3 elements of the insurance cycle:
Results, Capacity, Prices
Discuss the insurance cycle. Ensure to include in your answer the key occurrences in the cycle and how
they influence price and insurer response and behaviour:
The cycle involves six distinct steps.
Negative results lead to reductions in capacity this leads to upward pressure on rates which
leads to improved results which leads to increases in capacity leading to a lowering of prices and
we start all over again.
Negative Results – Poor underwriting or claims results result in losses. some of the cost of those
losses must be met by using investment income and equity. As the company may make no
profit, the equity component to pay the losses must come from retained earnings.
Reduced Capacity – by using its equity, the insurer reduces that amount of capacity it has and
thus is limited in its future business writings as the premiums it can write are a ratio of its equity
(premium to equity ratio). This reduction in capacity leads to a tightening of market terms and
conditions along with underwriting. As capacity is limited and underwriting is more particular
and supply is limited. Underwriters become more particular of the risks accepted tending for the
better quality risks.
Increased Prices – As supply is limited and underwriters more selective, the natural tendency
under supply demand characteristics of an economy is that prices increase. As well, those
questionable risks that might have been written at inadequate rates under more liberal terms
are now placed in their appropriate markets at appropriate prices.
Positive Results – As a result of the better underwriting performance and more adequate pricing
of the insurance service, results will tend to become profitable as the losses will resemble those
on which the rates were originally based. Insurers will return to profitability and earn a
reasonable return on their equity and profits will either be paid out to shareholders or retained
in the company
Increased Capacity – as results improve and the insurer returns to profitability it is able to return
to its capacity he equity that may have been used when results were poor. Additionally if the
insurer is profitable and retains its earnings it will be able to increase its capacity suing that
money.
Lowering Prices – Insurers wish to put their capacity to work in order to earn a return. As
capacity availability increases there is more equity available to write business but there is
limited business growth generated by the economy overall. The issue is to attract new business
from existing insurers and the best way to do this is by reducing prices and lowering
underwriting standards. The price reduction and lowering of underwriting standards results in
price inadequacy along with taking onto the books more questionable risk. As the results of
these practices become known we start the cyclical pattern all over again with negative results.
Briefly describe the main responsibilities of the Actuarial function:
Pricing actuaries = analyze data and performing calculations to determine pricing for insurance
policies
Reserving actuaries = determine the amount of money to be held in bulk claims reserves and
responsible for insurer's overall financial situation and alerting management if financial
regulatory requirements are not met
Briefly explain the three key steps included in the process of “Marketing”
, Research – process of identifying the customer’s needs that fall within the scope of the
organization’s mission.
Development – process of developing or designing coverages that respond to or meet the needs
identified through research.
Selling – process of convincing customers that the product or service will satisfy their needs.
Define “Rating”
Rating is the process by which underwriters apply the info developed by actuaries to the risk info which
has been gathered in order to establish a premium for a specific risk. There are 2 approaches: class
rating and schedule rating.
Discuss the contribution made by insurance to the economy.
Provides a safety need from financial ruin
Provides for peace of mind
Allows economy to function for such things as non profits, business enterprises, commercial
operations, professional liability exposures and many more.
Provides for the lending of money and financing of projects through surety bonds
Provides for employment of people in insurance operations
Purchases goods and services, repair materials, medical and rehabilitative treatments for injured
parties.
Pays taxes and license fees to governments
Fuels economic expansion and thrives by the need created for insurance through that
expansion.
Name the five parties identified as stakeholders in the insurance industry:
Consumers
Distributors
Insurers/Shareholders
Reinsurer
Regulator/Government
Identify and briefly discuss the two factors that prevent insurers from charging an adequate premium
that is commensurate with the risk:
Competition –
o The ultimate determinant of the price paid by the consumer is competition in the
marketplace.
o If competition is intense then it is not uncommon for the book rate to be substantially
reduced or discounted in order to retain existing clientele or to attract new business
from other insurers.
Government interference –
o Usually undertaken in response to consumer complaints in respect to the insurances
industry.
o Interference may be found in the form of rate regulation where a government agency is
empowered to review and approve rates.
o In these cases the process may entail hearings and the like which draws out the process
making it time consuming.
