The conception of insurance is the spreading of risks for a few individuals, among many. This is done when individuals and businesses pay a premium to an insurance company to cover them in case of a catastrophic occurrence. In other words, we all pay premiums in case something happens to one of us.
Believe it or not, this simple concept is what drives the existence of all insurance companies. As much as we all complain about insurance, we all have it. If something happens, we can’t afford to be without it. The attached article from “Business Insurance” magazine, an insurance industry publication outlines some ideas that make me think our insurance rates are going to go a lot higher before they come down at all.
In order for me to make my case, I think it’s necessary to review a basic concept of insurance that is referred to in this article. The very concept that I’m referring to is called an underwriting profit. The insurance industry would have us believe that underwriting and rating insurance policies is a complicated procedure. However, when you break it down to its simplest form, insurance is just like any other business. Profits are what’s left when you subtract expenses (dollars out) from revenues (dollars in). In insurance terms, this means a combined expense ratio far enough below 100 % to allow for an acceptable profit. In other words, how much is it going to cost to underwrite, issue, and service a policy and how much does the insurance company expect to pay in claims? If there is money left, that’s an underwriting profit. If the expenses and losses are higher than the premium collected, that’s an underwriting loss.
If the insurance industry accepts the concept laid out in the article by the chairman of Lloyd’s of London, Peter Levene, my opinion is not only are insurance rates going to rise but all kinds of coverage is going to be harder to get. If the insurance companies can no longer count on high incomes from their investments, their profits have to come from another source. Us, the customers. While this may not seem entirely fair, I’m sure very few people complained when rates were low. The disturbing point Lord Levene eludes to is that he advocates pursuing an underwriting profit even when investment returns are high. This is disturbing because in the past as the investment markets changed and higher returns were being earned. The insurance customer shared in these returns in the form of lower premiums and easier underwriting. For example, the premium for a particular business when investments are bad might be $10,000. In the past, when investments were good, that same business might have paid only $6,000 for their coverage. Assuming Lord Levene’s position is accepted, that $10,000 premium would remain constant regardless of how much the insurance company was making on their investments and would only rise if the markets turned even worse. To make things even more difficult, if this business had suffered any claims, they are at greater risk of having their coverage cancelled. At that point, this company would be forced to find a new insurance carrier. This is where things could begin to spiral out of control. Assuming the new insurance carrier is also looking for an underwriting profit, they would be forced to add the cost of what they consider to be a higher risk of claims to their expenses and this $10,000 policy might now cost $15,000. The customer now has a decision to make. Accept the higher premium and absorb the cost or pass this cost to their own customers in the form of a price increase.
At this point you may be wondering how all of this relates to why “my rates are so high.” My thinking is simply this. If the business insurers subscribe to Lord Levene’s theories, then the personal insurers will probably not be very far behind. I have the unique perspective of a father with twenty-three years experience in the insurance industry, which gives me some insight as to “why my rates are so high.” I pay around $3,000 a year for my car insurance. According to my father, the reason is that the insurance companies feel that due to my age and lack of driving experience, I am more likely to have an accident. This likelihood comes back to me in the form of higher rates. While I may never have that accident, other members of my age group have in the past been in more accidents than any other age group.
Statistically, that makes me a less desirable risk than someone in another group. For example, my parents pay less than the $3,000 I pay to insure both their cars. Another factor is geography. Where you live has as much to do with your rates as what group you belong to and what your claims history is. While my $3,000 premium seems ridiculously high, the premium for the same coverage might be as much as $4,000 just ten miles west of where I live. Move me to Brooklyn and that rate would be more than $7,000. This seems extremely unfair to me. Why should where I live have any bearing on my rates?
The answer apparently has to do with the same logic that makes younger drivers pay more than more experienced drivers. It seems that insurance companies not only group drivers by age but by other factors, such as population density (how many more cars are there in a given geographical area?), claim frequency (how many more claims are there in Brooklyn vs. Eastern Suffolk County?). The companies also take in to account moving violations. Statistically speaking again, a driver with multiple traffic violations is an accident waiting to happen. Add to that, the logic that someone who makes a habit of passing stop signs or red lights is individually increasing the probability that they will be involved in some type of loss. People who drive fast not only have the increased probability of loss but also because of the speed, increase the probability of a more severe loss. Thereby costing the insurance company, and all of us, that much more money. This is why insurance companies either refuse insurance or at the very least charge much more for drivers with violations on their records.
