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2007 20 nature and_importance_insurance

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  • 1. 20. The Nature and Importance ofInsuranceDr. Jan-Juy LinDept. of Risk Management and Insurance ETP course, CNCCU

2. Introduction The insurance production process Overview of insurance worldwide The international dimensions of insurance supply The role of insurance in economic growth Determinants of insurance market structure Question Discussion 2 3. The Insurance Production Process 4. The Production Process (Figure 20.1) 4 5. The Role of Capital and Surplus Insurance policies are contingent claim contracts that rely on pricing Inversion.The product is priced before actual productioncosts are known.Insurers must provide a margin for unfavorablepricing deviations. The greater an insurers capital compared with its premium writings and liabilities that is, the less its financial leverage the greater the perceived security and the more favorable its reception among informed buyers.5 6. Pricing and Product Development Pricing (premium rates and reserves) using their best estimates as to future losses and expenses with an eye toward competitiveness.The greater the average period between premiumreceipt and loss payout, the greater the influenceof investment returns in setting premium rates.(life vs. non-life) (experience rating v. exposurerating & model) Product innovation and price competitiveness are often understandably crucial determinants of success, especially for new entrants.6 7. Underwriting Two key functions: Selection (or rejection) of application Classification of accepted risksQ: adverse selection The underwriter must assemble information about the applicant and the subject of insurance in order to assess the loss potential. (complex case) It requires knowledge of local conditions and the local environment. 7 8. Claims Settlement Claims under life insurance policies typically can be settled easily. A local presence of the insurance company is not required. Health insurance claims can range from simple to complex. (e.g., insurance fraud, veteran hospital) In lines of insurance where losses require on-site examination (e.g., property insurance), some type of local presence is typically necessary. 8 9. Claims Settlement Claims personnel, sometimes with the assistance of an actuary, estimate amounts to be established as balance sheet liabilities (reserves) for unpaid nonlife claims. Contract situs The jurisdiction whose law applies to contract creation, interpretation and enforcement. One of principal consumer protection issues within the insurance pricing, underwriting and claim settlement process.9 10. DistributionDirect response systemCompanies distribute products without the use ofintermediary.Distribution through agents (authority granted)Captive (exclusive, tied) agentsIndependent agentsDistribution through brokersA broker is a legal representative of an insurancepurchaser, represents the interests of the insured.Distribution through other financial institutions e.g. bank, convenient store, post office 10 11. Investment Management Insurers are key institutional investors in capital markets worldwide. Regulators and supervisors pay close attention to the composition and management of invested assets of insurance companies Chapter 21 Nothing inherent in the investment management function requires a local presence.11 12. Investment Management Foreign investments can exacerbate the buyers (and the regulators) problem of information asymmetry.National regulation typically placessevere limits on foreign investmentsby domestic insurers.12 13. Investment Management A related but different concern arises with cross-border insurance trade.If a foreign insurer in cross-border businessfails to meet its obligations, the host-countryinsureds could be at a legal, not to mentiona practical, disadvantage.The resolution of this issue is essential ifcross-border insurance is to grow.Asset management, ALM, RM, DFA2nd significant function of insurers13 14. Overview of Insurance Worldwide 15. Worlds Largest Life Insurers (2005) (Table 20.1) 15 16. Worlds Largest Nonlife Insurers (2005) (Table 20.1) 16 17. Worlds Largest Reinsurers (2005) (Table 20.1)17 18. Nature of Insurance Companies Ownership structureStock insurersMutual insurers Assessment mutuals (e.g., Protection and Indemnity clubs) Non-assessment mutuals Licensing statusAdmitted vs. non-admitted insurersComposite insurers Place of domicileDomestic vs. foreign insurer (alien insurer in the U.S.)Home vs. host country18 19. Share of Insurance Premiums (2005) (Figure 20.2) Latin America North AmericaOceania WorldEuropeAfrica Asia 0%20% 40% 60%80% 100% Source: Swiss Re (2006) Life Nonlife19 20. Distribution of Insurance Premiums (2005) (Figure 20.3)Source: Swiss Re (2006)20 21. Worlds 10 Largest Markets (2005) (Figure 20.4) Source: Swiss Re (2006) 21 22. Insurance Density and Penetration Insurance densityThe average annual per capita premium within a