Module 4 LG - Product Rating and Pricing PDF

Occupational Certificate: Insurance Agent: Insurance Underwriter Module 4 - Product Rating and Pricing NQF Level 5 48 credits DOCUMENT 5 LEARNER GUIDE Page 1 of 157 TABLE OF CONTENTS 1. HOW TO USE...

Occupational Certificate: Insurance Agent: Insurance Underwriter Module 4 - Product Rating and Pricing NQF Level 5 48 credits DOCUMENT 5 LEARNER GUIDE Page 1 of 157 TABLE OF CONTENTS 1. HOW TO USE THIS GUIDE --------------------------------------------------------------------------------------------- 4 2. ICONS -----------------------------------------------------------------------------------------------------------------------4 3. HOW YOU WILL LEARN-------------------------------------------------------------------------------------------------5 4. OVERVIEW OF THE MODULE ----------------------------------------------------------------------------------------5 1. INTRODUCTION--------------------------------------------------------------------------------------------------------------7 1.1 THE CONCEPT OF RISK -------------------------------------------------------------------------------------------------7 1.2 PROBABILITY BASICS----------------------------------------------------------------------------------------------------8 1.3 PRINCIPLES OF RATE MAKING ------------------------------------------------------------------------------------- 18 COMPONENTS OF A PREMIUM RATE --------------------------------------------------------------------------------- 22 1.4 RATING METHODS ------------------------------------------------------------------------------------------------------- 24 JUDGEMENT/INDIVIDUAL RATING ------------------------------------------------------------------------------------------- 24 CLASS/MANUAL RATING ----------------------------------------------------------------------------------------------------- 25 PURE PREMIUM METHOD --------------------------------------------------------------------------------------------------- 25 MERIT RATING ---------------------------------------------------------------------------------------------------------------- 28 2 SHORT TERM INSURANCE UNDERWRITING --------------------------------------------------------------------- 32 2.1.1 FIRE INSURANCE ------------------------------------------------------------------------------------------------------ 32 2.1.2 THEFT INSURANCE ---------------------------------------------------------------------------------------------------- 34 2.1.3 BUSINESS INTERRUPTION INSURANCE ----------------------------------------------------------------------------- 36 2.1.4 FIDELITY GUARANTEE INSURANCE---------------------------------------------------------------------------------- 38 2.1.5 BUSINESS ALL RISKS INSURANCE ---------------------------------------------------------------------------------- 43 2.1.6 GROUP PERSONAL ACCIDENT INSURANCE UNDERWRITING ---------------------------------------------------- 45 2.1.7 GOODS IN TRANSIT INSURANCE ------------------------------------------------------------------------------------- 48 2.1.8 MONEY INSURANCE --------------------------------------------------------------------------------------------------- 50 2.1.9 MOTOR INSURANCE --------------------------------------------------------------------------------------------------- 52 TELEMATICS ------------------------------------------------------------------------------------------------------------------- 53 2.1.10 MOTOR TRADERS EXTERNAL INSURANCE ----------------------------------------------------------------------- 56 2.1.11 MOTOR TRADERS INTERNAL INSURANCE ------------------------------------------------------------------------ 58 2.1.12 MOTOR FLEETS INSURANCE --------------------------------------------------------------------------------------- 60 2.1.13 HOUSE OWNERS INSURANCE -------------------------------------------------------------------------------------- 63 2.1.14 PERSONAL LIABILITY INSURANCE --------------------------------------------------------------------------------- 68 2.2 LIFE INSURANCE RATING -------------------------------------------------------------------------------------------- 76 TERM ASSURANCE ----------------------------------------------------------------------------------------------------------- 77 W HOLE LIFE POLICIES ------------------------------------------------------------------------------------------------------- 78 ENDOWMENT POLICIES ------------------------------------------------------------------------------------------------------ 78 ANNUITIES --------------------------------------------------------------------------------------------------------------------- 79 2.2.1 FUNDING METHODS IN LIFE ASSURANCE ------------------------------------------------------------------- 80 2.2.2 LIFE INSURANCE RISK: GROUPS -------------------------------------------------------------------------------- 81 2.2.3 THE NUMERICAL RATING SYSTEM ----------------------------------------------------------------------------- 81 2.2.4 LIFE INSURANCE PREMIUM SETTING ------------------------------------------------------------------------- 83 2.2.5 ANCILLARY/RIDER/SUPPLEMENTARY/LIVING BENEFITS --------------------------------------------------------- 87 2.3 GROUP LIFE INSURANCE -------------------------------------------------------------------------------------------- 91 2.4 GROUP LIFE PRICING-------------------------------------------------------------------------------------------------- 94 2.6 MEDICAL SCHEMES UNDERWRITING AND RATING ------------------------------------------------------ 96 2.6.2 PRESCRIBED MINIMUM BENEFITS ------------------------------------------------------------------------------ 98 W HAT ARE PRESCRIBED MINIMUM BENEFITS? -------------------------------------------------------------------------- 98 W HY PMBS W ERE CREATED? --------------------------------------------------------------------------------------------- 98 MEDICAL SCHEMES ROLE IN PMBS ------------------------------------------------------------------------------------- 