Role of Insurance Companies:Life insurance and saving

<< Role of Insurance Companies:Indemnification, Insurerâ€™s business model

Role of financial Institutions in Agriculture Sector:What is â€œRevolving Credit Schemeâ€? >>

Management of Financial Institutions - MGT 604

Lecture # 36

Role of Insurance Companies

Types of insurance

Any risk that can be quantified can potentially be insured. Specific kinds of risk that may

give rise to claims are known as "perils". An insurance policy will set out in detail which

perils are covered by the policy and which is not.

Below is a (non-exhaustive) list of the many different types of insurance that exist. A single

policy may cover risks in one or more of the categories set forth below. For example, auto

insurance would typically cover both property risk (covering the risk of theft or damage to

the car) and liability risk (covering legal claims from causing an accident). A homeowner's

insurance policy in the U.S. typically includes property insurance covering damage to the

home and the owner's belongings, liability insurance covering certain legal claims against

the owner, and even a small amount of health insurance for medical expenses of guests who

are injured on the owner's property.

Automobile insurance, known in the UK as motor insurance, is probably the most

common form of insurance and may cover both legal liability claims against the

driver and loss of or damage to the insured's vehicle itself. Throughout most of the

United States an auto insurance policy is required to legally operate a motor vehicle

on public roads. In some jurisdictions, bodily injury compensation for automobile

accident victims has been changed to a no-fault system, which reduces or eliminates

the ability to sue for compensation but provides automatic eligibility for benefits.

Credit card companies insure against damage on rented cars.

Aviation insurance insures against hull, spares, deductible, hull war and liability

risks.

Boiler insurance (also known as boiler and machinery insurance or equipment

breakdown insurance) insures against accidental physical damage to equipment or

machinery.

Builder's risk insurance insures against the risk of physical loss or damage to

property during construction. Builder's risk insurance is typically written on an "all

risk" basis covering damage due to any cause (including the negligence of the

insured) not otherwise expressly excluded.

Business insurance can be any kind of insurance that protects businesses against

risks. Some principal subtypes of business insurance are (a) the various kinds of

professional liability insurance, also called professional indemnity insurance, which

are discussed below under that name; and (b) the business owners policy (BOP),

which bundles into one policy many of the kinds of coverage that a business owner

needs, in a way analogous to how homeowners insurance bundles the coverages that

a homeowner needs.[7]

Casualty insurance insures against accidents, not necessarily tied to any specific

property.

Credit insurance repays some or all of a loan back when certain things happen to the

borrower such as unemployment, disability, or death. Mortgage insurance (which

see below) is a form of credit insurance, although the name credit insurance more

often is used to refer to policies that cover other kinds of debt.

Crime insurance insures the policyholder against losses arising from the criminal

acts of third parties. For example, a company can obtain crime insurance to cover

losses arising from theft or embezzlement.

130

Management of Financial Institutions - MGT 604

Crop insurance "Farmers use crop insurance to reduce or manage various risks

associated with growing crops. Such risks include crop loss or damage caused by

weather, hail, drought, frost damage, insects, or disease, for instance."[8]

Defense Base Act Workers' compensation or DBA Insurance insurance provides

coverage for civilian workers hired by the government to perform contracts outside

the US and Canada. DBA is required for all US citizens, US residents, US Green

Card holders, and all employees or subcontractors hired on overseas government

contracts. Depending on the country, Foreign Nationals must also be covered under

DBA. This coverage typically includes expenses related to medical treatment and

loss of wages, as well as disability and death benefits.

Directors and officers liability insurance protects an organization (usually a

corporation) from costs associated with litigation resulting from mistakes incurred

by directors and officers for which they are liable. In the industry, it is usually called

"D&O" for short.

Disability insurance policies provide financial support in the event the policyholder

is unable to work because of disabling illness or injury. It provides monthly support

to help pay such obligations as mortgages and credit cards.

o Total permanent disability insurance insurance provides benefits when a

person is permanently disabled and can no longer work in their profession,

often taken as an adjunct to life insurance.

Errors and omissions insurance: See "Professional liability insurance" under

"Liability insurance".

Expatriate insurance provides individuals and organizations operating outside of

their home country with protection for automobiles, property, health, liability and

business pursuits.

Financial loss insurance protects individuals and companies against various financial

risks. For example, a business might purchase cover to protect it from loss of sales if

a fire in a factory prevented it from carrying out its business for a time. Insurance

might also cover the failure of a creditor to pay money it owes to the insured. This

type of insurance is frequently referred to as "business interruption insurance."

