Chapter 6

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

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

applicants for insurance
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

attain an underwriting profit
The second principle is to select prospective

insureds according to the company’s underwriting standards
The purpose of underwriting standards is to reduce adverse selection against the insurer
Adverse selection is the tendency of people with a higher-than-average chance of loss to seek insurance at standard rates. If not controlled by underwriting, this will result in higher-than-expected loss levels.
Underwriting should also maintain equity among the policyholders
One group of policyholders should not unduly subsidize another group

comes from:
The application
The agent’s report
An inspection report
Physical inspection
A physical examination

and attending physician’s report
MIB report
After reviewing the information, the underwriter can:
Accept the application
Accept the application subject to restrictions or modifications
Reject the application

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

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 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

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

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

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
Facultative reinsurance is often used when the primary insurer has an application for a large amount of insurance
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

losses:
Under the Pro rata method, where the ceding company and

reinsurer agree to share losses and premiums based on some proportion
Under the Excess method, where the reinsurer pays only when covered losses exceed aa certain level
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

to traditional reinsurance
Securitization of risk means that an insurable risk

is transferred to the capital markets through the creation of a financial instrument, such as a futures contract
Catastrophe bonds are corporate bonds that permit the issuer of the bond to skip or reduce the interest payments if a catastrophic loss occurs
Catastrophe bonds are growing in importance and are now considered by many to be a standard supplement to traditional reinsurance.

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

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