While all of this barely scratches the surface of what insurance companies look at when determining their rates, it does give us a pretty good idea of what we can do to keep our rates as low as possible. One thing would be to live in an area with less people and lower crime rates. For most of us, this is impossible. So what can we do without moving so far into the country that our nearest neighbors live five miles away? For one thing, avoid accidents and don’t pile up the moving violations.
All I can say is that as unfair as insurance seems, ultimately the blame for higher rates rests with all of us. If no one ever had an accident, all we would have to insure against would be fire and theft. Since no one ever having an accident is not realistic, we can thank the powers that be for greed. If the insurance companies can find a way to make more money, you can bet they will do it. So while Lord Levene’s theories are disturbing, we can count on the overriding greed of the insurance companies to offset the theory of always making an underwriting profit. What I am trying to say is that when the investment markets are good, insurance companies make more money. As long as they can make more money by writing more policies at lower rates then by looking for that pie in the sky underwriting profit, that’s exactly what they will do. You can always tell when an insurance company is doing well in the market. Rate increases are few and far between and the company is writing more policies. When the market turns bad as it is now, insurance companies raise rates and reduce the number of new policies they sell.
When you consider all of the factors that go into what an insurance company charges, combined with all the different laws and regulations they are required to comply with from state to state, it’s understandable why rates are what they are at any given time. So I guess the answer to my question is not as easy as my first thought. Between investment markets, geography, age group, driving experience, prior loss history, and driving record, it’s a wonder how they come with any rates that we can afford and still stay in business.
I am not sure if I agree or disagree with the logic and statistics used by the insurance companies but I am sure of one thing. My rates are too high!
You can also order a custom essay, term paper or research paper on insurance at our professional custom writing service which provides students with high-quality custom written papers.
Here is a list of the most popular insurance research paper topics:
1. The history of insurance law in Britain
2. Insurance Reform
3. Insurance Planning
4. Insurance companies should be allowed to use genetic testing before giving someone health or life insurance.
5. High insurance rates have nursing homes ‘going bare’
6. How Insurance Works
7. Importance of Car Insurance
8. Global insurance
9. Reliable Insurance Case Study
10. Quicken Insurance Case Study
5.00 avg. rating (91% score) - 1 vote
Tags: business essays, examples of research paper, insurance research papers, research paper on insurance, sample research paper
This article provides an overview of the financial strategies and analysis that are a part of the insurance industry. The article provides an introduction to the financial management of insurance companies, including the definition of an insurance company, the most common types of insurers and the unique financial considerations for insurance companies. In addition, this article also provides a financial analysis of insurance companies. This analysis includes explanations of the components of insurance company income, common insurance company dividend policies and the modern development of dynamic financial analysis. Further, the investment strategies of insurance companies are described, such as the variables that are involved in investment strategies, risk management techniques and the various investment portfolios held by insurance companies. Finally, this article explains some of the most important financial considerations facing insurance companies, such as the identification of loss exposures, contractual risk control measures and the identification of security risks.
Keywords Claim; Conditions; Damages; Liability; Premium; Reinsurance; Risk; Underwriting
Actuarial Science: Financial Strategies
The central objective of insurance companies is the to eliminate certain financial risks for businesses and individuals by transferring liability for the risk from businesses and individuals to the insurance company. To limit the scope of their liability, insurance companies specify the activities and events that they will insure, and may even specify activities or events that they will not insure. Thus, insurance functions as a means by which certain known, probable or potential risks are converted from an individual or business risk to an individual or business expense in the form of insurance premiums. The premiums, or payments, that the insurance companies charge insureds and the income received from investments held by the insurance company compose the reserves from which insurance companies pay benefits to insureds who suffer losses covered by a valid insurance policy.
In addition to underwriting insurance policies, insurance companies also act as financial intermediaries in other ways. Insurance company agents now market and sell various financial products such as mutual funds, IRAs, annuities, money market funds, investment securities and tax shelters. Insurance companies also manage large sums of money in the form of employee benefit, pension, retirement and profit-sharing plans. Thus, insurance companies play an important role in today's financial world, and as a result, must be carefully managed for proper growth and profitability. The following sections provide an overview of the financial strategies and analyses that play a central role in the insurance industry.