Fidelity bonds and surety bonds are included in this category, although these

products provide a benefit to a third party (the "obligee") in the event the insured

party (usually referred to as the "obligor") fails to perform its obligations under a

contract with the obligee.

Health insurance policies will often cover the cost of private medical treatments if

the National Health Service in the UK (NHS) or other publicly-funded health

programs do not pay for them. It will often result in quicker health care where better

facilities are available.

Kidnap and ransom insurance

Home insurance or homeowners insurance:

Liability insurance is a very broad superset that covers legal claims against the

insured. Many types of insurance include an aspect of liability coverage. For

example, a homeowner's insurance policy will normally include liability coverage

which protects the insured in the event of a claim brought by someone who slips and

falls on the property; automobile insurance also includes an aspect of liability

insurance that indemnifies against the harm that a crashing car can cause to others'

lives, health, or property. The protection offered by a liability insurance policy is

twofold: a legal defense in the event of a lawsuit commenced against the

policyholder and indemnification (payment on behalf of the insured) with respect to

a settlement or court verdict. Liability policies typically cover only the negligence of

the insured, and will not apply to results of willful or intentional acts by the insured.

131

Management of Financial Institutions - MGT 604

Environmental liability insurance protects the insured from bodily injury,

property damage and cleanup costs as a result of the dispersal, release or

escape of pollutants.

o Professional liability insurance, also called professional indemnity insurance,

protects professional practitioners such as architects, lawyers, doctors, and

accountants against potential negligence claims made by their

patients/clients. Professional liability insurance may take on different names

depending on the profession. For example, professional liability insurance in

reference to the medical profession may be called malpractice insurance.

Notaries public may take out errors and omissions insurance (E&O). Other

potential E&O policyholders include, for example, real estate brokers, home

inspectors, appraisers, and website developers.

Life insurance provides a monetary benefit to a decedent's family or other

designated beneficiary, and may specifically provide for income to an insured

person's family, burial, funeral and other final expenses. Life insurance policies

often allow the option of having the proceeds paid to the beneficiary either in a lump

sum cash payment or an annuity.

o Annuities provide a stream of payments and are generally classified as

insurance because they are issued by insurance companies and regulated as

insurance and require the same kinds of actuarial and investment

management expertise that life insurance requires. Annuities and pensions

that pay a benefit for life are sometimes regarded as insurance against the

possibility that a retiree will outlive his or her financial resources. In that

sense, they are the complement of life insurance and, from an underwriting

perspective, are the mirror image of life insurance.

Locked funds insurance is a little-known hybrid insurance policy jointly issued by

governments and banks. It is used to protect public funds from tamper by

unauthorized parties. In special cases, a government may authorize its use in

protecting semi-private funds which are liable to tamper. The terms of this type of

insurance are usually very strict. Therefore it is used only in extreme cases where

maximum security of funds is required.

Marine insurance and marine cargo insurance cover the loss or damage of ships at

sea or on inland waterways, and of the cargo that may be on them. When the owner

of the cargo and the carrier are separate corporations, marine cargo insurance

typically compensates the owner of cargo for losses sustained from fire, shipwreck,

etc., but excludes losses that can be recovered from the carrier or the carrier's

insurance. Many marine insurance underwriters will include "time element"

coverage in such policies, which extends the indemnity to cover loss of profit and

other business expenses attributable to the delay caused by a covered loss.

Mortgage insurance insures the lender against default by the borrower.

National Insurance is the UK's version of social insurance (which see below).

No-fault insurance is a type of insurance policy (typically automobile insurance)

where insureds are indemnified by their own insurer regardless of fault in the

incident.

Nuclear incident insurance covers damages resulting from an incident involving

radioactive materials and is generally arranged at the national level. (For the United

States, see the Price-Anderson Nuclear Industries Indemnity Act.)

Pet insurance insures pets against accidents and illnesses - some companies cover

routine/wellness care and burial, as well.

Political risk insurance can be taken out by businesses with operations in countries

in which there is a risk that revolution or other political conditions will result in a

loss.

132

Management of Financial Institutions - MGT 604

Pollution Insurance. A first-party coverage for contamination of insured property

either by external or on-site sources. Coverage for liability to third parties arising

from contamination of air, water, or land due to the sudden and accidental release of

hazardous materials from the insured site. The policy usually covers the costs of

cleanup and may include coverage for releases from underground storage tanks.

