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Manjeeta Rasaili

WEEK 9

Chapter 13: General Insurance Product Legislation & Regulation: Australia 1. The structure of general insurance industry in Australia is influenced by Insurance Act 1973. 2. General Insurance Reform Act 2001 and IA 1973 protects the interest of the policyholders. 3. General Insurance requires the authorization from the APRA to carry on the business and APRA is also capable of revoking the license. 4. ASIC regulates the company. 5. The Insurance Act and GIR Act protect the policyholders by: •

Requiring the higher position holders to meet certain qualifications requirements.

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Making higher position holders responsible for the protection of policy holders' interest.

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Imposing requirements to promote prudent (responsible and deserving who looks for the care and future) management.

6. APRA sets a prudential standard, and which must be comply by the general insurers. 7. A general insurer must hold assets in Australia of a value equal to or greater than the amount of its liabilities in Australia. 8. There must an auditor and an actuary in the company which is to be approved by APRA. 9. As per APRA the information given by auditor or actuary in the book or document about the insurer must be correct. 10. APRA is empowered to investigates a company’s financial situation, enter the premises of the company, examine the books, make copies or take extracts from the books. 11. IA gives a person affected by the reviewable decision to make a written request within the 21 days to the Treasurer of APRA to reconsider the decision.

Lloyd’s U Underwri nderwri nderwriter ter terss 12. It is a marketplace, underwriting authority authorized by APRA, a corporate body. 13. IA governs the operations of Lloyd’s underwriters. 14. APRA requires Lloyd’s underwriters to establish a security trust fund called a ‘designated security trust fund’ to satisfy the final judgements in respect of the class of insurance liabilities specified in the deed.

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General Insurance Market Dynamics The transfer of risk and the retention of risk is influenced by two factors: underwriting cycle and consolidation in the insurance industry. 15. Underwriting Cycle: The underwriting cycle is a graphical representation of the periods when general insurance companies will engage in cash flow underwriting to attract new business and periods when they tighten underwriting standards to preserve their underwriting results. •

Premium rate rises, terms and Conditions tighten, lower limits.

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Insurers make profit, Capital Flow in, Insurer desire for larger market share, Competition increases.

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Premium rates fall, Terms and Conditions relaxed, Higher limits.

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Insurers suffer losses, Capital exits, Supply contracts.

(Hard Soft) 16. One of the measures that can be used to ascertain the status of the underwriting cycle is to examine the combined ratio for the industry. 17. The combined ratio is a percentage calculated by applying the net claims and underwriting expenses to net premium. 18. Combined ratio: Apply net claims + Underwriting expenses /net premium. 19. When combined ratios are high, the industry tends to raise its underwriting 20. Combined ratio> 100 = unprofitable underwriting 21. Combined ratio< 100 = profitable underwriting.

Competitive Environ Environment ment 22. The competition in the market is prompted by two factors: the desire to compete and the means to compete.

Market Structure 23. Intermediaries facilitates the flow of insurance from the supplier to the end-user and it also provide advice on levels of protection, policy terms and assistance with claims.

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24. An insurance broker is an authorized professional adviser wo analyze the insured business and find the best insurance cover or the solution for the client’s risk and insurance needs. 25. Underwriting agencies is the stablished and supported by the group of insurers on the principle of sharing high risk or specialist exposure. 26. Reinsurers allows the insurer to stabilize its underwriting results by spreading the effects of any potential losses and to increase its capacity to underwrite larger risks. 27. Mortgage insurer provides the mortgage protection for property loans. 28. Captive Insurer are the companies that underwrite some or all of the risk faced by the company or its subsidiaries within the group of the related companies. 29. Section 37 exempt insurers who write a limited amount of insurance for the association only and do not write contract of insurance for any other persons.

Reinsurance 30. The agreement between two or more insurance companies to share proportionally in the risk of loss is reinsurance. 31. This helps to spread risk of loss and large loss under a single policy does not fall on one company. 32. Two Types: •

Contributing (proportional); insurance will pay proportion of the loss. For example, insurance company ‘A’ has accepted insurance for $200,000 and cedes 70 per cent to insurer ‘B’. The reinsurer accepts $140,000 of the liability and 70 per cent of the original premium. If a claim arose and the amount of damage was $20,000, then the reinsurer would pay its 70 per cent share of $14,000 to ‘A.

