Insurance Industry

Study guides: Exam 6C, Exam 6U, Exam GI-201

The Insurance Industry is the set of firms — insurers, reinsurers, and the brokers, agents and adjusters around them — that accept the transfer of risk from households and businesses for a premium and pay claims when insured events occur. Property and casualty insurance is a vital service: it finances recovery from loss, makes lending, trade and ownership possible, and supplies coverage the law makes compulsory, which is why the business is regulated far more heavily than most.

\text{Underwriting result} = \text{Earned premium} - \text{Losses and LAE} - \text{Expenses}

\text{Operating income} = \text{Underwriting result} + \text{Investment income}

• Why "vital". A mortgage requires property insurance, a car loan requires physical damage cover, a contractor cannot bid without liability insurance and bonds, and auto liability and workers' compensation are compulsory. Because failure harms third parties who never chose the insurer, the public interest justifies regulation of solvency, rates and conduct — and guaranty funds behind it.
• The inverted production cycle. Price is set before cost is known and claims are paid long after premium is collected. The gap creates investment income (float) and the underwriting cycle, and it makes the insurer's reported profit depend on reserve estimates — the actuary's contribution.
• Structure. Insurers organised as stock companies, mutuals and reciprocals; distribution through brokers and independent agents or through direct writers; reinsurers behind them. In Canada, insurers are federally or provincially incorporated or operate as branches of foreign insurers. In the U.S., admitted insurers are licensed state by state, with surplus lines carriers and Risk Retention Groups outside that system.
• Exposure to the courts. A court decision can change the cost of policies already written. In Canada the syllabus decisions — the Duty to Defend, Bad Faith Damages, Punitive Damages, Vicarious Liability, limitation periods, Prejudgment Interest, Collateral Benefits — each reprice exposure retroactively.
• Latent liability in the U.S. Latent Liability — injury manifesting decades after exposure, as with Asbestos and other mass torts — reaches occurrence policies written long before the hazard was understood. Courts' trigger and allocation rules can bring many policy years, and their limits, into play; coverage litigation adds cost; development triangles have no history to project; and the resulting reserve strengthening has impaired or bankrupted insurers.

How Latent Liability Stacks Old Policies A manufacturer bought annual occurrence general liability policies from one insurer from 1972 through 1985, each with a \$1 million per-occurrence limit. A claimant exposed in 1972 is diagnosed with an asbestos disease in 2010 and settles for \$7 million. Compare a manifestation trigger with a continuous trigger (exposure through manifestation) allocated pro rata by time on the risk.

Answer Manifestation trigger: injury is deemed to occur on diagnosis in 2010. No policy was in force, so this insurer pays nothing.

Continuous trigger: every policy from 1972 through 1985 is triggered — 14 policy years.

\begin{align*}
\text{Available limit} &= 14 \times \$1\text{M} \\
&= \$14\text{M} \\[4pt]
\text{Pro rata share} &= \frac{\$7\text{M}}{14} \\
&= \$0.5\text{M per year}
\end{align*}

The insurer pays the full \$7 million out of policies priced in the 1970s for risks nobody then associated with the product. Which trigger and allocation rule apply depends on the jurisdiction — which is itself the problem: the liability is set by courts decades after the premium was earned.

A Court Decision Hits the Industry An appellate court rules that a common water-damage exclusion in homeowners' wordings is ambiguous and must be read in favour of the insured. Over the past two years insurers denied about 12{,}000 claims under that exclusion, averaging \$18{,}000 each. An insurer holds 8\% of the market. Assess the impact.

Answer

\begin{align*}
\text{Industry exposure} &= 12{,}000 \times \$18{,}000 \\
&= \$216\text{M} \\[4pt]
\text{Insurer's share} &= 0.08 \times \$216\text{M} \\
&= \$17.28\text{M}
\end{align*}

That is an upper bound if every denied claim is re-opened. The consequences: reserves for past accident years must be re-estimated (the decision states the law as it always was, so for a valuation not yet signed it is a subsequent event to recognise, not merely disclose); current rates are inadequate for the in-force book; and every insurer will re-draft the wording. The industry absorbs retroactively a cost it never priced.