Intentional acts are specifically excluded

Property insurance provides protection against risks to property, such as fire, theft or

weather damage. This includes specialized forms of insurance such as fire insurance,

flood insurance, earthquake insurance, home insurance, inland marine insurance or

boiler insurance.

Protected Self-Insurance is an alternative risk financing mechanism in which an

organisation retains the mathematically calculated cost of risk within the

organisation and transfers the catastrophic risk with specific and aggregate limits to

an Insurer so the maximum total cost of the program is known. A properly designed

and underwritten Protected Self-Insurance Program reduces and stabilizes the cost of

insurance and provides valuable risk management information.

Purchase insurance is aimed at providing protection on the products people

purchase. Purchase insurance can cover individual purchase protection, warranties,

guarantees, care plans and even mobile phone insurance. Such insurance is normally

very limited in the scope of problems that are covered by the policy.

Retrospectively Rated Insurance is a method of establishing a premium on large

commercial accounts. The final premium is based on the insured's actual loss

experience during the policy term, sometimes subject to a minimum and maximum

premium, with the final premium determined by a formula. Under this plan, the

current year's premium is based partially (or wholly) on the current year's losses,

although the premium adjustments may take months or years beyond the current

year's expiration date. The rating formula is guaranteed in the insurance contract.

Formula: retrospective premium = converted loss + basic premium × tax multiplier.

Numerous variations of this formula have been developed and are in use.

Self Insurance is protection against loss by setting aside one's own money. This can

be done on a mathematical basis by establishing a separate fund into which funds are

deposited on a periodic basis. Through self insurance it is possible to protect against

high-frequency low-severity losses. To do this through an insurance company would

mean having to pay a premium that includes loadings for the company's general

expenses, cost of putting the policy on the books, acquisition expenses, premium

taxes, and contingencies.

Social insurance can be many things to many people in many countries. But a

summary of its essence is that it is a collection of insurance coverages (including

components of life insurance, disability income insurance, unemployment insurance,

health insurance, and others), plus retirement savings, that mandates participation by

all citizens. By forcing everyone in society to be a policyholder and pay premiums,

it ensures that everyone can become a claimant when or if he/she needs to. Along

the way this inevitably becomes related to other concepts such as the justice system

and the welfare state. This is a large, complicated topic that engenders tremendous

debate, which can be further studied in the following articles (and others):

o Social welfare provision

o Social security

o Social safety net

o National Insurance

o Social Security (United States)

o Social Security debate (United States)

Stop-loss insurance provides protection against catastrophic or unpredictable losses.

It is purchased by organisations who do not want to assume 100% of the liability for

133

Management of Financial Institutions - MGT 604

losses arising from the plans. Under a stop-loss policy, the insurance company

becomes liable for losses that exceed certain limits called deductibles.

Surety Bond insurance is a three party insurance guaranteeing the performance of

the principal.

Terrorism insurance provides protection against any loss or damage caused by

terrorist activities.

Title insurance provides a guarantee that title to real property is vested in the

purchaser and/or mortgagee, free and clear of liens or encumbrances. It is usually

issued in conjunction with a search of the public records performed at the time of a

real estate transaction.

Travel insurance is an insurance cover taken by those who travel abroad, which

covers certain losses such as medical expenses, lost of personal belongings, travel

delay, personal liabilities, etc.

Volcano insurance is an insurance that covers volcano damage in Hawaii.

Workers' compensation insurance replaces all or part of a worker's wages lost and

accompanying medical expense incurred because of a job-related injury.

Types of insurance companies

Insurance companies may be classified as

Life insurance companies, which sell life insurance, annuities and pensions products.

Non-life or general insurance companies, which sell other types of insurance.

General insurance companies can be further divided into these sub categories.

Standard Lines

Excess Lines

In most countries, life and non-life insurers are subject to different regulatory regimes and

different tax and accounting rules. The main reason for the distinction between the two

types of company is that life, annuity, and pension business is very long-term in nature --

coverage for

life assurance or a pension can cover risks over many decades. By contrast, non-life

insurance cover usually covers a shorter period, such as one year.

In the United States, standard line insurance companies are your "main stream" insurers.

These are the companies that typically insure your auto, home or business. They use pattern

or "cookie-cutter" policies without variation from one person to the next. They usually have

lower premiums than excess lines and can sell directly to individuals. They are regulated by

state laws that can restrict the amount they can charge for insurance policies.

