After studying this module, you should be
able to:
- Discuss the operation and structure of
insurance market
- Identify the different types of insurance
companies
- Identify the different types of intermediaries
- Identify the types of insurance buyers
- Outline the different distribution channels
used for buying and selling of insurance
Principles and Practices of Insurance
Introduction
A market is broadly defined as a place where buyers and sellers meet
to exchange goods and services. Insurance is a market and although
there may be no physical meeting place it is still a market where
buyers and sellers are brought together often with the assistance of
intermediaries.
In this module, we shall examine the structure of the insurance market
and the different groups of buyers, sellers and intermediaries that
together make the market place. Reinsurers’ role in the market is also
considered
Finally, we shall look at the role played by other parties who supply a
service to the insurance industry.
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Principles and Practices of Insurance
4.1 - Components of the insurance market
A market is where buyers and sellers meet to conduct business but
this does not necessarily have to be a physical meeting place. Modern
technology has made communications between parties much easier and
business is done at a time and place more convenient to everyone.
The insurance market includes three publicly known groups with a
fourth group known primarily by those within the industry.
The three publicly known groups are the buyers of insurance, the
intermediaries (middlemen), and the sellers of the service, collectively
known as insurers. The fourth group are the reinsurers who support
insurers.
In this section, we shall become familiar with the sellers or providers of
insurance, the insurers. The most well known are insurance companies,
who provide insurance to the public. These are classified according to
their ownership structure or type of business written.
Proprietary Companies
Shareholders who have either supplied the share capital or purchased
shares in the company own proprietary companies. It is to the
shareholders that any profits belong, in the form of dividends. The
shareholders would however endure the cost of any losses and could
lose their entire investment.
Mutual Companies
Policyholders own mutual companies and who share any profits, usually
either a bonus (mainly life assurance) or lower premiums for other types
of insurance.
Specialist/Composite
A specialist insurance company (either mutual or proprietary) is, as its
name implies one that specialises in a particular class of business. A
composite company on the other hand is one that deals with all, or
certainly the majority of classes of business.
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Principles and Practices of Insurance
Let us take a look at the concept of self –insurance, when a business
will make a conscious and deliberate decision to retain risk for itself. In
order to facilitate this process a business enterprise may form a captive
insurance company.
A parent company, typically a substantial national or multi-national
organisation, will form a subsidiary captive insurance company to insure
its own risk. Originally, designed as a tax efficient method of retaining
risks, though many of the original tax incentives have closed they are
still a very popular method of self-insurance for a company.
The captive insurer is not registered as an insurance company (even though
it may have the title in its name) and cannot do business with the public.
Trading sectors of the parent company pay premiums to the captive
who issue policies and deal with claims as a commercial insurer. Like a
commercial insurer, it will also protect its fund by using reinsurance.
Lloyd’s of London
A unique institution Lloyd’s began as
a marine insurer in the 1600’s. At that
time, Edward Lloyd’s coffee house in
London was a meeting place for people
generally interested in shipping that
gradually became a centre for marine
insurance. They increasingly wrote other classes of business and in 1871,
Lloyd’s Corporation was set up to govern and administer their affairs.
Lloyd’s is not an insurance company and does not itself transact business.
It provides the facilities (building, administrative support etc) for its
members who transact business. For many years, these were individuals,
operating on an unlimited liability basis, who formed themselves into
syndicates. The syndicate would appoint an underwriter to accept
risks on behalf of the syndicate. At one time Lloyd’s had some 30,000
individuals (known as names) grouped into some 400 syndicates.
Following a series of disasters in the 1980s and early 1990s, a large
number of these names lost their life savings. In some cases, family
fortunes built up over several generations were lost. Since that time the
number of names have reduced and Lloyd’s have allowed corporate
members with limited liability to join.
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Principles and Practices of Insurance
It is a feature of Lloyd’s that it does not deal directly with members of the
public. They only accept business from Lloyd’s brokers (insurance brokers
who have been approved by the Council of Lloyd’s) and only Lloyd’s
brokers are permitted on to Lloyd’s trading floor (known as the ‘room’)
Lloyds website: www.lloyds.com
The State
In many territories the state will also act as an insurer. This may be because
insurance is a nationalised industry or where the state has declared a
certain type of insurance compulsory (workmen’s compensation or
third party motor for example) and then insures that class of business.
