Seminar for Oklahoma State Legislators March 20, 2013

1. INFORM+INSPIRE Basic Principles of Insurance & Risk ManagementUniversity of Central Oklahoma Finance – Insurance and Risk Management Stuart MacDonald, Gerald Wilkins, Allen Arnold Seminar for Oklahoma State Legislators March 20, 2013 The Griffith Insurance Education Foundation

2. Seminar Agenda • Overview of Insurance Principles • Types of Insurance • Regulation and Legislation The Griffith Insurance Education Foundation

3. Overview of Insurance Principles • Definition of Risk • The Role of Insurance • Risk Pooling • Adverse Selection • Concept of Moral Hazard The Griffith Insurance Education Foundation

4. Definition of Risk • Risk refers to uncertainty • An unknown or unexpected event • Risk can be strategic, unintentional, systemic, fortuitous The Griffith Insurance Education Foundation

5. The Role of Insurance • According to the American Risk and Insurance Association, “insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risk” (Redja, p. 20, 2011). The Griffith Insurance Education Foundation

6. Characteristics of Insurance • Pooling of Losses • Payment of Fortuitous Losses • Risk Transfer • Indemnification The Griffith Insurance Education Foundation

7. Risk Pooling • Spreads the loss suffered by an individual over the whole group • Based on the Law of Large Numbers The Griffith Insurance Education Foundation

8. Payment of Fortuitous Losses • Unforeseen • Unexpected • Result of Chance The Griffith Insurance Education Foundation

9. Transfer of Risk • Pure risk transferred from an insured to an insurer for a fee (insurance premium) The Griffith Insurance Education Foundation

10. Indemnification • Restoring an insured to their approximate pre-loss financial position The Griffith Insurance Education Foundation

11. Concept of Peril and Hazard • A peril is the cause of a loss • A hazard is a factor that creates or contributes to a loss The Griffith Insurance Education Foundation

12. Physical Hazard • Physical condition that increases the frequency and/or severity of a loss The Griffith Insurance Education Foundation

13. Moral Hazard • Dishonest or deceitful statements or behavior in order to defraud the insurer, thereby increasing the frequency and/or severity of loss claims • Insurance fraud causes increases in premium rates for everyone The Griffith Insurance Education Foundation

14. Attitudinal Hazard • Carelessness or indifference to a loss, thereby increasing the frequency and/or severity of loss claims The Griffith Insurance Education Foundation

15. Legal Hazard • Characteristics of the legal system or regulatory environment that increases the frequency and/or severity of loss claims The Griffith Insurance Education Foundation

16. Adverse Selection • Tendency for insurance applicant with a higher than average loss potential (sub-standard risk) to acquire insurance protection at less expensive (standard risk) premium rates The Griffith Insurance Education Foundation

17. Characteristics of an Ideally Insurable Risk • Large number of exposure units • Accidental and unintentional loss • Determinable and measurable • Not a catastrophic loss • Chance of loss must be calculable • Economically feasible premium The Griffith Insurance Education Foundation

18. Risk Management Matrix • Low frequency and severity: Retention • High frequency and low severity: Loss Prevention and Retention • Low frequency and high severity: Transfer Risk (Insurance) • High frequency and high severity: Avoidance The Griffith Insurance Education Foundation

19. INFLATION-ADJUSTED U.S. CATASTROPHE LOSSES BY CAUSE OF LOSS, 1992-2011 (1) Estimated property losses adjusted for inflation through 2011 by ISO using the GDP implicit price deflator. Excludes catastrophes causing direct losses less than $25 million in 1997 dollars. Does not include flood damage covered by the federally administered National Flood Insurance Program.(2) Excludes snow.(3) Includes wildland fires.(4) Includes losses from civil disorders, water damage, utility service disruptions, and any workers compensation catastrophes generating losses in excess of PCS's threshold after adjusting for inflation.Source: The Property Claim Services (PCS) unit of ISO, a Verisk Analytics company. The Griffith Insurance Education Foundation

20. Why Insurers Become Insolvent • Note that Fraud outranks Catastrophe Losses. The Griffith Insurance Education Foundation

21. Types of Insurance • Personal Lines • Life • Health • Homeowners • Auto • Reinsurance and Surplus Lines The Griffith Insurance Education Foundation

22. Source: SNL Financial, Inc. The Griffith Insurance Education Foundation

23. Personal Lines - Life • Life insurance is justified if others are financially dependent on the insured • Term Insurance vs. Whole Life Insurance • Ownership Clause • Incontestable Period / Suicide Clause • Death benefit proceeds are tax-exempt • Life Income Options / Annuities The Griffith Insurance Education Foundation

24. Personal Lines - Health • Patient Protection and Affordable Care Act • State Health Insurance Exchanges • No pre-existing conditions • No lifetime or annual limits • Coverage for children to age 26 The Griffith Insurance Education Foundation

25. 2011 Life/A&H U.S. NPW by Line Source: SNL Financial, Inc. The Griffith Insurance Education Foundation

26. Personal Lines - Homeowners • Homeowners 3 (Special Form) • All-Risks Coverage, except named exclusions (Earthquake, Flood, War, Nuclear Radiation) • Homeowners 6 (Condominiums) • Same as above • Homeowners 4 (Renters Insurance) • Named Perils (NOT All-Risks) The Griffith Insurance Education Foundation

27. Personal Lines - Auto • Personal Auto Policy • Liability Coverage • Medical Payments Coverage • Uninsured / Underinsured Motorists • Collision and Comprehensive • Exclusions (intentional injury or damage, racing, road rage, business use, etc.) The Griffith Insurance Education Foundation

28. 2011 P&C U.S. NPW by Line Source: SNL Financial, Inc. The Griffith Insurance Education Foundation

29. State Trends in Auto and Homeowners Pricing • 2011 report by the Insurance Research Council indicates a rapid increase in the severity of claims, and a slow but steady increase in the frequency of non-severe claims. • Commercial Auto most stable underwriting The Griffith Insurance Education Foundation

30. Reinsurance • Primary insurer that writes the insurance transfers to another insurer (the reinsurer) part or all of the potential losses associated with such insurance The Griffith Insurance Education Foundation

31. Reasons for Reinsurance • Increase underwriting capacity • Stabilize profits • Reduce the unearned premium reserve • Protection against catastrophic losses (e.g. reinsurers paid a large part of the $41 billion insured losses arising from Hurricane Katrina which significantly reduced losses paid by primary insurers) The Griffith Insurance Education Foundation

32. Surplus Lines • Surplus lines refers to any type of insurance for which there is no insurer licensed by the State of Oklahoma that will write the type and amount of insurance requested by the insured • Coverage must be placed by a surplus lines broker with a nonadmitted insurer which is not licensed to do business in Oklahoma (e.g. Lloyd’s of London) The Griffith Insurance Education Foundation

33. Surplus Lines • Surplus lines carriers are registered with the Oklahoma Insurance Department • A 6% surplus lines tax is levied on insurance premiums for surplus lines coverage; tax is paid by the surplus lines broker placing the coverage for the insured The Griffith Insurance Education Foundation

34. Regulation of Insurance • National Association of Insurance Commissioners (NAIC) • All 50 states, Wash. D.C, 5 US Territories • Maintain insurer solvency • Regulate fair and reasonable rates • Ensure availability of insurance • Consumer protection and education The Griffith Insurance Education Foundation

35. State Regulation of Insurance • Oklahoma Insurance Department • Enforce insurance-related laws • Protect consumers • Promote competitive insurance markets • License and educate insurance agents and adjusters, funeral home directors, bail bondsmen, real estate appraisers The Griffith Insurance Education Foundation

36. State Guaranty Funds • Provide protection from losses if an insurer becomes insolvent • Life and Health Insurance Guaranty Association • Property and Casualty Insurance Guaranty Association The Griffith Insurance Education Foundation

37. Oklahoma Guaranty Associations • When a licensed insurer fails, other licensed insurance carriers are assessed according to the % of premiums they write in the State to pay the claims of the failed carrier The Griffith Insurance Education Foundation

38. Oklahoma Guaranty Associations • Each insurer who pays an assessment is permitted to take the amount they pay as a credit against their premium taxes (licensed insurance carriers pay a 2.25% premium tax on all premiums they bill their insureds) The Griffith Insurance Education Foundation

39. Solvency, Pricing, Rate Adequacy • Insolvency result of catastrophic losses, inadequate reserves and rates, mismanagement, bad investments, etc • Premium pricing function of expected losses, expense loading, investments • Rates regulated to balance insurer profitability and prevent consumer gouging The Griffith Insurance Education Foundation

40. Regulatory Methods to Ensure/Monitor Insurer Solvency • State insurance departments utilize strict methods and requirements to maintain insurer solvency • Licensing and financial requirements • Risk-based capital standards • Submission of financial statements • In-field examinations of insurer practices The Griffith Insurance Education Foundation

41. Policy Forms • Insure Consistency of Product • Consistency of Interpretation of Language • Set Coverage Standards The Griffith Insurance Education Foundation

42. Balance between Consumers and Insurers • Government Failure vs. Market Failure • Bad Faith vs. Fraud • State Guaranty Funds vs. Moral Hazard • Sound Underwriting vs. Red Lining The Griffith Insurance Education Foundation

43. Rate Filing • Interstate Insurance Compact • Must Insure Solvency • McCarran-Ferguson Act • Prevent “Destructive” Competition The Griffith Insurance Education Foundation

44. Issues in Insurance Legislation • Tag initiative uninsured drivers loss of state revenue • Workers Compensation • Captive Insurance The Griffith Insurance Education Foundation

45. Questions? Comments? The Griffith Insurance Education Foundation

46. INFORM+INSPIRE Thank you for allowing us to present this seminar on Insurance and Risk Management. Please contact us if we can be of further assistance.This presentation can be downloaded at: www.griffithfoundation.org/public-policy/resources/ Melissa Kuhn Wheeler, The Griffith Insurance Education Foundation, (855) 288-7743, mwheeler@griffithfoundation.org Dr. Stuart MacDonald, (405) 974-2152, smacdonald@uco.edu Gerald Wilkins, (405) 974-5566, gwilkins@uco.edu Allen Arnold, (405) 974-2171, aarnold1@uco.edu The Griffith Insurance Education Foundation