Excess line insurance companies (aka Excess and Surplus) typically insure risks not covered

by the standard lines market. They are broadly referred as being all insurance placed with

non-admitted insurers. Non-admitted insurers are not licensed in the states where the risks

are located. These companies have more flexibility and can react faster than standard

insurance companies because they don't have the same regulations as standard insurance

companies. State laws generally require insurance placed with surplus line agents and

brokers to not be available through standard licensed insurers.

134

Management of Financial Institutions - MGT 604

Insurance companies are generally classified as either mutual or stock companies. This is

more of a traditional distinction as true mutual companies are becoming rare. Mutual

companies are owned by the policyholders, while stockholders (who may or may not own

policies) own stock insurance companies. Other possible forms for an insurance company

include reciprocals, in which policyholders 'reciprocate' in sharing risks, and Lloyds

organizations.

Insurance companies are rated by various agencies such as A. M. Best. The ratings include

the company's financial strength, which measures its ability to pay claims. It also rates

financial instruments issued by the insurance company, such as bonds, notes, and

securitization products.

Reinsurance companies are insurance companies that sell policies to other insurance

companies, allowing them to reduce their risks and protect themselves from very large

losses. The reinsurance market is dominated by a few very large companies, with huge

reserves. A reinsurer may also be a direct writer of insurance risks as well.

Captive insurance companies may be defined as limited-purpose insurance companies

established with the specific objective of financing risks emanating from their parent group

or groups. This definition can sometimes be extended to include some of the risks of the

parent company's customers. In short, it is an in-house self-insurance vehicle. Captives may

take the form of a "pure" entity (which is a 100 percent subsidiary of the self-insured parent

company); of a "mutual" captive (which insures the collective risks of members of an

industry); and of an "association" captive (which self-insures individual risks of the

members of a professional, commercial or industrial association). Captives represent

commercial, economic and tax advantages to their sponsors because of the reductions in

costs they help create and for the ease of insurance risk management and the flexibility for

cash flows they generate. Additionally, they may provide coverage of risks which is neither

available nor offered in the traditional insurance market at reasonable prices.

The types of risk that a captive can underwrite for their parents include property damage,

public and products liability, professional indemnity, employee benefits, employers liability,

motor and medical aid expenses. The captive's exposure to such risks may be limited by the

use of reinsurance.

Captives are becoming an increasingly important component of the risk management and

risk financing strategy of their parent. This can be understood against the following

background:

heavy and increasing premium costs in almost every line of coverage;

difficulties in insuring certain types of fortuitous risk;

differential coverage standards in various parts of the world;

rating structures which reflect market trends rather than individual loss experience;

Insufficient credit for deductibles and/or loss control efforts.

There are also companies known as 'insurance consultants'. Like a mortgage broker, these

companies are paid a fee by the customer to shop around for the best insurance policy

amongst many companies.

Similar to an insurance consultant, an 'insurance broker' also shops around for the best

insurance policy amongst many companies. However, with insurance brokers, the fee is

135

Management of Financial Institutions - MGT 604

usually paid in the form of commission from the insurer that is selected rather than directly

from the client.

Neither insurance consultants nor insurance brokers are insurance companies and no risks

are transferred to them in insurance transactions.

Third party administrators are companies that perform underwriting and sometimes claims

handling services for insurance companies. These companies often have special expertise

that the insurance companies do not have.

Life insurance and saving

Certain life insurance contracts accumulate cash values, which may be taken by the insured

if the policy is surrendered or which may be borrowed against. Some policies, such as

annuities and endowment policies, are financial instruments to accumulate or liquidate

wealth when it is needed. See life insurance.

In many countries, such as the U.S. and the UK, the tax law provides that the interest on this

cash value is not taxable under certain circumstances. This leads to widespread use of life

insurance as a tax-efficient method of saving as well as protection in the event of early

death.

In U.S., the tax on interest income on life insurance policies and annuities is generally

deferred. However, in some cases the benefit derived from tax deferral may be offset by a

low return. This depends upon the insuring company, the type of policy and other variables

(mortality, market return, etc.). Moreover, other income tax saving vehicles (e.g., IRAs,

401(k) plans, Roth IRAs) may be better alternatives for value accumulation. A combination

of low-cost term life insurance and a higher-return tax-efficient retirement account may

achieve better investment return.

136

Table of Contents: