Chapter Four
Insurance Company
Operations
Insurance Company Operations
• Rate making
• Underwriting
• Production
• Claim settlement
• Reinsurance
• Investments
Rate making
• Rate making refers to the pricing of
insurance
– Total premiums charged must be adequate
for paying all claims and expenses during
the policy period
– Rates and premiums are determined by an
actuary, using the company’s past loss
experience and industry statistics
Underwriting
• Underwriting refers to the process of selecting,
classifying, and pricing applicants for insurance
– The objective is to produce a profitable book of business
• A statement of underwriting policy establishes
policies that are consistent with the company’s
objectives, such as
– Acceptable classes of business
– Amounts of insurance that can be written
• A line underwriter makes daily decisions concerning
the acceptance or rejection of business
• There are three important principles of
underwriting:
– The underwriter must select prospective insureds
according to the company’s underwriting
standards
– Underwriting should achieve a proper balance
within each rate classification
– Underwriting should maintain equity among the
policyholders
• Underwriting starts with the agent in the field
• Information for underwriting comes from:
– The application
– The agent’s report
– An inspection report
– Physical inspection
– A physical examination and attending physician’s report
• After reviewing the information, the underwriter
can:
– Accept the application
– Accept the application subject to restrictions or
modifications
– Reject the application
Production
• Production refers to the sales and marketing
activities of insurers
– Agents are often referred to as producers
– Life insurers have an agency or sales department
– Property and liability insurers have marketing
departments
• An agent should be a competent professional
with a high degree of technical knowledge in a
particular area of insurance and who also
places the needs of his or her clients first
Claim settlement
• The objectives of claims settlement include:
– Verification of a covered loss
– Fair and prompt payment of claims
– Personal assistance to the insured
• Some laws prohibit unfair claims practices,
such as:
– Refusing to pay claims without conducting a
reasonable investigation
– Not attempting to provide prompt, fair, and
equitable settlements
– Offering lower settlements to compel insureds to
institute lawsuits to recover amounts due
The claim process begins with a notice of
loss
• Next, the claim is investigated
– A claims adjustor determines if a covered
loss has occurred, and the amount of the
loss
• The adjustor may require a proof of loss
before the claim is paid
• The adjustor decides if the claim should
be paid or denied
– Policy provisions address how disputes may
be resolved
Reinsurance
• Reinsurance is an arrangement by which the
primary insurer that initially writes the
insurance transfers to another insurer part or
all of the potential losses associated with such
insurance
– The primary insurer is the ceding company
– The insurer that accepts the insurance from the
ceding company is the reinsurer
– The retention limit is the amount of insurance
retained by the ceding company
– The amount of insurance ceded to the reinsurer is
known as a cession
Reinsurance is used to:
– Increase underwriting capacity
– Stabilize profits
– Reduce the unearned premium reserve
• The unearned premium reserve represents the
unearned portion of gross premiums on all outstanding
policies at the time of valuation
– Provide protection against a catastrophic loss
– Retire from business or from a line of insurance or
territory
– Obtain underwriting advice on a line for which the
insurer has little experience
• There are two principal forms of 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 means the primary insurer has
agreed to cede insurance to the reinsurer, and the
reinsurer has agreed to accept the business
• Under a quota-share treaty, the ceding insurer and the
reinsurer agree to share premiums and losses based on
some proportion
• 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
• An excess-of-loss treaty is designed for catastrophic
protection
• A reinsurance pool is an organization of insurers that
underwrites insurance on a joint basis
Investments
• Because premiums are paid in advance, they can be
invested until needed to pay claims and expenses
• Investment income is extremely important in
reducing the cost of insurance to policyowners and
offsetting unfavorable underwriting experience
• Life insurance contracts are long-term; thus, safety
of principal is a primary consideration
• In contrast to life insurance, property insurance
contracts are short-term in nature, and claim
payments can vary widely depending on catastrophic
losses, inflation, medical costs, etc
Other Insurance Company Functions
• The electronic data processing area maintains
information on premiums, claims, loss ratios,
investments, and underwriting results
• The accounting department prepares financial
statements and develops budgets
• In the legal department, attorneys are used in
advanced underwriting and estate planning
• Property and liability insurers provide
numerous loss control services
End of the Chapter