This document provides an overview of key operations and functions within an insurance company, including ratemaking, underwriting, claims settlement, reinsurance, and investments. It discusses the roles of actuaries in determining insurance rates and reserves. It also describes the underwriting process, including evaluating applications, inspecting risks, and making acceptance decisions. Claims settlement and the different types of adjusters are also outlined. The document provides details on different types of reinsurance agreements and how losses are shared. It concludes with a discussion of investment principles for both life and property/casualty insurers.

1. INSURANCE COMPANY
OPERATIONS

2. Insurance Operations
Ratemaking
Underwriting
Production
Claim settlement
Reinsurance
Investments

3. RATING AND RATEMAKING
• Ratemaking refers to the pricing of insurance and the calculation of
insurance premiums
• A rate is the price per unit of insurance. An exposure unit is the unit of
measurement used in insurance pricing, which varies by line of insurance.
• Insurance pricing differs considerably from the pricing of other products.
• The person who determines rates and premiums is known as an actuary .
• In life insurance, the actuary studies important statistical data on births, deaths,
marriages, disease, employment, retirement, and accidents.
• A life insurance actuary must also determine the legal reserves a company needs for
future obligations.
• In property and casualty insurance, actuaries also determine the rates for different lines
of insurance.
• Rates are based on the company’s past loss experience and industry statistics.

4. UNDERWRITING
• Underwriting refers to the process of selecting, classifying, and pricing
applicants for insurance . The underwriter is the person who decides to
accept or reject an application on the basis of underwriting policy.
• Statement of Underwriting Policy
• An insurer must establish an underwriting policy that is consistent with
company objectives.
• Classes of business that are acceptable, borderline, or prohibited must be
clearly stated. The amounts of insurance that can be written on acceptable and
borderline business must also be determined.
• The insurer’s underwriting policy is determined by top-level management
in charge of underwriting. The underwriting policy is stated in detail in an
underwriting guide

5. Basic Underwriting Principles
Attain an underwriting profit.
• The objective is to produce a profitable book of business.
Select prospective insureds according to the company’s underwriting
standards.
• Underwriters should select only those insureds whose actual loss experience is
not likely to exceed the loss experience assumed in the rating structure.
• Rate is established based on a relatively low loss ratio.
• The purpose of the underwriting standards is to reduce adverse selection
against the insurer.
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.

6. Steps in Underwriting
• Agent as First Underwriter
• This step is often called field underwriting. The agent is told what types of
applicants are acceptable, borderline, or prohibited.
• For example, in auto insurance, an agent may be told not to solicit
applicants who have been convicted for drunk driving, who are under age
21, or who are young drivers who own high-powered sports cars.
• In property and casualty insurance, the agent often has authority to bind
the company immediately, subject to subsequent disapproval of the
application and cancellation by a company underwriter.
• In life insurance, the agent must also solicit applicants in accordance with
the company’s underwriting policy.

7. Sources of Underwriting Information
Application. The type of information required depends on the type of
insurance requested.
• In property insurance, the application provides information on the physical
features of the building
• In life insurance, the application indicates the age; gender; weight;
occupation; personal and family health history; and the amount of
insurance requested.
Agent’s Report. Many insurers require the agent or broker to give an
evaluation of the prospective insured.
Inspection Report. In property insurance, the company may require an
inspection report by some outside agency, especially if the underwriter
suspects moral hazard.

8. Inspection Reports
• Physical Inspection. For example, in workers compensation insurance, the
inspection may reveal unsafe working conditions, such as dangerous
machinery; violation of safety rules, such as not wearing goggles when a
grinding machine is used; and an excessively dusty or toxic plant.
• Physical Examination (An attending physician’s report)
In life insurance, a physical exam may be required to determine if the applicant
is overweight; has high blood pressure; or has any abnormalities in the heart,
respiratory system, urinary system, or other parts of the body.
As part of the physical exam, a life insurer may request a report from MIB
Group, Inc. ( Medical Information Bureau report )
Making an Underwriting Decision
 Accept the application
 Accept the application subject to certain restrictions or modifications
 Reject the application

9. Other Underwriting Considerations
• Rate adequacy and underwriting
• Property and casualty insurers are more willing to underwrite new business
for a specific line if rates are considered adequate.
• In addition, in commercial property and casualty insurance, the underwriters
have a considerable impact on the price of the product.
• Reinsurance and underwriting
• Renewal & underwriting
PRODUCTION
Agency Department
Professionalism in Selling

