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Agenda
Property and Casualty Insurers
Life Insurance Companies
Ratemaking in Property and Casualty Insurance
Ratemaking in Life Insurance
Chapter 7
Financial Operations of
Insurers
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Financial Statements of Property and Casualty Insurers
A balance sheet is a summary of what a company owns (assets) and what it owes (liabilities), and the difference between total assets and total liabilities (owners’ equity)
Total Assets = Total Liabilities + Owners’ Equity
Exhibit 7.1 ABC Insurance Company
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Financial Statements of Property and Casualty Insurers
The primary assets for an insurance company are financial assets
Insurers’ liabilities include required reserves
A loss reserve is an estimated amount for: Claims reported and adjusted, but not yet paid Claims reported and filed, but not yet adjusted Claims incurred but not yet reported to the
company
Financial Statements of Property and Casualty Insurers
Case reserves are loss reserves that are established for each individual claim
Methods for determining case reserves include: The judgment method: a claim reserve is established for
each individual claim
The average value method: an average value is assigned
to each claim
The tabular method: loss reserves are determined for
certain claims for which the amounts paid depend on data derived from mortality, morbidity, and remarriage tables
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Financial Statements of Property and Casualty Insurers
The loss ratio method establishes aggregate
loss reserves for a specific coverage line A formula based on the expected loss ratio is
used to estimate the loss reserve
The 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 reported
Financial Statements of Property and Casualty Insurers
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The unearned premium reserve is a liability item that represents the unearned portion of gross premiums on all outstanding policies at the time of valuation
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Its purpose is to pay for losses that occur during the policy period
It is also needed so that refunds can be paid to policyholders that cancel their coverage
It also serves as the basis for determining the amount that must be paid to a reinsurer for carrying reinsured polices
The annual pro rata method is one method of calculating the reserve
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Financial Statements of Property and Casualty Insurers
Policyholders’ surplus is the difference
between an insurance company’s assets
and liabilities
The stronger a company’s surplus position, the
greater is the security for its policyholders
The level of surplus is an important determinant of the amount of new business that an insurance
company can write
Financial Statements of Property and Casualty Insurers
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The income and expense statement summarizes revenues and expenses paid over a specified period of time
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The two principal sources of revenue for an insurance company are premiums and investment income
Earned premiums are those premiums for which the service for which the premiums were paid (insurance protection) has been rendered
Expenses include the cost of adjusting claims, paying the insured losses that occurred, commissions to agents, premium taxes, and general insurance expenses
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Exhibit 7.2 ABC Insurance Company
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Measuring Profit or Loss
The loss ratio is the ratio of incurred losses and loss adjustment expenses to premiums earned
The expense ratio is equal to the company’s underwriting expenses divided by written premiums
The combined ratio is the sum of the loss ratio and the expense ratio.
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The investment income ratio compares net investment income to earned premiums
The overall operating ratio is equal to the combined ratio minus the investment income ratio
Financial Statements of Life Insurers
The balance sheet
The assets of a life insurer have a longer
duration, on average, than those of property and casualty insurers
Because 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 annuities
Measuring Profit or Loss
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Policy reserves are a liability item on the balance sheet that must be offset by assets equal to that amount
Financial Statements of Life Insurers
State laws specify the minimum basis for calculating policy reserves
The reserve for amounts held on deposit is a liability that represents funds that are owed to policyholders and to beneficiaries
The asset valuation reserve is a statutory account designed to absorb asset value fluctuations not caused by changing interest rates
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Financial Statements of Life Insurers
Policyholders’ surplus is less volatile in the life insurance industry than in the property and casualty insurance industry
Benefit 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 taxes
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Measuring the Performance of Life Insurers
A number of measures can be used to
gauge the performance of life insurers Pre-tax or after-tax net income vs. total assets Rate of return on policyowners’ surplus
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Ratemaking in Property and Casualty Insurance
State Laws Require:
Rates should be adequate for paying all losses
and expenses
Rates should not be excessive, such that
policyholders are paying more than the actual value of their protection
Rates must not be unfairly discriminatory; exposures that are similar with respect to losses and expenses should not be charged significantly different rates
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Ratemaking in Property and Casualty Insurance
Business Rate-Making Objectives include:
Rates should be easy to understand
Rates should be stable over short periods of time
Rates should be responsive over time to changing loss exposures and changing economic conditions
The rating system should encourage loss control activities
Basic Ratemaking Definitions
A rate is the price per unit of insurance.
An exposure unit is the unit of measurement used in insurance pricing, e.g., a car-year
The pure premium is the portion of the rate needed to pay losses and loss adjustment expenses
Loading is the amount that must be added to the pure premium for other expenses, profit, and a margin for contingencies
The gross rate consists of the pure premium and a loading element
The gross premium paid by the insured consists of the gross rate multiplied by the number of exposure units
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Ratemaking in Property and Casualty Insurance
There 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 underwriter
Class, or manual rating means that exposures with similar characteristics are placed in the same underwriting class, and each is charged the same rate
Ratemaking in Property and Casualty Insurance
Class 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 units
Under the loss ratio method, the actual loss ratio is compared with the expected loss ratio, and the rate is adjusted accordingly
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Ratemaking in Property and Casualty Insurance
Merit rating is a rating plan by which class
rates are adjusted upward or downward
based on individual loss experience
Under a schedule rating plan, each exposure is
individually rated
Under experience rating, the class or manual
rate is adjusted upward or downward based on past loss experience
Under a retrospective rating plan, the insured’s loss experience during the current policy period determines the actual premium paid for that period
Ratemaking in Life Insurance
Life insurance actuaries use a mortality table or individual company experience to determine the probability of death at each attained age
Expected future payments are discounted back to the start of the coverage period and summed to determine the net single premium or level installment premiums
The annual expected value of death claims equals the probability of death times the amount the insurer must pay if death occurs
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