Archive for Actuaries

How Insurance Shares Risk Across The Population And Aims For Fair Premiums

Insurance Blog often gets unusual requests, more proof that Insurance is not grey and boring, the latest being particularly unusual so we thought we’d rise to the challenge.

A mature student friend of ours was struggling with his first year accountancy exams when asked to write an essay on the following, so he thought he’d approach us for some answers and help writing his assignment.

1.Explain how Insurance shares risk across the population?
2.What is a fair insurance premium?
3.How can adverse selection prevent Insurance being available at a fair premium?
4.What strategies do insurance companies follow to reduce the problem of adverse selection?

So we farmed it out to our technical expert Dave Healey and this is what he came up with.

The Primary Functions Of Insurance As A Service Industry

By Dave Healey

There are three primary functions of Insurance which determine how Insurance companies operate and how the public interacts with these companies.

The first is as a risk transfer mechanism, whereby the individual or business can shift some of the uncertainty of life onto the shoulders of others. In return for a known premium, usually a very small amount compared to the potential loss, the cost of that loss can be transferred to an insurance company. Without Insurance there would be a great deal of uncertainty experienced by both the individual and the enterprise, not only as to how and whether a loss would occur, but also to the extent and size of the potential loss.

The second primary function is the establishment of the common pool. The Insured’s premium is received by the Insurer into a fund or pool for that type of risk, and the claims of those suffering losses are paid out this pool. Applying Bernoulli’s ‘Law of Large Numbers’, because of the large number of clients that any particular risk fund or pool will have, Insurance companies can predict with high accuracy the amount of claims or losses that might be suffered over a period of time. The will be some variations in losses over different years and Insurance companies include an element of premium to build up a reserve, to pay for additional losses in bad or catastrophic years. Therefore in principle, subject to the limitations of the type of cover bought, the client should not have to pay additional premiums into the common fund after a loss or claim.

The third primary function of Insurance is to provide fair and equitable premiums. Assuming that a risk transfer mechanism has been set up through a common fund or pool, the contributions paid into the fund should be fair to all parties participating. Each party wishing to insure and paying into the fund will bring with it varying degrees of risk. To avoid adverse selection and provide equitable premiums each risk is broken down into various components and rating factors that can be priced individually on a statistical scale of probability determined by Actuaries. Therefore those who present the greater statistical risk will pay more into the common fund for the same cover, when their individual premiums are calculated.

Insurance companies employ underwriters to reduce the problem of adverse selection and protect the fund. The underwriters will determine parameters of the hazard and value of a risk that is acceptable for the fund, and decline risks that fall outside these parameters. In fixing a fair level of premium they must also take into account the contributions made by others into the common fund and price accordingly.

Underwriters and insurance companies will employ many techniques to deter or price adverse selection out of the risk pool. These typically include exclusions to cover in the form of policy wordings and additional conditional clauses, exempting the risk under certain conditions. They will employ all types of mechanisms and devices to install fear into the population to increase the size of the risk pool and attract the niche or sector of the market that they are aiming for. For example large marketing campaigns aimed at the ‘safe’ sector e.g. women drivers who are statistically less likely to claim. On the Internet, Insurance companies employ automated underwriting that excludes cover to everything that does not fit the desired risk pool parameters.

Ultimately the Government can in certain cases decide the size of the risk pool through leglislation and compulsory insurance as is the case for car insurance where it is illegal to drive without cover and business insurance where it is illegal to trade without liability insurance cover.

Insurance companies can also take further risk transfer from the insurer to a reinsurer (reinsurance) laying of some of their exposure as a mechanism for adverse risk control.

We originally published the Article at:

Well there’s obviously a lot more to write on this subject so if some of you FCII fellows out there who read this blog  wish to contribute, feel free to leave your comments on the questions!

Insurance Companies must be held to account for the Recession

Who really calls the shots – The Government or Big Business when it comes to setting the direction and flow of the future economy?
You don’t need to look much further than the Insurance Industry to see that new forces are in play in a new world economy, driven perhaps by Government steering rather than a cyclical wave of uncertainty created by the money markets who are ultimately the owners, underwriters and profiteers of the multi national corporations.

The Insurance Industry which is at the top of the triangle of the money market distribution, is renowned for it’s slow reaction to change.
You’ve only got to ask a dynamic young business analyst or insurance product underwriter how difficult it is to implement solutions that would ultimately bring an Insurance Company competitive advantage……
Insurance Companies are naturally cautious and are able to absorb external change over time through their ability to control the provision of products and the levels of competition within the market.
They do this by controlling the rates at which they sell their products to the retail market through various differing distribution channels.
The rates that Insurance Companies set for Insurance are typically determined by the levels of profit that the investment side of the company is making.

This level of profit is ultimately determined by the Base Interest Rate set by the Government above which the Insurance Companies can not only sell you products with hiked up rates such as mortgages and pensions, but much more importantly make the bulk of their profits from reinvesting your money in very large chunks, for guaranteed long term profits.
For example ,the current Government borrowing deficit of 165 billion pounds sterling has mostly been underwritten by Global Insurance Companies buying up the bonds.

Incredibly the money was borrowed, to bail out many of the private corporations who created the recession but who are now profiting from the debt.

Even more incredibly the Insurance Companies are crying ‘Please don’t tie us in with the banks – We’re not the baddies’!

Well I’ve got news for you Insurance companies!
Thanks to the policies followed by all those chairmen of the Insurance Companies throughout the 1990′s of agglomeration, Cartels, price fixing and that word that they now pretend never existed ‘Banc-Assurance‘ …

You are the bad boys- You and the Banks are the same thing!