10. CLAIMS SETTLEMENT
• Every insurance company has a claims division or department for adjusting
claims. This section of the chapter examines the basic objectives in adjusting
claims, the different types of claim adjustors, and the various steps in the
claim-settlement process.
• Basic Objectives in Claims Settlement
• Verification of a covered loss
• Fair and prompt payment of claims
• Personal assistance to the insured
• Types of Claims Adjustors
• Agent
• Company adjustor
• Independent adjustor
• Public adjustor

11. Steps in Settlement of a Claim
• Notice of loss must be given.
• The claim is investigated.
• Did the loss occur while the policy was in force?
• Does the policy cover the peril that caused the loss?
• Does the policy cover the property destroyed or damaged in the loss?
• Is the claimant entitled to recover?
• Did the loss occur at an insured location?
• Is the type of loss covered?
• Is the claim fraudulent?
• A proof of loss may be required.
• A decision is made concerning payment.

12. • Filing a Proof of Loss: An adjustor may require a proof of loss
before the claim is paid. A proof of loss is a sworn statement by the
insured that substantiates the loss.
• Decision Concerning Payment

13. REINSURANCE
Reinsurance is an arrangement by which the primary insurer that initially
writes the insurance transfers to another insurer (called the reinsurer) part
or all of the potential losses associated with such insurance.
• Ceding Company: The primary insurer that initially writes the insurance is
called the ceding company.
• Reinsurer: The insurer that accepts part or all of the insurance from the
ceding company is called the reinsurer.
• Retention: The amount of insurance retained by the ceding company for
its own account is called the retention limit or net retention .
• Cession: The amount of insurance ceded to the reinsurer is known as the
cession
• Retrocession: The reinsurer in turn may reinsure part or all of the risk with
another insurer. This is known as a retrocession . In this case, the second
reinsurer is called a retrocessionaire.

14. Reasons for Reinsurance
• Reinsurance is used for several reasons. The most important reasons include the
following:
■ Increase underwriting capacity
• Reinsurance permits the primary company to issue a single policy in excess of its
retention limit for the full amount of insurance.
■ Stabilize profits
• For example, reinsurance may be used to cover a large exposure. If a large, unexpected
loss occurs, the reinsurer would pay that portion of the loss in excess of some specified
limit.
• For example, an insurer may wish to stabilize its loss ratio at 70 percent. the reinsurer
then agrees to reimburse the ceding insurer for part or all the losses in excess of 70
percent up to some maximum limit.
■ Reduce the unearned premium reserve
The unearned premium reserve is a liability item on the insurer’s balance sheet that
represents the unearned portion of gross premiums on all outstanding policies at the
time of valuation .
■ Provide protection against a catastrophic loss

15. • An insurer can also use reinsurance to retire from the business or
from a given line of insurance or territory.
• Finally, reinsurance allows an insurer to obtain, the underwriting
advice and assistance of the reinsurer. An insurer may wish to write a
new line of insurance, but it may have little experience with respect
to underwriting the line.

16. Types of Reinsurance
• There are two principal types of reinsurance:
(1) facultative reinsurance and (2) treaty reinsurance.
• Facultative reinsurance is an optional, case-by-case method that is
used when the ceding company receives an application for insurance
that exceeds its retention limit .
• Treaty Reinsurance: Treaty reinsurance means the primary insurer
has agreed to cede insurance to the reinsurer, and the reinsurer has
agreed to accept the business . All business that falls within the scope
of the agreement is automatically reinsured according to the terms of
the treaty.

17. Methods for Sharing Losses
The following reinsurance methods for the sharing of losses are
examples of both methods:
■ Quota-share treaty
• Under a quota-share treaty , the ceding company and
reinsurer agree to share premiums and losses based on some
proportion. For example, assume that Apex Fire Insurance and
Geneva Re enter into a quota-share arrangement by which losses and
premiums are shared 50 percent and 50 percent. Thus, if a $100,000
loss occurs, Apex Fire pays $100,000 to the insured but is reimbursed
by Geneva Re for $50,000.