Financial Management of Insurance Companies
Financial management involves implementing the techniques, research and analysis necessary to provide a company's management team with sufficient information to make sound financial decisions on behalf of the company. At least three kinds of financial management decisions are essential in the development of successful insurance companies: Investment decisions, financing decisions and dividend decisions.
- Investment decisions involve the most efficient use and replacement of current and fixed assets and take into account the time value of money, cash flows and the risks and returns of various investment and insurance underwriting options. Investment decisions are also referred to as capital budgeting.
- Financing decisions deal with identifying and selecting the sources of funds that will operate the insurance company and implement its various goals and projects. Financing decisions involve current liabilities, long-term debt and equity.
- Dividend decisions refer to the percentage of earnings to be paid as dividends to stockholders. These decisions are closely related to financing decisions, but are also concerned with the stability of dividends over time and the impact of periodic dividend payments on the company's net worth.
The combination of these decisions allows a company's management team to put in place the necessary changes to achieve the financial goals of the insurance company and its owners, which are often different than owners of a typical for-profit corporation. Many insurance companies are known as mutual insurance companies and are owned by policyholders, not stockholders. Regardless of the owners, a company's management team most likely has as its goal to create profit or economic surplus while sustaining a healthy level of growth and productivity for the organization. Like stock companies, insurance companies must grow at least as rapidly as inflation to maintain their profitability and service to policyholders. However, the insurance industry is governed by certain regulatory guidelines that establish certain financial requirements for insurance companies. Thus, for any type of insurance company, the goal of financial management is to maximize the surplus of policyholders while complying with regulatory guidelines.
The following sections provide a more detailed explanation of the financial management of insurance companies, including a definition of insurance companies, the most common types of insurers and unique considerations for insurance companies.
Definition of Insurance Company
Insurance companies provide a medium through which individuals and businesses may transfer an element of risk in exchange for payments, called premiums. However, to actually form and maintain an insurance company, an organization must comply with special state statutes, regulations and common-law principles that govern insurance companies and insurance law. The insurance industry is largely regulated by state laws. Each state has a state insurance department that is charged with the power to oversee and regulate insurers. These insurance departments, among other things, certify that newly formed insurers comply with special statutes governing business organization and formation; license out-of-state insurers who satisfy certain requirements to operate in the state; require the filing of detailed annual statements showing the insurer's assets, liabilities, income, losses and expenses; and supervise the general conduct of insurers. To support the administrative and regulatory costs of maintaining insurance departments, states levy premium taxes on insurers. At the federal level, Internal Revenue Service ("IRS") regulations mandate that to be taxed as an insurer, the majority of a company's business must be issuing insurance. Key elements in the definition of an insurance company are the transfer of risk and the distribution of losses.
Transfer of Risk
An insurance policy transfers some risk from the insured to the insurer. To effectuate a legally cognizable transfer of risk, there must be a binding contract between two or more parties that states the terms of the risks that are transferred between or among the parties and the consideration that supports the risk transfer. If these elements are not met, an activity that purports a transfer of risk may not fall within the scope of the definition of insurance. For instance, deposits that are made into a fund administered by another party would not constitute insurance if the insured entity was essentially paying toward its own losses because this arrangement does not involve a transfer of risk.
Distribution of Losses
The IRS also defines insurance as involving the pooling of exposure and the proportional sharing of losses. Traditional insurance companies distribute the costs of losses among a group of insureds exposed to such losses. Certain distribution arrangements are often made, however, to adjust the premiums paid by the insureds to reflect the individual losses. These arrangements are generally subject to maximum and minimum limits. Otherwise insurance companies would be acting as a type of financial organization in distributing and redistributing the flow of cash flows among insureds, and this activity would fall within the realm of banking rather than insurance. Thus, financial managers must pay careful attention to the activities of insurance companies to ensure that they continue to operate within the prescribed activities of insurers, or the companies may risk losing their tax status as insurance companies.
Types of Insurers
The legal form of organization of a company acting as an insurer is also an important factor in the financial management of insurance companies. The major types of insurers are stock companies, mutual companies and reciprocal exchanges.