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Non-contributory or non-proportional reinsurance, which is an arrangement where the reassured retains a certain percentage of the risk and cedes the remainder. For example, if ‘A’ arranges a non-proportional treaty with ‘B’ to reinsure all losses above $30,000 up to $100,000, then ‘A’ will pay any one loss up to $30,000 and ‘B’ assumes liability for a loss up to $70,000 in excess of $30,000. Also, ‘B’ does not receive a proportional share of the original premium.

33. There are three ways for effecting reinsurance: •

Facultative: It is a simple reinsurance where a direct insurer offers the portion of the individual risk to another insurer and the portion is usually larger than the direct insurer’s retention capacity.

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Manjeeta Rasaili •

WEEK 9

Obligatory (surplus) treaty: It is the agreement between the reassured and the reinsurer to allow the insure to automatically accept a risk offered by a client or broker within the formally agreed limits and parameters.

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Contract or Policy of indemnity: An agreement between two or more insurance companies under which the reinsuring companies agree to accept and to indemnify the issuing company for all or part of the risk of loss under policies specified in the agreement. The ceding company retains its liability to and its contractual relationship with the insured.

Inves Investm tm tments ents 34. About half of the total investment of the general insurance companies are held in debt securities, government bonds, floating rate notes, short terms note and other in deposits. The company needs funds to meet their liabilities.

Practice Questions 9.1 Compare the number of general insurance companies to life insurance companies. What does this tell about the state of these industries? Ans: According to APRA 2019, there are 109 listed general insurance companies and 29 listed life insurance companies. These figures indicate that the general insurance market is likely to be more volatile than the life market. This volatility is demonstrated in underwriting cycle that is characteristic of this market. The life industry is not subject to these cycles mainly because of the long-term nature of their policies. Therefore, life insurers do not compete on price, but compete on policy coverage and engage in heavy advertising.

9.2 If an underwriter is experiencing underwriting losses, what effects will continuously increasing premium have on policy retention and risk concentration? Ans: If an underwriter experiences a loss, the writer will likely increase the premiums on existing policies for those higher at risk, leading to added pressure upon existing policy holders, placing greater risks on existing holders, and impacting upon others.

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However, in the case of a company increasing its premiums above what is freely available in the marketplace; consumers will cease to buy insurance from that company and will move their insurances to another company. Those insured’s who remain will be paying a price above the market price and suffer a loss of utility. If sufficient insured’s take their insurance away from the company, the effect on the company will be to reduce their premium pool and an increase in risk concentration. Risk concentration has the potential of leading to higher claims costs, earnings volatility and lower profitability. 9.3 How do insurance company seeks to maximize underwriting profitability? Ans Reinsurance performs a technical function of spreading risk and a financial function of reducing the surplus drain. In its role of ‘insurer for insurance companies’ reinsurance protects the direct underwriter from catastrophic losses caused by a comparatively large single loss or many small losses caused by a single occurrence. In addition, it permits the transfer of excess capacity from one insurer to another by permitting the direct underwriter to transfer its unearned premium reserve obligation to the reinsurer. The assets of the ceding company are reduced by less than the reduction in its liabilities. Facultative reinsurance is individually negotiated reinsurance where the direct underwriter offers another insurer a proportion of an individual risk where the amount accepted is above the direct underwriter’s retention capacity. On the other hand, treaty reinsurance can be either facultative or obligatory. In either case, the terms under which the transfer of risk takes place are agreed in advance. Under a facultative treaty, the direct underwriter need not cede, and the reinsurer need not accept the risk. Under an automatic treaty, the cession and acceptance are automatic.

