholders • In exchange, the other policyholders agree to insure that policyholder • Lloyd's associations • Example – Lloyd's of London • Not an insurance company • Provides facilities where insurance is transacted with its members

3. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Property and casualty companies (cont’d) • Risk retention groups (RRGs) • Organizations formed to spread the liability risks of groups of similar businesses • Product Liability Risk Retention Act of 1981 • Congress gave businesses rights to form RRGs to provide products and completed operations liability coverage to members of the group • 1986 – Congress expanded the act • Broader range of liability coverages • Premises and operations liabilities in addition to products and completed operations

4. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Regulation: federal and state law • Insurance companies are regulated on a state-by-state basis • Each state has an insurance department headed by an insurance commissioner • State insurance departments • Protect consumers • Monitor solvency of insurance companies • Regulate coverage wording and insurance policy structure of admitted insurers

5. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Regulation: federal and state law (cont’d) • National Association of Insurance Commissioners (NAIC) • Formed by state insurance commissioners • Coordinates regulation of multi-state insurers • Supports the development of uniform practices and policies

6. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Types of insurance arrangements • Admitted and non-admitted insurers • Admitted • Licensed to conduct business within a state • Subject to state regulation and guaranty funds • Non-admitted • Not licensed in particular state or territories • Not directly regulated in states where they are not admitted

7. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Types of insurance arrangements (cont’d) • Financial strength • Most important aspect of policy selection • Financial strength rating agencies • A.M. Best Moody's • Fitch Weiss • Standard and Poor's • Rating agencies • Monitor the financial stability of insurance companies • Offer guidance on their ability to adequately handle the accounts the insurers write • Publish rating grades, which the agents and brokers use when selecting a company

8. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Types of insurance arrangements (cont’d) • Risk-based capital • Developed by the NAIC • System for analyzing the financial strength of insurance companies • Designed to determine if the insurance company has an adequate amount of capital • System determines a desirable level of capital based on • Investment philosophy , book of business, cash flow • Asset risk • Likelihood value of investment portfolio will decline

9. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Types of insurance arrangements (cont’d) • Risk-based capital (cont’d) • Credit risk • Chance the insurer will not collect premiums, reinsurance and other receivables • Underwriting risk • Premiums or loss reserves will be inadequate • All other business risk • Large guaranty fund assessment • Excessive premium growth • Guarantee of parent companies • Affiliated obligations

10. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Types of insurance arrangements (cont’d) • Insurance Regulatory Information System (IRIS) • Provides state insurance departments integrated approach to screening and analyzing financial condition of insurance companies • IRIS ratios • Calculations used to gauge the acceptability of financial measures • Example – Adequacy of policyholder surplus • Key indicator of insurer's ability to absorb above average loses

11. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Other aspects of insurance companies • Size • Published by various rating agencies • Reflects assets that are available to back the liabilities of the insurance companies • Claims paying philosophy • Can only be measured subjectively • Reputation varies among insurance companies • Support services • How well can they support policyholders by offering loss control and other services • Loss control – effort to prevent claims from happening and managing those that do occur

12. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Investments and insurance companies • Insurance company reserves • Required by law to be established • Estimates of what claims will ultimately cost • Money set aside as claim reserves are invested • Invested income accounts for substantial portion of insurance companies' income • Investments are regulated

13. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Reinsurance • Transferring part or all of a risk among insurers • Reason to engage in reinsurance • Stabilize loss ratio and underwriting results • Protect against catastrophes • Increase policyholders' surplus • Increase capacity • Exit a line of business • Ceding reinsurer • Company that purchases reinsurance • Reinsurer • Company that accepts the risk

14. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Reinsurance (cont’d) • Treaty reinsurance • Treaty – contract governing what portion of risks are ceded to reinsurer • Reinsurer automatically assumes part of each risk that meets criteria of treaty • Pro-rata treaties (proportional) • Quota share • Reinsurer participates in fixed percentage of premiums and losses • Surplus share • Reinsures amounts only in excess of the primary carrier's retention limit • Stated as a dollar amount rather than as a percentage

15. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Reinsurance (cont’d) • Treaty reinsurance (cont’d) • Excess of Loss treaties (Non-proportional) • Per risk treaties • Reinsurer does not pay anything unless an individual claim exceeds the retention • Only pays amount in excess of retention • Per occurrence treaties (catastrophe treaties) • Similar to per risk treaties except both the retention and treaty limit apply to all losses arising from a single event • Aggregate excess treaties (stop loss treaties) • When aggregate losses exceed retention • Stated in dollars or as a loss ratio • Loss ratio – ratio of insured losses to earned premiums

16. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Reinsurance (cont’d) • Facultative reinsurance • Reinsure specific policies rather than entire books of business • Reason to use facultative reinsurance • Coverage for areas excluded in treaty • Protect a treaty when direct insurer wants to write a higher than average exposure • Coverage for limits that exceed treaty maximums • Provide large line capacity on a single risk • Provide stabilization of loss experience • Provide a pricing advantage

17. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Reinsurance (cont’d) • Facultative reinsurance (cont’d) • Reinsurance pools • Used when potential loss exceeds company's ability to underwrite the risk • Number of companies combine resources and assume percentage of risk

18. Insurance Company Selection Chapter 4 Risk Management For Financial Planners • Underwriting • Process through which insurance company analyzes risk • Decides whether and how much of those risks to accept • Designs the insurance program it will offer • Establishes a premium for the coverage • Often uses rates and coverage wording established with the state insurance department