REVIEW NOTES: OVERVIEW OF THE INSURANCE INDUSTRY
Benefits and the Costs of Insurance to Society
- Loss control refers to actions taken and strategies implemented to reduce the frequency or severity of a loss. Insurance companies commonly incentivize their customers to implement loss controls by offering discounts that reduce insurance premiums.
- Insurers make loss payments to insureds when a loss is experienced to satisfy their contractual obligation to indemnify insureds against covered losses.
- Insurance may be used to protect large purchases of real and personal property.
Risk Management Key Terms
- Risk is the chance or uncertainty that a loss will occur.
- A pure risk is the only type of risk considered to be potentially insurable. To be considered a “pure risk,” the risk must only present the chance for loss.
- A speculative risk is any kind of risk that could result in either loss or gain and is typically not insurable.
- Loss exposure is the possibility of financial loss due to risk. The severity of an individual or entity’s loss exposure increases or decreases depending on their habits, location, and many other characteristics.
- Property loss exposure is the possibility of loss to the value or usability of property or a physical, tangible asset.
- Liability loss exposure is loss resulting from injuries or damages the insured causes to another party as a result of negligence, requiring the insured to compensate the other party for the injuries or damages caused.
- Loss is any injury or damage suffered by the insured because of an accident or event covered under an insurance policy.
- A peril is an event, situation, or circumstance that results in property damage or loss.
- A hazard is a condition, circumstance, or situation that increases the chance of a loss occurring or increases the severity of a loss.
- Insuranceis a means of managing financial risk by transferring the risk from one party to another through a legal contract or other arrangement.
- Insurance spreads the risk of loss from one person to a large number of persons through the pooling of premiums collected from the group as a whole.
- Indemnity refers to compensation that is paid or promised to be paid to a party for losses that have already occurred or may occur in the future.
- The principle of indemnity states that the purpose of an insurance contract is to make a policy whole again after a loss is experienced and that an insured may not profit from a loss.
Methods of Handling Risk/Risk Management Techniques
- Risk retention is when the person, business owner, or professional decides to retain part or all of an exposure to a given risk. This means that they will be fully responsible for any losses that occur regarding the retained risk.
- Risk sharing (also known as risk distribution) occurs when multiple entities form a group for the purpose of creating a plan where each group member pays into a fund to be used for anticipated future losses that any group member may experience.
- Risk avoidance is when the person, business owner, or professional consciously seeks to avoid or eliminate loss exposure to a specific type of risk.
- Risk reduction is when the person, business owner, or professional is making a conscious effort to minimize the frequency or the severity of losses.
- Risk transfer is the strategy of shifting the risk of potential losses to another party, typically through a formal contract and in exchange for some form of compensation. Insurance is the most common risk transfer method used today.
Elements of Insurable Risks/Ideally Insurable Risk
- Generally, the following elements must be present for a risk to be considered insurable:
- Losses must be definite and definable;
- Loss must be great enough to create a hardship for the insured;
- Losses must not be completely catastrophic in nature (war or nuclear attack, for instance);
- Losses must be accidental; and
- The insurance company must be able to calculate the chance of a loss occurring.
Adverse Selection
- In general terms, adverse selection refers to situations where one party entering into a contract has more knowledge about information relevant to the contract than the other.
- Whether through unintentional omission, intentional misrepresentation, or concealment of information, sometimes an applicant will not provide important information regarding their level of risk. This can lead to an insurer offering a policy to the applicant for a premium that does not accurately reflect the level of risk the applicant truly represents as a below-average risk.
- Insurance underwriting is intended to avoid adverse selection and make certain insurers are fairly compensated for the actual risks they accept exposure to when issuing insurance contracts.
Law of Large Numbers/ Spread of Risk
- The Law of Large Numbers is a probability theory stating that as a sample size grows larger, the average of the sample results will begin to approach the expected value more closely.
- The Law of Large Numbers also applies to insurance. As an insurance company increases the number of policyholders it has issued policies to, its estimated losses in the form of claims payments become closer to what is estimated or expected.
Reinsurance
- The purpose of reinsurance is to limit the liability of the original insurer, allowing the original insurer to assume more risk than they could handle otherwise. This could be done for the purpose of transferring the risk of catastrophically large losses that would lead to the company’s bankruptcy or to give the original insurer some breathing room and allow it to expand its business.
Rate Filing and Forms Services
- The Insurance Services Offices (ISO)is an advisory organization responsible for developing standard policy forms, coverages, structure, provisions, agreements, clauses, deductibles, definitions, conditions, exclusions, endorsements, and other conventions for use by the insurance industry.
- ISO standards and forms are the most common found in use throughout the industry.
- The American Association of Insurance Services (AAIS) is an organization responsible for collecting statistical data, distributing rating information, developing standard policy forms, and filing information with state regulators on behalf of insurers that purchase its services.
- The Surety and Fidelity Association of America (SFAA) is a trade association working with all segments of the surety and fidelity bonding industry, acting as a resource to promote and maintain outreach to the public as well as industry and government regulators.
- The National Council on Compensation Insurance (NCCI) provides comprehensive data, statistics, and solutions for the workers’ compensation industry.
Federal Regulation
- The Gramm-Leach-Bliley (GLB) Act of 1999, also known as the Financial Modernization Act of 1999, dictates how financial institutions such as banks and insurance companies are to handle the private information of consumers.
- Under the GLB Act, financial institutions are also required to deliver privacy policy notices that detail the institution's information-sharing practices and inform consumers of their rights.
- The Fair Credit Reporting Act (FCRA)is federal legislation created for the purpose of promoting the accuracy, fairness, and privacy of consumer information that is held and provided by credit reporting agencies.
- The FCRA places the following responsibilities upon companies that use credit information:Users can only obtain consumer reports for permissible purposes under the FCRA;Users must notify the consumer when an adverse action is taken on the basis of such reports (such as a higher insurance rate); andUsers must identify the company that provided the report, so that the accuracy and completeness of the report may be verified or contested by the consumer.
- Because insurers also provide information back to credit reporting agencies, they must also:Provide complete and accurate information to the credit reporting agencies;Investigate consumer disputes received from credit reporting agencies;Correct, delete, or verify information within 30 days of receipt of a dispute; andInform consumers about negative information which is in the process of or has already been placed on a consumer's credit report within one month.
- The Telemarketing Sales Rule, as defined by the FTC, requires telemarketers to make specific disclosures of material information, prohibits misrepresentations, sets limits on the times telemarketers may call consumers, prohibits calls to a consumer who has asked not to be called, and sets payment restrictions for the sale of certain goods and services.
- The Controlling the Assault of Non-Solicited Pornography and Marketing (CAN-SPAM) Act of 2003established the United States' first national standards for the sending of commercial emails. The most relevant section of the law involves rules surrounding the sending behavior of a company that sends a commercial email:
- A message cannot be sent without an unsubscribe option;
- A message cannot contain a false header;
- A message should contain at least one sentence;
- A message cannot be null; and
- An unsubscribe option should be below the message.
- The Terrorism Risk Insurance Act (TRIA) was initially enacted as a temporary three-year program to calm insurance markets through the creation of a government reinsurance program that would share in terrorism-related losses. The TRIA will pay certain claims in the event of a loss due to a certified act of terrorism.
- The Violent Crime Control and Law Enforcement Act of 1994 made it illegal for any individual convicted of a crime involving dishonesty, breach of trust, or other related crimes to work in the insurance industry.