Stock insurers are corporations engaged in the insurance business and owned by stockholders, who are not necessarily policyholders. The stockholders elect the board of directors, which appoints the executive officers, who in turn hire the remaining managers and personnel. The stockholders share the gains or losses from operations through stock dividends established by the board of directors as well as through ups and downs in the market value of their shares of stock.
Stock insurers write almost three-fourths of the property and liability insurance premiums written by United States private insurers. Stock property and liability insurers range from small insurers writing only one line of insurance to large insurers writing practically all kinds of insurance.
Mutual insurers are corporations owned by their policyholders. They elect the board of directors. The board of directors appoints the executive officers, who then hire the other employees. There are two types of mutual insurers: Assessment mutuals and advance premium mutuals.
Assessment mutuals operate by taking a cash deposit, or premium, from members in exchange for insurance protection. If the company's losses and expenses exceed these deposits, the company can assess members for additional monies to cover losses. On the other hand, advance premium mutuals have no legal right to assess their policyholders. Some advance premium mutuals pay dividends at the discretion of the board of directors. Most of these insurers charge more than they expect they will need and thus return some of the excess premium as dividends on a regular basis. Others pay policyholder dividends only under certain specified circumstances. Instead they set a price that is close to their expected needs and the "dividend" takes the form of a lower initial premium. Advance premium mutuals write a significant portion of the life insurance and property and liability insurance policies in force today. Many of the nation's largest insurers are advance premium mutuals.
Unlike mutual insurers, reciprocal exchanges are not corporations but are unincorporated associations that involve individuals writing insurance as individuals, not as an organized business affiliation or as joint owners. Each subscriber agrees to insure individually all of the other subscribers in the exchange and is in turn insured by each of the other subscribers. Thus, there is a "reciprocal exchange" of insurance promises. Instead of writing a separate contract for each promise, the reciprocal exchange issues one contract to each subscriber that states the nature of the association and its business protections and operations.
Reciprocal exchanges write only a small fraction of the property and liability premiums today and they seldom write life insurance policies. Many reciprocal exchanges specialize in one type of insurance, such as auto insurance, although a few do offer multiple lines of insurance. Some reciprocal exchanges are affiliated with trade associations and write insurance only for members of the association.
Unique Financial Considerations for Insurance Companies
The financial statements prepared by insurance companies differ from those prepared by other corporations for audits or tax purposes. Insurance companies have relatively few fixed assets, and most of these do not appear on the balance sheet as admitted assets. In addition, on the liabilities side of a financial statement, insurance companies utilize minimal debt, so their liabilities generally consist primarily of reserves. The equity of insurance companies is generally identified as policyholders’ surplus or, in the case of stock companies, capital and surplus.
The preparation of financial statements for insurance companies follows statutory accounting principles. These principles differ in several ways from the generally accepted accounting principles ("GAAP") used by other business entities. Most of the deviations from GAAP are due to requirements imposed by state insurance regulatory authorities or are accounting adaptations that have been created to accommodate the special characteristics of the insurance business. These special accounting principles tend to be much more conservative than GAAP.
In order to focus on a company's solvency, insurance accounting procedures apply special rules for the valuation of assets. While GAAP recognize all assets, statutory accounting principles only recognize what are called admitted assets, or assets that are readily convertible to cash. Furniture and fixtures, automobiles, premiums due over 90 days and other assets of an insurance company, which are referred to as nonadmitted assets, do not appear on the balance sheet. Unrealized capital gains or losses are recognized under the statutory system but not under GAAP.
Financial Analysis of Insurance Companies
Earning income is a major objective of all businesses that seek to attract and retain capital. This applies to all forms of insurance companies as well-stock, mutual or reciprocal. Even though these organizations do not vie for funds in capital markets in the same manner as other businesses, their ability to increase insurance operations is dependent on their earning capacity.
Thus, insurance company managers face the same decisions as stock company managers and executives. They must set growth objectives and determine how desired growth will be financed. Even if an insurance company does not increase the number of policies it underwrites, it has to expand its insuring capacity simply to provide coverage to existing policyholders as their insured assets increase in value. The following sections explain the financial analysis performed by insurance companies in pursuit of their growth and profitability objectives.
Components of Insurance Company Income
Income determination rules have a wide influence of the financial and...