Topic 9 Characteristics of Risk Insurance I Economic View of Insurance A The transaction can occur only when the premium charged by the insurer is higher than the minimum premium the insurer is willing to accept and lower than the maximum premium the insurance buyer is willing to pay B Supply and Demand 1 Demand The higher the price the smaller the quantity that consumers are willing to purchase Alternatively the smaller the quantity that can be purchased the higher the price that consumers are willing to pay to offer and vice versa the higher the price of a product the greater the quantity that sellers are willing 2 Supply 3 Combining the supply and demand curves on one graph reveals that there is a point at which the two curves intersect a Market equilibrium P and equilibrium quantity Q 1 Can be attained in a free market demand and supply are equal reached at equilibrium price 4 The supply of and demand of insurance is influenced by many factors that depend not only on consumers and insurers but also on the economic and regulatory environment C Insurance Supply 1 Supply of a product depends on raw materials administrative costs manufacturing costs and the total compensation of the workers For insurance products the supply de pends on factors such as how much the insurers must pay for rent marketing services and salaries covered by the premium plus any losses the insurer has to cover 2 The fixed premium combined with the unknown cost of the promise to pay losses dis tinguishes insurance tom most other products or services sold in the economy 3 Supply of insurance is determined by a Capacity to assume new business b Investment opportunities c Production costs d Regulatory environment D Capacity to Assume New Business 1 An insurer s capacity to assume new business is limited by the risk that it will be unable to fulfill payment promises that is has made Insolvency Risk 2 3 The two major variables that affect an insurer s claims paying ability The risk of an insurers being unable to meet its financial obligations a The number and and the size of the policies sold its liabilities and the funds avail able to pay for the promises made under those policies its assets 1 Written Premiums during a particular period a Measures liabilities typically used as an approximation of the liability that The total premium on all policies written put into effect the insurer is expected to face in the future 2 Policyholders Surplus admitted assets minus its total liabilities a Measure of how much capital the insurer has to pay claims that are greater Under statutory accounting principles an insurer s total b Second variable is measured by assets stocks bonds real estate and other than expected investments E Premium to Surplus Ratio 1 Premium to Surplus Ratio A capacity ratio that indicates an insurer s financial strength by relating net written premiums to policyholder s surplus a Written Premiums Policyholder s Surplus b Indicates the extent to which insurers can issue new policies because it provides a rough measurement of how adequate available funds are ti pay unexpected claims measured by the total written premiums F Investment Opportunities 1 Until the event occurs for which the individual or organization bought insurance and the claim is made the insurer has the opportunity to invest the premium it collected at the start of the policy G Production Costs 1 The production of insurance involves a variety of expenses that limit the supply of in surance policies that an insurer can provide a Physical Office space company vehicles for claim representatives efficient informa tion system to track information such as the premiums paid the insureds the pay ments made to claimants etc b Human Salaries paid to claim representatives producer commissions compensa tion paid to underwriters etc H Regulatory Environment 1 Regulatory constraints on the supply of insurance a Business Practices Regulation licensing policy language minimum financial re quirements participation in residual markets b Price Regulation insurance rate increases underwriting factors used in setting pre miums for many lines of business I J 2 Regulators have used these powers primarily in automobile liability and in worker s compensation insurance lines although other lines have been affected on occasion Insurance Demand 1 Several factors affect the demand for insurance These factors relate to both the market and the characteristics of the typical insureds 2 See the exhibit Hurricane Andrew and the Supply of Property Insurance on p 9 12 Insurance Mandates and Regulation 1 Demand for insurance products and services does not necessarily have to be voluntary There are insurance mandates in many common lines of insurance auto worker s comp that increase demand for those insurance products a Most employers are required to provide the worker s compensation benefits pre b All these mandates and contractual requirements to purchase insurance increase scribed by law the demand for insurance K Risk Tolerance 1 The greater the individual s risk tolerance the less insurance that customer will pur chase a The cost of the premium outweighs the benefits of the reduced uncertainty when a consumer has a greater risk tolerance b A consumer s risk tolerance may change with age with economic or social condi tions or with a significant loss event like a hurricane c Alternatively a change in economic conditions may increase the cost of retaining risk so that risk tolerance is reduced L Financial Status 1 The higher an individual s income wealth or asset level is the more likely it is that an insurance policy will be purchased a As levels of income or wealth increase the demand for some forms of insurance ac tually diminishes because the individual has the financial resources sufficient to re tain losses as current expenses or use other forms of retention captive M Real Services Rendered 1 Insurers can achieve product differentiation by offering services that are valued by the consumers such as fast claims service loss control services or a personable sales force a Another way to increase demand is to introduce new insurance products such as extended warranty products for automobiles warranties for home buyers and in surance against financial losses resulting from identity theft N Tax Incentives 1 Tax incentives affect demand by encouraging people to purchase certain lines of insur ance in which the premium is tax deductible a Deduction is provided by the