There are several other examples of types of insurers but these are
formed due to legislative or tax consideration in particular countries.
Friendly Societies, Mutual Indemnity Associations, Industrial Life are
examples from the UK of insurers who exist because of a tax and
legislation advantages.
In any typical market place, sellers compete with each other for business.
Think of a market with which you are familiar e.g. local vegetable market,
a market for consumer goods, say a TV or newspapers. List the various
methods that the suppliers of these goods use to attract customers.
Now consider the suppliers of insurance. Do they use the same methods
you have outlined above or do you think there are differences?
Buyers of Insurance
Buyers of insurance are usually classified into two broad groups, private
individuals and commercial organisations. The needs of each group
are different and the types of policies arranged for each group are
different.
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Principles and Practices of Insurance
Private individuals usually referred to as personal insurances or personal
lines and the bulk of the market is in respect of private motorcars and
houses insurance.
Other insurances in this sector include travel, life and personal accident.
Individually the premiums are not large but together the personal lines
market can produce a large volume of business.
It is however the commercial sector that supply the bulk of the premium
income for insurers. Most insurance companies are organised on the
lines of personal and commercial with possibly the commercial sector
sub-divided according to size or type of insured.
A third category occasionally used is that of public bodies or not for
profit organisations. These organisations provide a public or voluntary
service, charities, government departments, schools, hospitals, sports
clubs etc.
What do you think is the advantage to insurers of classifying buyers
into personal and commercial?
4.2 - Intermediaries
Introduction
In general, the term agency describes a situation when one party (the
principal) authorises another party (its agent) to act on its behalf. The
rights and duties of each party are subject to the law of agency. In
insurance, the term agent has a different meaning and therefore to avoid
confusion between the insurance agent and the general law of agency
it has become customary to use the term intermediary when referring
to insurance.
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Principles and Practices of Insurance
It is quite possible and in many cases
quite common for buyers to go direct
to an insurance company and purchase
insurance. They will consider and decide
their insurance requirements, find the
correct insurer and negotiate accordingly.
Others may decide they need someone
to act on their behalf, provide impartial
advice, and consequently visit an insurance intermediary.
The intermediary is a middleman whose role is to bring buyers and
sellers together into a contractual relationship. He receives payment in
the form of commission deducted from the premium that is payable to
the insurer. Although insurers pay the commission and it is with insurers
that he may have a close and long term professional relationship, it is
the insured who is the client and the insured for whom the intermediary
is acting.
One of the problems when considering the intermediary sector of the
market is its fragmentation, with a variety of people doing the role and
many with different titles although they may be effectively doing the same
job. Brokers, consultants, agents and advisers are titles intermediaries
may call themselves. Some countries have tried to regulate this sector
of the market by using legislation to control who may use titles or who
may perform certain functions.
Intermediaries in KSA
The implementing regulations of the Saudi Arabian Cooperative
Insurance Companies Control Law have defined the participants in this
sector into three types.
SAMA is still introducing the regulations and their impact on the
structure of the market is unknown. Before the regulations, it was a
fragmented sector comprising Brokers, Agents, Consultants and others,
many of whom are professional but others less so and simply using the
title to give themselves status. Within the industry professional could
recognise each other but to the insuring public their competence is
unknown.
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Principles and Practices of Insurance
Brokers
Traditionally an insurance broker is an individual or firm whose full
time occupation is insurance. Use of the term broker implies that
they are holding themselves out to be experts in insurance. They are
knowledgeable about insurance and can give independent and impartial
advice to a policyholder on their professional needs. They know the
insurance companies in the market and which offers the most appropriate
product for their client’s need at the most favourable terms.
In KSA there are local companies operating nationally often with
international connections and they compete with multi-national
companies who operate in many territories and employing several
thousands of staff. The larger multi nationals have in excess of 50,000
employees, over 500 offices in more than 120 countries and enjoy
revenues in excess of US$8Billion.
The regulations make it clear that a broker is representing his client
whose interests should be of primary importance.
