Bảo hiểm - Chapter 7: Financial operations of insurers

Chapter 7Financial Operations of InsurersAgendaProperty and Casualty InsurersLife Insurance CompaniesRatemaking in Property and Casualty InsuranceRatemaking in Life InsuranceThe Financial Crisis and InsurersFinancial Statements of Property and Casualty InsurersBalance Sheet: a summary of what a company owns (assets) and what it owes (liabilities)Total Assets = Total Liabilities + Owners’ EquityExhibit 7.1 ABC Insurance Company Financial Statements of Property and Casualty InsurersThe primary assets for an insurance company are financial assetsInsurers’ liabilities include required reservesA loss reserve is an estimated amount for:Claims reported and adjusted, but not yet paidClaims reported and filed, but not yet adjustedClaims incurred but not yet reported to the companyFinancial Statements of Property and Casualty InsurersCase reserves are loss reserves that are established for each individual claimMethods for determining case reserves include:The judgment method: a claim reserve is established for each individual claimThe average value method: an average value is assigned to each claimThe tabular method: loss reserves are determined for certain claims for which the amounts paid depend on data derived from mortality, morbidity, and remarriage tablesFinancial Statements of Property and Casualty InsurersThe loss ratio method establishes aggregate loss reserves for a specific coverage lineA formula based on the expected loss ratio is used to estimate the loss reserveThe incurred-but-not-reported (IBNR) reserve is a reserve that must be established for claims that have already occurred but that have not yet been reportedFinancial Statements of Property and Casualty InsurersThe unearned premium reserve is a liability item that represents the unearned portion of gross premiums on all outstanding policies at the time of valuationIts purpose is to pay for losses that occur during the policy periodIt is also needed so that refunds can be paid to policyholders that cancel their coverageIt also serves as the basis for determining the amount that must be paid to a reinsurer for carrying reinsured policesThe annual pro rata method is one method of calculating the reserveFinancial Statements of Property and Casualty InsurersPolicyholders’ surplus is the difference between an insurance company’s assets and liabilitiesThe stronger a company’s surplus position, the greater is the security for its policyholdersFinancial Statements of Property and Casualty InsurersThe income and expense statement summarizes revenues and expenses paid over a specified period of timeThe two principal sources of revenue are premiums and investment incomeEarned premiums are those premiums for which the service for which the premiums were paid (insurance protection) has been renderedExpenses include the cost of adjusting claims, paying the insured losses that occurred, commissions to agents, premium taxes, and general insurance expensesExhibit 7.2 ABC Insurance CompanyMeasuring the Performance of Property and Casualty InsurersThe loss ratio is the ratio of incurred losses and loss adjustment expenses to premiums earnedThe expense ratio is equal to the company’s underwriting expenses divided by written premiumsThe combined ratio is the sum of the loss ratio and the expense ratio. A positive ratio indicates an underwriting lossMeasuring the Performance of Property and Casualty InsurersThe investment income ratio compares net investment income to earned premiumsThe overall operating ratio is equal to the combined ratio minus the investment income ratioThis ratio measures the company’s total performance (underwriting and investments)Financial Statements of Life InsurersThe balance sheetThe assets of a life insurer have a longer duration, on average, than those of property and casualty insurersBecause many life insurance policies have a savings element, life insurers keep an interest-bearing asset called “contract loans” or “policy loans” A life insurance company may have separate accounts for assets backing interest-sensitive products, such as variable annuitiesFinancial Statements of Life InsurersPolicy reserves are a liability item on the balance sheet that must be offset by assets equal to that amountState laws specify the minimum basis for calculating policy reservesThe reserve for amounts held on deposit is a liability representing funds that are owed to policyholders and to beneficiariesThe asset valuation reserve is a statutory accounting account designed to absorb asset value fluctuations not caused by changing interest ratesFinancial Statements of Life InsurersPolicyholders’ surplus is less volatile in the life insurance industry than in the property and casualty insurance industryBenefit payments, including death benefits paid to beneficiaries and annuity benefits paid to annuitants, are the life insurer’s major expense A life insurer’s net gain from operations equals total revenues less total expenses, policyowner dividends, and federal income taxesMeasuring the Performance of Life InsurersA number of measures can be used to gauge the performance of life insurersPre-tax or after-tax net income vs. total assetsRate of return on policyowners’ surplusRatemaking in Property and Casualty InsuranceState Laws Require:Rates should be adequate for paying all losses and expensesRates should not be excessive, such that policyholders are paying more than the actual value of their protectionRates must not be unfairly discriminatory; exposures that are similar with respect to losses and expenses should not be charged significantly different ratesRatemaking in Property and Casualty InsuranceBusiness Rate-Making Objectives include:Rates should be easy to understand.Rates should be stable over short periods of timeRates should be responsive to changing loss exposures and changing economic conditionsRates should encourage loss preventionRatemaking in Property and Casualty InsuranceA rate is the price per unit of insurance.An exposure unit is the unit of measurement used in insurance pricing, e.g., a car-yearThe pure premium is the portion of the rate needed to pay losses and loss adjustment expensesLoading is the amount that must be added to the pure premium for other expenses, profit, and a margin for contingenciesThe gross rate consists of the pure premium and a loading elementThe gross premium paid by the insured consists of the gross rate multiplied by the number of exposure unitsRatemaking in Property and Casualty InsuranceThere are three basic rate making methods in property and casualty insurance:Judgment rating means that each exposure is individually evaluated, and the rate is determined largely by the judgment of the underwriterClass rating means that exposures with similar characteristics are placed in the same underwriting class, and each is charged the same rateRatemaking in Property and Casualty InsuranceClass rates are determined using two basic methods:Under the pure premium method, the pure premium can be determined by dividing the dollar amount of incurred losses and loss-adjustment expenses by the number of exposure unitsUnder the loss ratio method, the actual loss ratio is compared with the expected loss ratio, and the rate is adjusted accordinglyRatemaking in Property and Casualty InsuranceMerit rating is a rating plan by which class rates are adjusted upward or downward based on individual loss experienceUnder a schedule rating plan, each exposure is individually rated A basis rate is determined for each exposure, which is then modified by debits or credits depending on the physical characteristics of the exposureCommonly used in commercial property insuranceRatemaking in Property and Casualty InsuranceUnder experience rating, the class or manual rate is adjusted upward or downward based on past loss experienceThe insurer’s past loss experience is used to determine the premium for the next policy periodUnder a retrospective rating plan, the insured’s loss experience during the current policy period determines the actual premium paid for that periodA provisional premium is paid at the beginning of the policy period; the final premium is calculated at the end of the policy periodCommonly used in workers compensation insuranceRatemaking in Life InsuranceLife insurance actuaries use a mortality table or individual company experience to determine the probability of death at each attained ageThe annual expected value of death claims equals the probability of death times the amount the insurer must pay if death occursThe Financial Crisis and InsurersThe recent financial crisis has affected financial institutions in different waysBanks were more negatively impacted as they issued the sub prime mortgage loansInsurers were not heavily involved in sub prime lendingInsurers did not securitize the bad mortgage loans and mortgage debt was not a significant share of insurers’ investment portfoliosInsurers were most affected by the sharp decline in the value of their investment portfolios