Functions of Insurers Prepared By Md. Sagar Rana Assistant Professor Banking and Insurance University of RajshahiKs amenetins Functions of Taselgslas) e are definite operatio oe r companies and property and liability insurers, the major activities of all in eo Coe Moura1. Ratemaking + An insurance rate is the price per unit of insurance. Like any other price, it is a function of the cost of production. * Difference between insurance pricing and the pricing function in other industries: *based on a prediction *subject to government regulation. * The ratemaking function in a life insurance company is performed by the actuarial department. + Rates must be adequate, not excessive, and not unfairly discriminatory, there are certain other characteristics considered desirable. 3. D> eran > vate > »>smanee > 4. Loss adjustment.Some Basic Concepts + A rate is the price charged for each unit of protection or exposure and should be distinguished from a premium, which is determined by multiplying the rate by the number of units of protection purchased. + The final premium that the insured pays is called the gross premium and is based on a gross rate. + The gross rate is composed of two parts: payment of losses and loading, to cover the expenses of operation. + That part of the rate that is intended to cover losses is called the pure premium when expressed in dollars and cents, and the expected loss ratio when expressed as a percentage. + For example, if 100,000 automobiles generate $30 million in losses, the pure premium is $300: Losses ‘$80,000,000 Exposure Unis = — 100,000 = 89%Gross Rate * In converting the pure premium into a gross rate, expenses are usually treated as a percentage of the final rate, on the assumption that they will increase proportionately with premiums. + The final gross rate is derived by dividing the pure premium by a permissible loss ratio. The permissible loss ratio is the percentage of the premium (and so the rate) that will be available to pay losses after provision for expenses. The conversion is made by the formula ure Premium Gross Rate = 7" pense Ratio Using the $300 pure premium computed in our previous example, and assuming an expense ratio (0f 0.40, we obtain $300 _ $300 Gross Rate = 59007, = Se = $500Types of Rates + Class Rates The term class rating refers to the practice of computing a price per unit of insurance that applies to all applicants possessing a given set of characteristics. For example, a class rate might apply to all types of dwellings of a given kind of construction in a specific city. Rates that apply to all individuals of a given age and sex are also examples of class rates. + Individual Rates In some instances the characteristics of the units to be insured vary so widely that it is deemed desirable to depart from the class approach and calculate rates on a basis that attempts to measure more precisely the loss-producing characteristics of the individual. There are four basic individual rating approaches: Cuudgment rating, Oschedule rating, Caxperience rating, and Retrospective rating.2. Production + The production department of an insurance company, sometimes called the agency department, is its sales or marketing division. This department supervises the external portion of the sales effort, which is conducted by the agents or salaried representatives of the company. + The internal portion of the production function is carried on by the production (or agency) department. It is the responsibility of this department to select and appoint agents and assist in sales. 4. Loss adjustment. 3.3. Underwriting The underwriting process often involves more than acceptance or rejection. In some instances, an exposure that is unacceptable at one rate may be written at a different rate. In the life insurance field, for example, applicants may be classified as standard, preferred, substandard, and uninsurable. Underwriting starts with a clear statement of underwriting policy that is consistent with a company's mission and goals. _Top-level management in charge of underwriting determines the insurer’s underwriting policy, which involves decision such as: {1} what ines of insurance to sel ( ) Santee borderine, or prohibited; [3] whether to write a large volume of business with low prt margin or asmaler volume with lager margin of profit ( ) (a) the amounts of insurance that ean be (6) territories tobe developed; and (6) forms and rating plans tobe sed. 4. Loss adjustmentBasic Underwriting Principles Underwriting is based on a number of principles. Three principles are especially important: O Attain an underwriting profit: The first principle is that the underwriting process must achieve an underwriting profit so that the company will be successful. O Select prospective insureds according to the company’s underwriting standards: the underwriting department must select prospective insureds according to the company's underwriting standards. In other words, the underwriters should select only those insureds whose actual loss experience is not likely to exceed the loss experience assured in the rating structure. 