Management of Insurance Enterprise
The insurance industry is essential to the world economy and many companies offer coverage for a wide range of risks that people and businesses face everyday. From a consumer's perspective, the transaction may be as simple as paying a premium every month in exchange for the piece of mind of knowing that recovery from a loss is possible. Within a complex framework of government regulation, an insurance company must evaluate risks and assign probabilities to determine a price for the protection sought. They need to invest funds and even seek to insure their own risks with other insurers. The marketplace demands efficiency and insurance companies are turning to technology to address the need. This article discusses the basic components on an insurer's business model and the fundamental forces that affect the management of an insurance enterprise.
Keywords Actuarial Science; Adjuster; Administrative Agency; Combined Ratio; Earned Premium; Float; Insolvency; Property & Casualty Insurance; Reinsurance; Retroceding; Statute; Underwriting; Underwriting/Insurance Cycle
Risk in some form is present in every act. Whether the risk is remote or closer to assured, disasters both natural and otherwise have the potential to destroy fortunes. The prospect of catastrophic loss can halt progress. Insurance companies address these concerns by spreading the economic impact of a loss over a large group of people. The products they provide are essential to the normal operation of our non-agrarian society. The insurance industry in the United States is composed of some four thousand companies that sell policies to protect against a wide variety of the risks faced by individuals, organizations and entities alike. The industry is also important to the economy as an employer of over two million people. This article discusses some of the major functions, challenges and techniques unique to the management of an insurance company.
Businesses have many basic functions and principles in common. Every business must produce something of value to the market, employ techniques to sell that product, and manage human resources with the appropriate knowledge, skills and abilities to complete the tasks. Each industry has a particular group of core efficiencies necessary for production and distribution to profit from its chosen product line. For example, General Motors, on a fundamental level, must be able to efficiently produce cars at a cost below the price a consumer is willing to pay for those cars. While there are certainly many other factors that determine the success of a company, it would be difficult to imagine a successful company that lacked expertise and efficiency in those areas fundamental to its nature. For an insurance company, the basic model to generate revenue involves two areas; underwriting and investing. The cost of administration and the total amount of claims paid are subtracted from the revenue centers to form the basic insurer business model. To employ this basic model, the insurance industry must operate within a legal framework of state and federal laws and regulation (Encyclopedia of Business & Finance, 2008).
An insurance company can make money in two basic ways.
- First, the insurance company can profit from underwriting. When an insurance company underwrites a risk they assume responsibility for an agreed amount of economic consequences arising from the occurrence of certain events. The premiums earned are applied toward potential profit once they become earned premiums. The amount of premium that is considered earned is a function of the time the insurance company has been exposed to loss under a given policy. For example, if a person purchases a one-year policy and 100 days have elapsed since the policy took effect, the insurance company has earned 100/365 of the total premium paid. Conversely, 265/365 of the premium paid is unearned. An insurance company makes an underwriting profit when the total of earned premiums exceeds the total claims under those policies.
- Second, there insurance company makes money by investing the premiums they receive. Insurance companies invest insurance premium payments as soon as they are received and leave those funds invested until claims are paid. The total amount of cash that an insurance company has on hand and not paid out in claims is called "float," or available reserve. While the company may not be able the keep the investments themselves, they are able to keep the interest that accrued on the funds while in the company's possession. For this reason, insurance companies are important investors in the economy, putting billions of dollars in credit and equity markets. The profits made from investing the "float" are an important source of income for insurance companies and can offset underwriting losses.
The other end of the business equation for an insurance company is largely composed of the underwriting administrative expense and losses incurred. The full equation in total profit earned by an insurance company is the underwriting profit plus the investment income less the losses incurred, or claims paid, and the underwriting expenses. Insurance company mangers have to apply this business model within a highly regulated industry, at both state and federal levels. Each of these areas will be discussed in more detail.Underwriting
Underwriting is at the heart of the insurance business and it is likely the most difficult part of the business. An insurance policy distributes the economic losses arising from a specific type of risk to a group of people. The term derives from the times when the person assuming the risk actually signed their name on the contract under the risk assumed. In modern usage, it refers to a party who has assumed risk under an insurance policy. The term is also commonly used in investment banking and in that context; the underwriter assumes the risk of the sale of particular securities.
Underwriting is the assumption of a risk; the decision as to assume a particular risk involves a process of quantifying risks and then assigning a price for the assumption. That quantification is a prediction about the claims that will be made under a policy and pricing of the policies accordingly. To perform this prediction, insurers use actuarial science. Actuarial science is a formal mathematical discipline used to calculate the likelihood and frequency of occurrence of covered risks and therefore the...
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