9.5 Distinguish between the different types of reinsurance and give an example of each. What are the advantages of reinsuring? Ans: There are two types of reinsurance: a. Contributing or proportional reinsurance, which is an arrangement where an insurer (reassured) passes on a proportion of the liability of an individual risk or several risks and pays the same proportion 5

Manjeeta Rasaili

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of the individual premium to the reinsurer. For example, insurance company ‘A’ has accepted insurance for $200,000 and cedes 70 per cent to insurer ‘B’. The reinsurer accepts $140,000 of the liability and 70 per cent of the original premium. If a claim arose and the amount of damage was $20,000, then the reinsurer would pay its 70 per cent share of $14,000 to ‘A’. b. Non-contributory or non-proportional reinsurance, which is an arrangement where the reassured retains a certain percentage of the risk and cedes the remainder. For example, if ‘A’ arranges a nonproportional treaty with ‘B’ to reinsure all losses above $30,000 up to $100,000, then ‘A’ will pay any one loss up to $30,000 and ‘B’ assumes liability for a loss up to $70,000 in excess of $30,000. Also, ‘B’ does not receive a proportional share of the original premium. Advantages of reinsurance: 1. a. Protects an insurance company from assuming more risk than it can afford to retain. It also protects the original insurer from catastrophic losses. 2. b. The financial stability of insurers is enhanced by spreading the risk. 3. c. It allows insured to place large or unusual risks with one company and thus eliminate the need for the insured to try and arrange insurance with a number of different companies to cover one exposure. 4. d. It helps small insurance companies to continue writing business, thereby increasing competition. Small companies would have considerable trouble staying in business if reinsurance did not exist. 9.6 Explain the underwriting cycle. What causes the underwriting cycle? When would there be a hard market and a soft market? Ans: The underwriting cycle have two market conditions: hard market downsizing to soft and soft market upsizing to hard. The hard market starts with the insurer with high profits, flow of capital, increase in competition which downsizes to the soft market with fall in premium rates, relaxed terms and conditions and higher limits which results the insurer suffering losses, capital outflow and the contraction of supply. It will upsize from soft market to hard market with high premium rates, tight terms and conditions and lower limits. Hard markets occur when there is increases in premium rates and the coverage is hard to find. And soft market occurs when there is hold or decrease in premium and higher limits.

9.7 What is meant by solvency? Why Is solvency important to current and intending insured?

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Manjeeta Rasaili

WEEK 9

Ans .Solvency means to have the funds and the ability to pay what is due, with insurance this refers to companies having the ability to pay any claims that are put in, it is important to current and intending insureds as they are the ones that will require the payments if an event occurs and the incur a loss. For this reason, general insurance companies invest in short term instruments to ensure they have solvency and easily accessible funds to pay claims. 9.8 What reasons can you give for the world reinsurance market becoming hard in 2001? Ans: The loss for the general insurance company in 2000 and negative underwriting result maybe the reasons. Note: Insurance companies have identified several factors that can increase or decrease the likelihood of a claim on a policy. There are two important considerations, the physical risk and the moral risk. The physical risk is related to the physical characteristics of the insured object that may increase the possibility of a claim. For instance, in motor insurance the age of car is an important variable to determine the possibility of theft. Similarly, in property insurance the construction code of a building will determine the possible damage under an earthquake. In Life insurance, an individual with a history of cancer possess a physical risk that increases the individual’s probability of dying sooner than an individual of the same age and sex who does not present the same medical history. On the other hand, the moral risk is related to the applicant’s reputation, financial position or criminal record. When underwriters evaluate applications for insurance, they follow a very thorough thought process to identify the moral and the physical risk. Underwriters analyze information on insurance applications to determine whether a risk is acceptable and will probably not result in an early claim to the insurance company. To be able to properly assess the risk insurance companies have developed underwriting guidelines to which all underwriters must abide. For example in a general insurance application for, depending on the applicant’s age and the sum assured certain requirements are necessary: An individual age 46 applying for $1,000,000 term life sum assured in would in general need to provide the following: the application form, have a medical examination by a qualified doctor have a range of blood tests and a urine test. The underwriter needs to understand the significance of abnormal test results and how these abnormalities translate to adverse mortality or morbidity. This underwriting process will help ensure that only acceptable risks are written by the company and so enhance the possibility of the company achieving underwriting profitability

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