1 Provide equity among the policyholders: This means that equitable rates should be charged, and that each group of policyholders should pay its own way in terms of losses and expenses.Additional Sources of Underwriting Information4. Loss Adjustment ‘The Loss Adjustment Process (~¥ Investigation5. The Investment Function + Asa result of their operations, insurance companies accumulate large amounts of money for the payment of claims in the future. When these are added to the funds of the insurers themselves, assets total over $5.6 trillion. It would be a costly waste to permit these funds to remain idle, and itis the responsibility of the insurer's finance department or a finance committee to see that they are properly invested. Because a portion of their invested funds must go to meet future claims, the primary requisite of insurance company investments is safety of principal. In addition, the return earned on investment is an important variable in the rating process: life insurance companies assume some minimum rate of interest earnings in their premium computations. Increasingly, property and liability insurers are also required to include investment income in their rate calculations. It may be argued that even when investment income is not explicitly recognized, it subsidizes the underwriting experience and is therefore a factor in ratemaking in this field as well. > mete vomit > ae > semen =Fundamental Legal Principles eth] NCR cia Pena rs Cur ett Nee eae uriPRINCIPLE OF INDEMNITY than the actual amount of the loss; stated differently, the insured should not $ The principle of indemnity states that the insurer agrees to pay no more profit from a loss. oe t 4 The first purpose is to prevent the insured from = The principle of indemnity has two ee ea fundamental purposes. The second purpose is to reduce moral hazard.PRINCIPLE OF INDEMNITY ‘Actual Cash Value In property insurance, the basic method for indemnifying the insured is based on the actual cash value of the damaged property at the time of loss. The courts have used a number of methods to determine actual cash value, including the following: Replacement Cost Less Depreciation ‘actual cash value is defined as replacement cost less depreciation. Viele ccia\ | [F(a *the price a willing buyer would pay a willing seller in a free market. ‘the determination of actual cash value should include all relevant {actors an expert would use to determine the value of the property. Broad Evidence RulePRINCIPLE OF INDEMNITY ‘Actual Cash Value Exceptions to the Principle of Indemnity I values Poticy a policy that pays the face amount of insurance if a total loss occurs. (I valved Poticy taw * a law that exists in some states that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law. Replacement Cost Insurance * there is no deduction for physical depreciation in determining the amount paid for a loss. I tite insurance * contract is not a contract of indemnity but is a valued policy that pays a stated amount to the beneficiary at the time of the insured’s death.PRINCIPLE OF INSURABLE INTEREST The principle of insurable interest states that the insured must be in a position to lose financially if a covered loss occurs. Purposes of an insurable Interest “To prevent gambling “To reduce moral hazard “To measure the amount of the insured’s loss in property insurance Examples of an insurable Interest Property and Casualty Insurance: Ownership of property, Potential legal liability, Secured creditors, contractual right. life insurance: Own life, Close family, pecuniary (financial) interest.PRINCIPLE OF SUBROGATION Subrogation means substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance.7 Stated differently, the insurance company is entitled to recover from a negligent third party any loss payments made to the insured. Purposes of Subrogation + First, subrogation prevents the insured from collecting twice for the same loss. + Second, subrogation is used to hold the negligent person responsible for the loss. ‘© Third, subrogation helps to hold down insurance rates. Exceptions to Subrogation subrogation does not apply to life insurance contracts. O The insurer cannot subrogate against its own insureds.PRINCIPLE OF UTMOST GOOD FAITH ‘An insurance contract is based on the principle of utmost good faith—that is, a higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts. The principle of utmost good faith is supported by three important legal doctrines: Representations: In the process of buying insurance, the applicant makes certain oral or written statements to the insurance company concerning the desired coverage. These are representations, or statements made by the applicant for insurance to induce the insurer to enter into an insurance contract. A representation that is false is called a misrepresentation. The legal significance of a misrepresentation is that the insurance contract is voidable at the insurer’s option if the misrepresentation is (1) material, (2) false, and (3) relied on by the insurer. Material means that if the insurer knew the true facts, the policy’ would not be issued, or it would be issued on different terms. False means that the statement is not true or is misleading, Reliance means that the insurer relies on the misrepresentation in issuing the policy at a specified premium. Concealment.A concealment is intentional failure of the applicant for insurance to reveal a material fact to the insurer. Warranty:A warranty is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects.REQUIREMENTS OF AN INSURANCE CONTRACT Offer and Exchange of Competent Acceptance Consideration Parties FeaDISTINCT LEGAL CHARACTERISTICS OF INSURANCE CONTRACTS Aleatory Unilateral Conditional Personal Contract of Contract Contract Contract Contract Adhesion the insurer’s where the obligation to values fy pay acclaim the insured exchanged oy ate dependson | the contractis|__ Must accep may not be Porgaly whether the between the an ‘equal but = ree insured or the insured and all of ts terms depend on an aaa beneficiary the insurer. di uncertain iB has complied een event. with all policy ” conditions.Law of Agency Important rules of law govern the actions of agents and their relationship to insureds. They include the following: + There is no presumption of an agency relationship. + An agent must have authority to represent the principal, **(1) actual or express authority, (2) imj 1d authority, and (3) apparent authority. + Aprincipal is responsible for the acts of agents acting within the scope of their authority. + Limitations can be placed on the powers of agents. Waiver and Estoppel + Waiver is defined as the voluntary relinquishment ofa known legal right. + Estoppel is the Joss of a legal defense because of previous actions that are now inconsistent with that defense.