Agents
Traditionallyaninsuranceagentiseitherafulltimesalespersonrepresenting
a single insurance company or a part time insurance salesman who has
other business interests that provided an opportunity to sell insurance.
Typical would be the car dealer who sells a car and insurance to go
with it. Estate agents, accountants, legal personnel are other examples.
These part time agents normally confine their activities to introducing
the business; they do not claim to be experts in insurance and will not
offer guidance except in the most general way
The new regulations make it clear that an insurance agent represents
the insurance company and can only give advice on, or recommend the
products for that one company.
Advisor
The regulations introduce the advisor as someone who provides
consultative services. Brokers and agents receive a commission on the
products they recommend to the policyholder but it appears that this
category of insurance service provider will be paid by charging a fee,
based on the service provided for giving consultation and advice that
may not necessarily result in the purchase of an insurance product.
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Principles and Practices of Insurance
Your friend has asked your advice about buying insurance. He wonders if there is
any advantage in visiting a broker. What would you reply?
4.3 - Distribution channels
The distribution channel of a product describes the methods used
to bring a product from its manufacturer to the final consumer. In
insurance, the ‘manufacturer’ is the insurer and in order to distribute
his product there are two principal routes; either, direct to the consumer
or indirect, using intermediaries. Each has their benefits and drawbacks.
Some companies prefer to deal with one method exclusively whilst
others use a combination of the two.
Direct Business:
Direct business involves the insurer selling his product direct to the
insuring public without any independent intermediary being involved.
A traditional method of direct selling is to employ a direct sales force and
although paid on a ‘commission only’ basis, they are employees of the
company. This system is very popular especially with life assurance.
There has been a great expansion of
direct business in the last decade or
two mainly in personal lines business.
Improvements in communications
and the use of computers makes it
possible to do business from a central
processing office (a call centre) with
quotations and cover given instantly over the telephone. These direct
companies pay no commission but need to advertise heavily. This type
of business is mainly suited to personal lines insurance, primarily car
and house insurance.
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Principles and Practices of Insurance
Indirect Business:
Intermediaries introduce business to the insurance company in return
for which they receive commission. The insured receives the benefit of
independent and impartial advice from the broker who will place the
business with the company that offers the best terms and conditions for
his client’s business. The broker may also assist his client in dealing with
claims or any other problem with the insurance. Intermediaries, usually
insurance brokers arrange the majority of commercial business.
The insurer will have to pay commission to the broker but has no
major advertising expense. The relationship with the broker can be long
standing and because the brokers are themselves professionals, insurers
can entrust a great deal of the administrative work to them.
Many brokers do not wish to handle
too much personal lines insurance,
as the individual premiums can be
relatively small for work involved.
With the improvements in technology,
the trend has been for personal
business to be handled direct and
commercial insurances indirect. This trend may continue as the future
makes communication easier in the form of WAP mobile telephones,
Interactive Digital TV, the Internet and whatever else the future may
bring.
Why do you think that direct business is more suited to personal lines
insurance e.g. private car insurance than to commercial business?
Reinsurance
Reinsurers are part of the supply chain
as they support and extend the supply
of insurance. They accept business only
from insurers, i.e. insurance companies
(including captives), Lloyds and other
reinsurers, often dealing through an
intermediary, the reinsurance broker.
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Principles and Practices of Insurance
Reinsurers may be a specialised reinsurance company i.e. they do not
transact business with the insuring public. Insurance companies also act,
as reinsurers, through either a separate division or subsidiary company.
Lloyd’s syndicates are also active in reinsurance.
Reinsurance also has a ‘jargon’ of its own such as retrocession, cedant,
ceding office. (See Glossary for explanation of these terms). Reinsurance
is an international business and risks shared in many parts of the world
by co-reinsurers are spread over several reinsurance companies.
Insurance operates because it shares the losses of the few by the many by
transferring risk. How does reinsurance fit into this broad concept?
4.4 The role of ancillary players in the insurance market.
We have looked at the insurance market and the various roles
of the parties involved in the
industry -the buying public,
intermediaries, insurers and
reinsurers. There are also other
businesses working in the
industry, not directly involved
with the supply of the product
but providing services and
support to the industry. We shall
consider the principal ones.
