Overview of Risk and Insurance Fall 2013

Contents 9/1/2015Risk Management Introduction2  Insurance Industry Overview - Size and Performance  Definition Insurance and Risk  Risk Management and Insurance  Types of Insurance Property Insurance Liability Insurance Life Insurance Health Financial Planning – Disability and Retirement funding mechanisms  General Insurance Concepts  Careers in Insurance  Hot Topics  Conclusions

Insurance Industry Overview  Insurance Information Institute   World insurance premiums totaled $4. 6 trillion in 2012  III Fact Book:  In 2007 there were:  2,723 U.S. property/casualty insurance companies with $1.3 trillion in assets  1,190 U.S. life/health insurance companies with $3 trillion in assets  The insurance industries employed over 2.3 million people in 2008  Catastrophe losses were  $45 billion in 2012 (majority from Sandy)  $6.7 billion in 2007  $25.6 billion in 2008 (2 nd highest year on record)   The P/C industry had an average annual rate of return of.5 percent in 2008, down from 12.4 percent in 2007  Forty banks have failed since the financial crisis began, yet no insurance claim has gone unpaid because of the crisis. 9/1/ Risk Management Introduction

Profitability of the Insurance Industry  2012  9/1/2015Risk Management Introduction4

Insurance 9/1/2015Risk Management Introduction5  not just transfer of risk;  a device for transferring, sharing, and reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable.

Key Term 9/1/2015Risk Management Introduction6  Risk - not just uncertainty of financial loss; - possibility of deviation between actual and expected outcomes - measured in units called “exposures”

How Insurance Reduces Risk (assume 1/100 Probability of Loss)  #Exposures ExpectedLossActual LossDeviation 1?1?  %  1, %  10, %  100,0001,0001,001.1% 9/1/20157Risk Management Introduction

What assumptions are required to make this situation work?  Assuming the exposures are houses….. 9/1/2015Risk Management Introduction8

In Homeowners Insurance  Houses must be similar value  Houses must be geographically disbursed  Houses must be construction  Houses must have similar probability of loss  Must be able to value the loss  ……….. 9/1/2015Risk Management Introduction9

So, what are the requisites of an insurable risk?  With what type of people or exposures do we want to share losses? 9/1/2015Risk Management Introduction10

Requisites for an Insurable Risk  Large Number of Exposure Units  Accidental and Unintentional Loss  Determinable and measurable loss  No catastrophic loss  Calculable Chance of Loss  Economically feasible premium 9/1/2015Risk Management Introduction11

Is the Risk of Collision Insurable? Requisite:  Large #s?  Accidental/Unintentional?  Measurable?  Potentially catastrophic?  Calculable chance  Affordable premium Requisite Met?  Yes  Yes, except for arson to car  Yes, ACV  Yes, not all insured vehicles should have collision at same time  Yes, chance can be statistically determined  Yes, rate per car value is low 9/1/2015Risk Management Introduction12

Is the Risk of Unemployment Insurable?  Large #s?  Accidental/Unintentional?  Measurable?  Potentially catastrophic?  Calculable chance  Affordable premium  Possibly  No, may be voluntary or involuntary  No, Measurement of loss is difficult/ambiguous  No, recession/depression could be catastrophic  No, too many types of unemployment  No, adverse selection/ moral hazard problem 9/1/2015Risk Management Introduction13

Risk Management 9/1/2015Risk Management Introduction14  The process of identifying and analyzing all possible loss exposures, selecting a method of handling the exposure, and monitoring the method and exposure regularly.  Everyone is exposed to risk management!

“Sub-prime underwriting” How feasible would it be to insure:  Only those over age 75  No serious underwriting requirements  Charge “insured” no premium (retroactively taken out of benefits)  Assign benefits to third party automatically 9/1/2015Risk Management Introduction15

Risk Management and Insurance Connection? 9/1/2015Risk Management Introduction16  Risk Management techniques:  risk avoidance  risk control  hazard or loss reduction  risk retention  risk transfer  Hedging and sub-contracting  Insurance

Property Insurance 9/1/2015Risk Management Introduction17  Property insurance – a type of insurance designed to pay for damage or loss to property caused by direct perils  Automobile vs. Homeowners  Personal vs. Commercial Lines  Commercial Property

Liability Insurance 9/1/2015Risk Management Introduction18  Coverage for responsibility to third parties  Students are often most interested in automobile claims:  You let your roommate drive your car and she causes an accident; who is responsible for ensuing damages?  You are stopped at a red-light and someone hits you, causing the tire tool in the back of your pickup truck to fly out and hit a pedestrian. Could you be held responsible?  You let your friend leave your apartment after a party you gave in which alcohol was served. If your friend has an accident, who is responsible?

Life Insurance 9/1/2015Risk Management Introduction19  Significance of the Life Insurance Industry  Life insurers have nearly $4 trillion invested in the U.S. economy--including $1.2 trillion in new net investments between 2002 and  To create an estate  To replace funds that the insured would have been able to accumulate had he/she lived  Purpose of life insurance?  Preservation of family’s economic security  Moral obligation to provide protection  Financial needs  Key person indemnification  Credit enhancement  Business continuation  Employee benefit plans  Term vs. Whole Life?