18. • ■ Surplus-share treaty
• Under a surplus-share treaty, the reinsurer agrees to accept insurance in excess
of the ceding insurer’s retention limit, up to some maximum amount. The
retention limit is referred to as a line and is stated as a dollar amount.
• For example, assume that Apex Fire Insurance has a retention limit of $200,000
(called a line) for a single policy, and that four lines, or $800,000, are ceded to
Geneva Re. Apex Fire now has a total underwriting capacity of $1 million on any
single exposure. Assume that a $500,000 property insurance policy is issued
Apex Fire takes the first $200,000 of insurance, or two-fifths, and Geneva Re
takes the remaining $300,000, or three-fifths. These fractions then determine
the amount of loss paid by each party. If a $5000 loss occurs, Apex Fire pays
$2000 (two-fifths), and Geneva Re pays the remaining $3000 (three-fifths).
• Under a surplus-share treaty, premiums are also shared based on the fraction of
total insurance retained by each party. However, the reinsurer pays a ceding
commission to the primary insurer to help compensate for the acquisition
expenses.

19. Excess-of-Loss Reinsurance
• Excess-of-loss reinsurance is designed largely for protection against a
catastrophic loss. The reinsurer pays part or all of the loss that exceeds the
ceding company’s retention limit up to some maximum level. Excess-of-loss
reinsurance can be written to cover
• (1) a single exposure,
• (2) a single occurrence, such as a catastrophic loss from a tornado, or
• (3) excess losses when the primary insurer’s cumulative losses exceed a
certain amount during some stated time period, such as a year.
• For example, assume that Apex Fire Insurance wants protection for all
windstorm losses in excess of $1 million. Assume that Apex Fire enters into
an excess-of-loss arrangement with Franklin Re to cover single occurrences
during a specified time period.
• Franklin Re agrees to pay all losses exceeding $1 million but only to a
maximum of $10 million. If a $5 million hurricane loss occurs, Franklin Re
would pay $4 million.

20. Reinsurance Pool
• Reinsurance Pool Reinsurance can also be provided by a reinsurance pool.
A reinsurance pool is an organization of insurers that underwrites
insurance on a joint basis.
• For example, the combined hull and liability loss exposures on a large
commercial jet can exceed $500 million if the jet should crash.
• Such high limits are usually beyond the financial capability of a single
insurer. However, a reinsurance pool for aviation insurance can provide the
necessary capacity.
• The method for sharing losses and premiums varies depending on the type
of reinsurance pool. Pools work in two ways.10 First, each pool member
agrees to pay a certain percentage of every loss.

21. ALTERNATIVES TO TRADITIONAL
REINSURANCE
• Many insurers and reinsurers are now using the capital markets as an alternative
to traditional reinsurance. The financial capacity of the property and casualty
industry to pay catastrophic losses from hurricanes, earthquakes, and other
natural disasters is limited.
• Securitization of Risk
• There is an increasing use of the securitization of risk to obtain funds to pay for a
catastrophe loss. Securitization of risk means that an insurable risk is transferred
to the capital markets through the creation of a financial instrument, such as a
catastrophe bond, futures contract, options contract, or other financial
instrument. These instruments are also called risk-linked securities that transfer
insurance-related risks to the capital markets.
• Catastrophe bonds are made available to institutional investors in the capital
markets through an entity called a special purpose reinsurance vehicle (SPRV),
which is specifically established for that purpose.

22. INVESTMENTS
• The investment function is extremely important in the overall
operations of insurance companies. Because premiums are paid in
advance, they can be invested until needed to pay claims and
expenses.
• A life insurer divides its assets into two accounts.
• The assets in the general account support the contractual obligations
for guaranteed fixed dollar benefits, such as life insurance death
benefits.
• The assets in the separate account support the liabilities for
investment-risk products, such as variable annuities, variable life
insurance, and private pension benefits.

23. Distribution of Assets of Life Insurance

24. Principles followed for Investment
• Life insurance investments have an important economic and social
impact on the nation for several reasons.
• First, safety of principal is a primary consideration. Consequently, as
stated earlier, the majority of investments in the general account are
in bonds.
• Second, investment income is extremely important in reducing the
cost of insurance to policyholders because the premiums can be
invested and earn interest.
• Finally, life insurance premiums also are an important source of
capital funds to the economy.

25. Property and Casualty Insurance
Investments
• Most assets are invested in securities that can be quickly sold to pay
claims if a major catastrophe occurs—primarily in high-quality bonds,
stocks, and cash rather than real estate (see Exhibit 6.3 ).
• First, in contrast to life insurance, property insurance contracts
generally are short-term in nature. The policy period in most
contracts is one year or less, and property claims are usually settled
quickly. For these reasons, the investment objective of liquidity is
extremely important.
• Second, investment income is extremely important in offsetting
unfavorable property and casualty underwriting experience .