Actuary
Actuaries use mathematical and statistical techniques to solve business
problems by predicting future events. They have been used in life
assurance for many years but are more and more being used in general
branch insurance.
Companies may employ actuaries or use the services of an external
actuarial consultancy company.
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Principles and Practices of Insurance
Loss Adjusters
Loss adjusters are employed by insurers to handle and process claims
on their behalf.
Some companies employ loss adjusters to
handle the majority of their work and others
prefertohandleallclaimsinternally.However,
even these companies will need the services
of a loss adjuster at some stage either for a
particularly large claim that requires detailed
investigation and negotiation or when there
are a large volume of claims to be dealt with.
A loss adjuster specialises in insurance claims. He will investigate the cause
of the loss, check that policy conditions have not been breached, negotiate
with the insured and make a final recommendation, which should be fair
and reasonable to both the insured and insurers, for settlement.
Loss adjusters hold themselves to be independent but insurers who
appoint them pay their fees.
Loss Assessors
Loss assessors are appointed by the insured to prepare, present and
negotiate a claim on their behalf.
It is the duty of the loss assessor to negotiate the maximum entitled
settlement under the terms and conditions of the policy and to provide
support to the claimant during the processing of a claim. He is paid by the
insured usually based on an agreed percentage of the final settlement.
As far as it is known, there are no loss assessors operating in the Kingdom
although the service of assisting in the preparation, presentation and
negotiation of a claim may be offered by some intermediaries.
Risk Management:
Industry and commerce employ risk managers although insurance
brokers may offer a risk management service on a fee basis. There are
three steps in risk management, first risk identification followed by a
risk analysis and finally risk control.
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Principles and Practices of Insurance
The first stage is to identify the risks that a business enterprise is exposed.
This could be physical, financial or monetary. Having identified the risk,
it will be analysed possibly using past data, examining the frequency and
severity profiles, and trying to predict the future outcome. Finally, the
risk manager will try to control the risk preferably by eliminating it (e.g.
changing work practices) reducing it (locks and bolts to prevent theft)
or by transferring it (insurance).
Risk management and insurance are closely linked but insurance is only
one option available to a risk manager when deciding on risk control.
Insurers employ loss adjusters to investigate claims and loss assessors
by policyholders to prepare and present a claim on their behalf. They
operate in only area i.e. they are either a loss adjuster or loss assessor. It
would be unusual for one business or person to work in the area of the
other. Why do you think this is so?
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Principles and Practices of Insurance
Progress Check
Directions: Choose the best answer to each question.
1. The company owned by its shareholders is a
a. proprietary company
b. mutual company
c. reinsurance company
d. captive company
2. The company who insures insurers is a
a. proprietary company
b. mutual company
c. reinsurance company
d. captive company
3. The company that distributes its surplus profits to its policyholders is
known as a
a. proprietary company
b. mutual company
c. reinsurance company
d. captive company
4. The company that does not provide insurance to the general public is
called a
a. proprietary company
b. mutual company
c. reinsurance company
d. captive company
5. What is the difference between a specialist company and a composite
company?
a. Specialist deal with one type of insurance while composite in many
b. Composite deal with one type of insurance while specialist with one
type
c. Specialist cannot be mutual
d. Composite cannot be captive
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Principles and Practices of Insurance
6. What is the difference between a broker and an agent?
a. Broker deal with one insurance company while agent with many
b. Broker deal with many policyholders while agent with one
c. Broker deal with many insurance companies while agent with one
d. Broker deal with one policyholder while agent with many
7. Insurance may only be placed at Lloyd’s through a Lloyd’s
a. Agent
b. Underwriter
c. Loss adjustor
d. Broker
8. An insurer doing only direct business will claim to have lower costs
because;
a. They pay no commission
b. They do not advertise
c. They pay lower salaries
d. They take less reserves
9. A loss adjustor:
a. Assesses the financial impact of future uncertain events
b. Investigates claims on behalf of insurers
c. Prepares and presents a claim on behalf of an insured
d. Advises a manufacturer on safety and loss control
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