Results, Capacity, Prices
Discuss the insurance cycle. Ensure to include in your answer the key occurrences in the cycle and how
they influence price and insurer response and behaviour:
The cycle involves six distinct steps.
Negative results lead to reductions in capacity this leads to upward pressure on rates which
leads to improved results which leads to increases in capacity leading to a lowering of prices and
we start all over again.
Negative Results – Poor underwriting or claims results result in losses. some of the cost of those
losses must be met by using investment income and equity. As the company may make no
profit, the equity component to pay the losses must come from retained earnings.
Reduced Capacity – by using its equity, the insurer reduces that amount of capacity it has and
thus is limited in its future business writings as the premiums it can write are a ratio of its equity
(premium to equity ratio). This reduction in capacity leads to a tightening of market terms and
conditions along with underwriting. As capacity is limited and underwriting is more particular
and supply is limited. Underwriters become more particular of the risks accepted tending for the
better quality risks.
Increased Prices – As supply is limited and underwriters more selective, the natural tendency
under supply demand characteristics of an economy is that prices increase. As well, those
questionable risks that might have been written at inadequate rates under more liberal terms
are now placed in their appropriate markets at appropriate prices.
Positive Results – As a result of the better underwriting performance and more adequate pricing
of the insurance service, results will tend to become profitable as the losses will resemble those
on which the rates were originally based. Insurers will return to profitability and earn a
reasonable return on their equity and profits will either be paid out to shareholders or retained
in the company
Increased Capacity – as results improve and the insurer returns to profitability it is able to return
to its capacity he equity that may have been used when results were poor. Additionally if the
insurer is profitable and retains its earnings it will be able to increase its capacity suing that
money.
Lowering Prices – Insurers wish to put their capacity to work in order to earn a return. As
capacity availability increases there is more equity available to write business but there is
limited business growth generated by the economy overall. The issue is to attract new business
from existing insurers and the best way to do this is by reducing prices and lowering
underwriting standards. The price reduction and lowering of underwriting standards results in
price inadequacy along with taking onto the books more questionable risk. As the results of
these practices become known we start the cyclical pattern all over again with negative results.
Briefly describe the main responsibilities of the Actuarial function:
Pricing actuaries = analyze data and performing calculations to determine pricing for insurance
policies
Reserving actuaries = determine the amount of money to be held in bulk claims reserves and
responsible for insurer's overall financial situation and alerting management if financial
regulatory requirements are not met
Briefly explain the three key steps included in the process of “Marketing”
, Research – process of identifying the customer’s needs that fall within the scope of the
organization’s mission.
Development – process of developing or designing coverages that respond to or meet the needs
identified through research.
Selling – process of convincing customers that the product or service will satisfy their needs.
Define “Rating”
Rating is the process by which underwriters apply the info developed by actuaries to the risk info which
has been gathered in order to establish a premium for a specific risk. There are 2 approaches: class
rating and schedule rating.
Discuss the contribution made by insurance to the economy.
Provides a safety need from financial ruin
Provides for peace of mind
Allows economy to function for such things as non profits, business enterprises, commercial
operations, professional liability exposures and many more.
Provides for the lending of money and financing of projects through surety bonds
Provides for employment of people in insurance operations
Purchases goods and services, repair materials, medical and rehabilitative treatments for injured
parties.
Pays taxes and license fees to governments
Fuels economic expansion and thrives by the need created for insurance through that
expansion.
Name the five parties identified as stakeholders in the insurance industry:
Consumers
Distributors
Insurers/Shareholders
Reinsurer
Regulator/Government
Identify and briefly discuss the two factors that prevent insurers from charging an adequate premium
that is commensurate with the risk:
Competition –
o The ultimate determinant of the price paid by the consumer is competition in the
marketplace.
o If competition is intense then it is not uncommon for the book rate to be substantially
reduced or discounted in order to retain existing clientele or to attract new business
from other insurers.
Government interference –
o Usually undertaken in response to consumer complaints in respect to the insurances
industry.
o Interference may be found in the form of rate regulation where a government agency is
empowered to review and approve rates.
o In these cases the process may entail hearings and the like which draws out the process
making it time consuming.