country.Values are usually converted from national currency to USdollars currency fluctuations affect comparisons. Insurance penetrationThe ratio of yearly direct premiums written to GDP.It shows roughly the relative importance of insurancewithin national economies unaffected by currencyfluctuations.22 23. Insurance Density (2005) (Figure 20.5)Source: Swiss Re (2006)23 24. Insurance Penetration (2005) (Figure 20.6) Source: Swiss Re (2006) 24 25. Insurance Supply 26. Cross-border Insurance Trade Pure cross-border insurance trade When the resultant insurance contract is entered into because of solicitations. Own-initiative cross-border insurance trade Many corporations often seek insurance abroad trying to secure coverage either more favorable terms. Consumption-abroad cross-border insurance trade Ex. Travelers may purchase a short-term automobile insurance for rental car. 26 27. Cross-border Insurance TradeDifference-in-conditions (DIC) and difference-in-limits (DIL) insurance trade A global firm purchases DIC or DIL coverage as part of its global management.Excess and surplus (E&S) insurance An insurer places the risk with a non-admitted insurer. E&S brokers such trades are prohibit except through specialty domestic E&S brokers. 27 28. Establishment of Insurance Trade AgencyA domestic agent represents a foreign insurer for thepurpose of making sales. BranchNot separate corporation but a part of the home-countryinsurers. SubsidiaryThe local subsidiary of a foreign insurer is a domesticcorporation. Representative office (532 in China)market research, interest promotionNo risk bearing, no insurance selling 28 29. Market-share of Foreign-owned Insurers (Table 20.2)Source: Swiss Re (2004) 29 30. The Role of Insurance inEconomic Growth 31. Property Rights and Economic Development Property rights The right to own and alienate real and personal property The right to contract The right to be compensated for damage resulting from the tortuous conduct of others Private financial services will not flourish unless individuals ownership interests in property are well defined and protected. (legal environment and infrastructure) Ex. Shin Kongs joint venture in Beijing. 31 32. Property Rights and Economic Development Any action that diminishes the value of ones ownership interest in private property hinders private financial services development. Failure to control inflation Substantial trade restrictions High income tax rate Private property rights, however, are restrictive by their nature. Without some restraints, their complete exercise could actually interfere with the efficient functioning of markets.32 33. Financial Development and Economic Growth As financial intermediaries, insurance companies perform the same types of functions and provide similar generic benefits to a national economy as other financial intermediaries. Financial services generally and insurance in particular are of primordial importance to economic development. 33 34. Financial Development and Economic Growth Financial services offer the possibility of providing such externalities, thereby enhancing economic growth.Non-life insurance, life insurance andbanking are all shown to be importantpredictors of economic productivity.Thus, the more developed and efficient acountrys financial market, the greater willbe its contribution to economic prosperity.34 35. Benefits of Insurance in Economic Growth Promote financial stability By indemnifying those who suffer or harm, insurance helps stabilize the financial situation of individuals, families and organizations. It encourages individuals and firms to invest and create wealth. Peach of mind and financial carelessness.35 36. Benefits of Insurance in Economic Growth Substitutes for and complements government security programs Private insurance can relieve pressure on social insurance system, preserving government resources for essential social security.Pension fund and life insuranceNatural disaster indemnity planQ&A: surname of insurance?36 37. Benefits of Insurance in Economic Growth Facilitates trade and commerce Many products and services are produced and sold only if adequate liability insurance is available to cover any claims for negligence. Ex. PL and Malpractice Innovation Credit enhancement37 38. Benefits of Insurance in Economic Growth Helps mobilize savingsInsurance and financial intermediationInsurance enhance financial systemefficiency in three ways Reduce transaction costs associated with bringing together savers and borrowers Create liquidity Facilitate economies of scale in investment 38 39. Benefits of Insurance in Economic GrowthFinancial intermediaries vs. financialmarkets The more developed a countrys financial system, the greater the reliance on markets and the less the reliance on intermediaries.Insurers vs. other financial intermediaries Commercial banks short-term deposits Contractual saving institutions long-term view 39 40. Benefits of Insurance in Economic Growth En

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