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Webinar Speakers Presenter – Dr. Conrad Ciccotello Associate Professor and Executive Director of the Huebner Foundation Georgia State University 2
Insurance Basics Insurance provides financial security, and it does so based on principles that ensure that all covered losses will be indemnified. 3
Icebreaker: Issues associated with which type of insurance have the greatest impact on your constituents? a. Healthcare insurance b. Homeowners insurance c. Workers compensation d. Auto insurance 4
Motivating Theme: Given the explosion of data, have our lives become any safer? How does this data impact insurers and the insured? 5
What Is Insurance? A means of treating risk by transferring the financial consequences of a loss to an insurance company A means of protecting financial interests when losses occur 6
How Insurance Benefits Insureds • Pays insured’s covered losses (indemnifies) • Reduces uncertainty • Encourages efficient use of resources • Helps reduce and prevent losses 7
How Insurance Benefits Business and Society Supports credit Satisfies legal requirements Satisfies business requirements Provides sources of investment funds Reduces social burdens 8
Costs of Insurance to Insureds Premiums Opportunity costs 9
Costs Associated With Insurance Operating costs – including profit Fraudulent and inflated claims (moral hazards) Claims caused by carelessness or indifference (morale hazards) Frivolous lawsuits that are settled as nuisance claims 10
Fundamental Insurance Principles These principles help ensure that the insurance mechanism is actuarially sound: Indemnification Law of large numbers Insurable interest 11
The Principle of Indemnity Insurance should not benefit an insured beyond the value of a loss. Violations of this principle can increase the frequency and severity of losses. 12
The Law of Large Numbers The mathematical basis of insurance. Insurance coverage provided is large relative to the premium paid. What would be an unexpected loss for an individual becomes an expected loss in aggregate for an insurer. 13
Insurable Interest Means that the insured must suffer financially should a loss occur Supports the principle of indemnity—one cannot gain from an insurable loss 14
Economic Issues Related to Insurance Pricing An insurance policy is priced to reflect the loss exposures the policy covers while allowing for expenses, profit, and contingencies. 15
What do you think? What issues affect insurance market pricing? 16
Key Issues in Pricing Adverse selection Moral and morale hazard Equity: actuarial and social Timing 17
Adverse Selection Adverse selection increases insurers’ costs. Those with the greatest probability of loss are most likely to buy insurance. They tend to have more losses and higher claims than insureds with an average loss probability. 18
Avoiding Adverse Selection: Data Collection Insurers need information about insureds to set prices that reflect risks. Data collection raises privacy concerns: What information is relevant? How much information is too much? 19
Moral and Morale Hazard Behaviors that increase loss frequency and/or severity Moral—dishonesty Morale—carelessness or indifference Common in auto, products liability, and general liability insurance Can be discouraged with policy risk-sharing features (deductibles) 20
Actuarial Equity Versus Social Equity Fair discrimination—equitable premium for each insured—is essential to insurance pricing. State insurance laws prohibit unfair discrimination in insurance pricing. Opinions vary about what is fair and unfair. 21
Actuarial Equity Premium is directly proportional to each insured’s loss exposures. Cost-based pricing—identifies every variable unique to each insured. Use of some variables may be prohibited by state law. 22
Social Equity Social equity involves two concepts: Pricing should relate to ability to pay. Factors beyond an insured’s control should not affect premium. 23
Timing Most losses are recognized, valued, and settled quickly (short-tail losses). Some losses take a long time to manifest, value, and settle (long-tail losses). The longer the tail, the greater the uncertainty in expected losses. 24
What Is an Ideally Insurable Risk? An ideally insurable risk has six characteristics. Insurers use these characteristics to decide which risks to insure. Insurers select only those risks that meet most of the criteria. 25
Characteristics of Insurable Risks A large quantity of similar people or objects may be subject to a loss. Loss would be fortuitous. Loss would not be catastrophic to the insurer. 26
Characteristics of Insurable Risks Time, location, and extent of a loss can be determined. The amount of an expected loss can be predicted. Covering the expected loss is economically feasible for the insurer. 27
Characteristics of the Insurance Product Insurance products share several characteristics that distinguish them from other types of consumer products. 28
Intangibility The insurance product Lacks physical characteristics Is more than the policy on paper Represents a promise (to pay in the event of loss) 29
What do you think? How does the complexity of the insurance product get in the way of consumer satisfaction? 30
Complexity and Legal Status An insurance policy contains complicated terms and concepts. An insurance policy is a legal contract. Insureds and claimants may hire attorneys to resolve or clarify issues. Some issues may involve courts, regulators, or legislators. 31
Insurance Circumstances Product benefits become most apparent at time of loss. Insureds or claimants are typically facing unpleasant circumstances. Heightened emotions complicate the customer service experience 32
Insurance as a Risk Management Technique Loss exposures with serious financial consequences typically require the purchase of insurance. 33
What do you think? What are some typical techniques people or companies use to manage risk? 34
Risk Management Techniques Identify Analyze Mitigate Prevention Reduction Retain or Transfer 35
Retaining Loss Exposures Some loss exposures have the potential to cause financial ruin. Others present minimal potential costs and can be safety retained. 36
Transferring Risk Some loss exposures are most effectively managed by transfer. The financial consequences of loss are borne by another party. Insurance is a common risk transfer technique. 37
Why Insurance Operations Are Regulated The fundamental purpose of insurance regulation is to protect the public as consumers and policyholders. 38
Consumer Protection Regulating and standardizing insurance policies and products Controlling market conduct and preventing unfair trade practices Ensuring that insurance is available and affordable 39
Insurer Solvency Regulation Ensure an insurer’s claim-paying ability Protect the public interest Safeguard insurer-held funds 40
Summary: Insurance Principles Insurance is A risk management technique that involves transfer of risk to an insurance company A complex legal contract Affected by adverse selection, moral and morale hazard, actuarial and social equity, and timing Regulated to protect consumers and policyholders 41
Insurance Fundamentals for Policymakers For more information, please contact: The Griffith Insurance Education Foundation 720 Providence Road, Suite 100 Malvern, PA 19355 Phone: 855-288-7743 Email: PPE@griffithfoundation.org 42
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