And where are all those Chairman of the Bank Assurers who created and introduced risk into the Economy now?
Yes, all sitting pretty in the House of Lord’s, unelected and having further say ion the Country’s future. Outrageous!

Back to the point, Insurance Companies must now adjust to the new economics.
In the past they have had the arrogance to talk about fixed seven year cycles between hard markets where they can increase the rates to high profit levels and soft markets where wider levels of competition keep the prices down. At the end of the day the volume of business is exactly the same and the levels of claims homogeneous, so why the fluctuations?

Purely for profit!

Now though these very same companies are stuck between a rock and a hard market as they no longer have either the control over the flow of money or thanks to Global business and The Internet, the number of entrants able to enter the market,

In the past when Insurance Companies were making losses or wanted to make super-profit, the Insurance market would Cartel like, hike it’s prices across the board. A so called hard market. They are no longer in a position to do this!
Furthermore the profits they make from their investment vehicles are down due the Interest rates sensibly being held low by the Bank of England.
It won’t be long before the Insurance Company shareholders start screaming when they don’t get the dividends they expect or deserve! The Insurance Companies are already moaning about how incredibly unfair the Base Rate is to their investment vehicles!

Remember these are the same people – The Banks – who would like to charge you 15% on your mortgage debt and make super profits – if they thought they could get away with it. They’re already charging you more than that on your Credit Cards!

The Car Insurance Market is traditionally the first to harden it’s rates, with you and me the motorist suffering, but with increased number of distribution channels and the ability to shop around, it would be a foolish insurer who hardened his rates and expected to keep his book of business in the current economy.

You can expect similar resistance to unfair and unwarranted commercial insurance premium hikes, especially when the business had carried out good risk management and claims loss prevention.
Why should they pay more?
Because they are in a poorly managed risk pool?
Shop around Shop owners!

If the collective Insurance industry try to impose a hard market on the public during a recession they will create untold social problems as individuals and businesses under insure and health and safety practices go out the window.

Insurance Companies have to develop a real sense of social responsibility not just some hyped up marketing blurb about planting tress or paying to brand yourselves with Athletics and Football!

Insurance Companies have got to learn to be symbiotic and not Parasites on the State and it’s People! Restricting their profits would be a good place to start!

UK Car Insurance Rates Must Harden As Loss Making Companies Claims Reserves Run Dry!

Incredibly Car Insurance companies in the UK are struggling to make a profit and 2010 is likely to see a large reduction in the supply of car insurance, with many famous brands and suppliers predicted to disappear from the high street and our television screens as the market adjusts to cater for the massive losses, according to analysts from car insurance comparison website

Recently released figures show that the UK Motor Insurance market has been consistently losing money since 2004 when the total UK profit from underwriting car insurance policies was £77 million.
In 2007 the UK car insurance market made a £1.1 billion underwriting loss, last year the loss was £1.3 billion and the figures for 2009 are expected to be worse……..

Very few car insurance providers have escaped the losses and are profitable, whilst many have released claims reserves held from previous profitable years to disguise the ‘actual ‘ loss.

So what is causing such massive losses in a large compulsory market that not so long ago was the most aggressive in the world?

On the face of it the answer appears to be simple …… The Cost of Claims!

Claims are the problem not because the Car Insurance Companies have failed to include the rising costs of claims into their pricing structures; but because they have failed to cover the true costs in the retail price!

Car Insurance underwriters seem to have forgotten the basic rules of betting when setting their prices – and that is, that the Bookie never loses…….

To understand where the car insurance underwriting companies have gone wrong you first need to examine how they arrive at the price of a car insurance policy premium.

The cost of your car insurance premium is basically made up of three components:

1. The costs of production – Staff, Systems, Distribution etc
2. The costs of losses – known claims ratios ( the proportion of a policy premium pool that gets eaten up in claims)
3. Profit

The cost of all these components can be calculated by clever people called actuaries who work for the insurance companies and the rates set accordingly.

So what’s gone wrong?

Well naturally it is obvious to first look at claims as the cause of the losses – but the truth is far from this end of the life of a car insurance policy……

The frequency of claims has either fallen or remained fairly constant over the period of losses and the actual cost of claims has only risen by 1 percent.

Despite all the noise made about gangs of car insurance claims fraudsters roaming the streets of the UK, the fact of the matter is that most of this is propaganda aimed at deterring fraud which naturally rises during a recession/depression. The number of fraud cases are really insignificant in the true scale of the market to affect pricing.
Admittedly there has been a significant increase in the number of personal injury related claims, egged on by claims farming companies, which would affect long term pricing, however the losses experienced by Car Insurance companies are nothing to do with claims and claims pricing.

These type of claims fluctuations have always been dealt with successfully in the past by car insurance companies by adjusting reserve ratios or negotiating better re-insurance ( laying the risk off), or more importantly by adjusting price ……..

But this time something is different….

Car Insurance Companies can no longer set the price! Not if they want to win the business anyway!
And they certainly cannot sell policies at the premium levels that the Actuaries suggest!

Why? Seemple …….The Internet!

And more importantly Car Insurance Price Comparison websites or aggregators as they are known in the industry, which account for around 90 percent of the Car Insurance sold online. Since around 2004 it has been possible to easily compare car insurance quotes online from numerous suppliers, and invariably the cheapest premium wins the business.

Car Insurance companies not longer set their own prices. And this is the problem!
In a race to achieve enough volume to make a book of car insurance business profitable the car insurance companies have been selling their car insurance polices too cheap and covering their losses with their claims reserves……..time is running out!