Uses of Life Insurance 9/1/2015Risk Management Introduction20  Uses of Term  Temporary need for protection  Lack of finances for permanent insurance  Danger of relying solely on group term insurance  Uses of Whole Life  A way to provide death benefit protection for the entire span of life  Enables insured to build retirement fund  Allows “permanent” protection  Accounts for the great bulk of total assets of life insurers and the economy

Present Value Example 9/1/2015Risk Management Introduction21  How much life insurance does it take to provide dependents $40,000 per year for 30 years? Assume 7% interest could be earned during this time.  Is the answer $40,000 times 30? [$1,200,000]  No! One must consider the Time Value of Money benefit.  $496,362

Health Insurance Facts 9/1/2015Risk Management Introduction22  Morbidity rates higher than mortality rates  At age 40, there is a 50% chance of becoming disabled while working  Health care costs average $7,868/year per person in the U.S. (Kaiser Foundation, October 08)  The share of the economy (GDP) devoted to health care spending has gone from 7.2% in 1970 to 16.6% in 2008;  Costs have risen 700% in last 20 years  85% of people in the U.S. have some type of health insurance; the 15% uninsured are typically self-employed or work for someone self-employed  The indigent population typically have health insurance through a government-sponsored plan like Medicaid or a state managed plan  90% of private health insurance is through a group plan

Health Insurance History 9/1/2015Risk Management Introduction23  Initially health insurance was only short-term disability income coverage  became obsolete during depression  In 1929, first group formed agreement with hospital (teachers/hospital in Dallas)  would pay monthly fee for hospital costs if needed; members only  First Blue Cross arrangement  Physicians later formed Blue Shield plans

Health Insurance History (cont.) 9/1/2015Risk Management Introduction24  Medical expense coverages began in 1940s  Premiums became tax deductible for employers  Group policies were the most popular conduit as employers needed to attract employees  Often included life and disability ins.  Experience rating began through idea that different groups incurred different types/amounts of losses  By the 1950s, more medical expense policies than BC/BS policies

Typical Types of Health Plans 9/1/2015Risk Management Introduction25  PPO  providers service members and non-members  smaller co-pay/deductible if insured selects provider on list  insured may go to provider of choice  HMO  Cost containment lead to the development of HMOs  “insurance company” actually provides medical services  managed care  focuses on preventive care and treatment  POS  Hybrid between HMO and PPO  The best of both worlds?

Disability Income Insurance 9/1/2015Risk Management Introduction26  Insure one’s income  Payment made typically as frequent as paycheck was received  Elimination period serves as deductible  Static costs therefore more predictable

Social Security 9/1/2015Risk Management Introduction27  Old Age, Survivors, and Disability Insurance Act of 1935  SS Benefits  Retirement, survivor, and disability  Medicare - health and hospitalization exp.  Tax  6.2% SS, up to $113,700 for 2013  1.45% Medicare; no limit  Matched by employer  15.3 percent of all income under $113,700 is paid into the social security system

Workers Compensation 9/1/2015Risk Management Introduction28  Benefits prescribed by different laws in each state  Typically includes  Medical care benefits  Disability income  Death benefits  Rehabilitation benefits  Still necessary?

Financial Planning 9/1/2015Risk Management Introduction29  If you were to be unable to work after today, how much money would your family need to replace your income?  If you retired today, how much money would you like to have each month to live on for rest of your life?

Basic Insurance Terminology 9/1/2015Risk Management Introduction30  Indemnification  Very important to having many insurance products succeed!  Policies enforcing indemnity: property, business income and extra expense, and liability  Policies not contracts of indemnity: life insurance

Exclusions in Insurance 9/1/2015Risk Management Introduction31  Why do we have or need exclusions?  May result in catastrophic loss  Should be covered elsewhere  Not fortuitous (unexpected and unforeseen)  To control moral or morale hazards  To eliminate duplicate coverage  To eliminate coverage not needed by the average insured

How Indemnity is Enforced 9/1/2015Risk Management Introduction32  Insurable Interest  Subrogation  ACV Loss Measurement (versus valued/face amount contracts)  Other Insurance Clause  Pro Rata Clause  Other Restrictive Clauses

Insurance Related Laws 9/1/2015Risk Management Introduction33  COBRA  allows portability/continuation of benefits for specified reasons  18 or 36 months  HIPAA (Health Ins. Portability and Accountability Act – 1996)  requires new group insurer to accept new member even with preexisting

Current Hot Insurance Topics 9/1/2015Risk Management Introduction34  Health Care Reform  Financial Crisis and Bankruptcies  Social Security Funding  Long-Term Care Funding  STOLI (Stranger-originated life insurance) and other Senior issues  Federal Charters for Insurers  Tort Reform  Ponzi Schemes

Examples of Careers in Insurance 9/1/2015Risk Management Introduction35  Underwriters  Claims Adjusters  Actuaries  Agents  Brokers  Reinsurance  Insurance Law  Financial Services  Estate Planning  Employee Benefit Management

For Further Information… 9/1/2015Risk Management Introduction36  Insurance Information Institute   American Council of Life Insurers   Social Security Administration 