101 Page 2 of 157 2.6.3 ACTUAL PRICING: MEDICAL SCHEMES --------------------------------------------------------------------- 103 2.7 THE UNDERWRITING CYCLE -------------------------------------------------------------------------------------- 105 2.8 INSURANCE RATIO ANALYSIS ------------------------------------------------------------------------------------ 110 2.9 UNDERWRITING REVIEW ------------------------------------------------------------------------------------------- 116 2.11 UNDERWRITING BEST PRACTICES --------------------------------------------------------------------------- 119 3.0 INTRODUCTION TO BASIC RESEARCH METHODOLOGY ------------------------------------------------ 122 3.1 PRINCIPLES OF RESEARCH --------------------------------------------------------------------------------------- 122 3.2 RESEARCH THEORIES ---------------------------------------------------------------------------------------------- 129 3.3 DATA COLLECTION METHODS ----------------------------------------------------------------------------------- 135 3.4 THE RESEARCH REPORT ------------------------------------------------------------------------------------------ 145 3.5 CONCLUSION ----------------------------------------------------------------------------------------------------------- 148 GLOSSARY OF TERMS --------------------------------------------------------------------------------------------------- 149 BIBLIOGRAPHY ------------------------------------------------------------------------------------------------------------- 156 Page 3 of 157 1. HOW TO USE THIS GUIDE This guide belongs to you. It is designed to serve as a guide for the duration of your training programme and as a resource for after the time. It contains readings, activities, and application aids that will assist you in developing the knowledge and skills stipulated in the specific outcomes and assessment criteria. Follow the guide as the facilitator takes you through the material, and feel free to make notes and diagrams that will help you to clarify or retain pertinent information. Jot down things that work well or ideas that come from the group. Also, note any points you would like to explore further. Participate actively in the skill practice activities, as they will give you an opportunity to gain insights from other people’s experiences. Do not forget to share your own experiences so that others can learn from you too. 2. ICONS Page 4 of 157 3. HOW YOU WILL LEARN The programme methodology includes facilitator presentations, readings, individual activities, group discussions, and skill application exercises. 4. OVERVIEW OF THE MODULE Insurers are in the business to make a profit. Their ability to make a profit depends on a number of factors namely, the stage of the underwriting cycle, the performance of investment markets, how well they manage their operating costs, the level of expertise they use in determining the acceptability of risk among others. This module focuses on the process of determining whether a risk is acceptable to an insurer in terms of its risk appetite. It is important to note that the underwriter is the second stage in the insurance transactions after the sales and marketing. The role of the underwriter should be assumed in view of its impact on the other functions such as marketing, finance, claims and human resources. There is a strong dependency between all the departments within an insurance company. The failure of one might cascade to all the departments. Success in one department also has the power to flow through to other departments. Sound decisions in underwriting is dependent upon the amount of information that is available in respect of the risk. The underwriter’s skill and experience also enables the underwriter to make sound decisions. The need for information therefore makes it mandatory for underwriters to be able to conduct different forms of research either formally or informally. In this module we will look at the different rating factors, discuss different research methodologies and look at different insurance products and competitors in the industry. After completing this module, you will be able to understand and apply different rating factors for different benefits, and use research effectively and efficiently to gain knowledge on competitors and different insurance offerings. Page 5 of 157 LEARNING UNIT 1: RATING FACTORS On completion of this learning unit you will be able to:  Identify and explain relevant rating factors  Identify and explain Underwriting considerations/ criteria  Quantify and calculate the risk  Apply the risk rating  Explain Product development and pricing  Describe the relationship between underwriting loss ratio, operating profits and the return on capital  Demonstrate understanding of insurance and financial technical terms relevant to underwriting rating and profitability Page 6 of 157 1. INTRODUCTION 1.1 The Concept of Risk Risk is the potential variation in outcomes. The outcomes could be either positive or negative. Thus risk must be viewed from both its upside and downside dimensions. Alternatively, risk can be defined as an object. Risk as object refers to physical objects such as buildings, motor vehicles, jewellery, or household contents. Some of the losses that might affect an object are: - Theft - Physical damage - Fire - Deterioration/depreciation. A person (i.e. a human being) can also define risk. In life insurance, an insurer considers human beings as risks in the sense that the insurer is insuring the person in the event of his/her death. A human being is further exposed to various risks that include namely: - Injury due to an accident - Disability which might make their life require adjustments in terms of the car they drive or the house they live in - Illnesses can affect an individual in various forms. These range from minor sicknesses such as flu to life threatening diseases such as cancer. - Loss of income due to retrenchment, illness or disability - Inability to honour their credit obligations due to death, illness or retrenchments - Death causes families to lose the support they had form breadwinners - Failure to meet living expenses - Inability to meet emergency cash obligations The list could be longer but these few risks show us the level of risks to which an individual can be exposed. Another way of defining risk is to define it as an event, i.e. loss causing an event such as a robbery, retirement, tsunami, earthquake, or road accident. Consequential versus Direct Losses Direct losses refer to a loss that arises from the loss of an object. For example, when a car belonging to a salesman is involved in an accident and the cost of repairs are estimated to be R50 000. The R50 000 refers to a direct loss. As an example, let us assume that the salesman, as a consequence of the accident, is unable to travel for a week and as a result, loses out on Page 7 of 157 commission/sales of up to R200 000. The R200 000 is a loss which has occurred as a result of the direct loss. Thus, it represents a consequential loss. In underwriting, insurers cover both risks depending on the policy wording. 1.2 Probability Basics An estimation of the proportion of outcomes in which a specified condition is expected to occur is known as probability. Supposed that the probability of a car accident in Gauteng is 0.20, it would mean that there is a 20% chance of at least one accident for 20% of the cars/drivers on the road. The other 80% will be accident free. The concept of probability is highly linked to the measurement of the chances of a loss and the size of the loss. These two concepts are critical in the pricing of insurance. Risk is made up of two parts: the probability of something going wrong, and the negative consequences if it does. Once an insurance underwriter has identified the threats faced, he/she will need to calculate both the likelihood of these threats being realised, and their possible impact. One way of doing this is via probability. Let us examine how to calculate the total probability of two or more events that are mutually exclusive (i.e. they cannot occur at the same time). The concept of probability began in the 1660’s. The theory of probability (also known as probability theory or theoretical probability) is a statistical method used to predict the likelihood of a future outcome. Probability theory is a means of predicting random events by analysing large quantities of previous similar events. To obtain a probability ratio, the number of favourable results in a set is divided by the total number of possible results. The probability ratio expresses the likelihood that the event will take place. In terms of life insurance and annuities, when analysing mortality rates, the insurer considers where the policyholder lives and what socioeconomic factors apply to the policyholder’s current age and health. Page 8 of 157 Mutually Exclusive Events Two or more events are said to be mutually exclusive if the occurrence of any one of them means the others will not occur. In probability, the outcomes of an experiment are what insurers call the “events”. Some events have relations with other events – i.e. some events effect the occurrence of other events. As an example, the losses may range from R0, R500 000, R1 000 000, R5 000 000 to R10 000 000. If the possibilities of the loss in the example above is given as 0.001 for R5 000 000 loss and 0.0005 for a R10 000 000 loss, the chances of a loss above R5 000 000 will be the total of the probabilities for losses R5 000 000 and above. That would be 0.001 plus 0.0005 = 0.0015. The sum of all probabilities under the mutually exclusive events is one (1). This is because at least one of the events (including non-occurrence) is certain to occur. You are given the following losses and their probabilities for a mining plant. Calculate the probability that a loss suffered will be above R20 000 000.00 Loss Probability R10 000 000.00 0.0007 R20 000 000.00 0.0005 R40 000 000.00 0.0003 R80 000 000.00 0.0001 Page 9 of 157 Independent Events Events where the occurrence does not preclude the occurrence of the other is known as an independent event. I.e. if an insured owns two buildings, one in Sandton in Johannesburg and the other in Waterfront in Cape Town, the occurrence of a fire in Waterfront will be independent from the occurrence of a fire in Sandton. Suppose that you, as the underwriter, are provided with the probabilities of the losses as follows: Risk Location Probability of a Fire Sandton Building 0.005 Waterfront Building 0.003 The probability of a loss occurring in both places is the product of their probabilities meaning that we simply multiply the two probabilities. 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝐿𝑜𝑠𝑠 𝑖𝑛 𝑏𝑜𝑡ℎ 𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛𝑠=𝑃𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝐿𝑜𝑠𝑠 𝑖𝑛 𝑆𝑎𝑛𝑑𝑡𝑜𝑛 × 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑙𝑜𝑠𝑠 𝑖𝑛 𝑊𝑎𝑡𝑒𝑟𝑓𝑟𝑜𝑛𝑡 =0.005×0.003= 0.000015 Outcome Calculation Probability Fire in Waterfront and in (0.005) (0.003) 0.000015 Sandton Page 10 of 157 Fire in Waterfront and none (0.003)(1-0.005) 0.002985 in Sandton Fire in Sandton and none in (0.005)(1-0.003) 0.004985 Waterfront No fire in both locations (1-0.005)(1-0.003) 0.992015 1.000000 The probability of at least one fire will be: 0.005 + 0.003 – (0.005 x 0.003) = 0.007985. Note that this is the same as Total Probability – Probability of no fire in both locations = 1 – 0.992015 = 0.007985. Africa connect is a leading telecoms company in Africa. It has operations in operations in various African countries. The table below show the probability of a fire at their various African offices Location Probability of a fire Lagos 0.0005 Dare Salam 0.0004 Pretoria 0.00045 Nairobi 0.0007 Calculate the probability that there will be no fire at all locations. Page 11 of 157 Dependent Events The occurrence of one event subsequently causes the occurrence of another event. For example, in the event of a fire, buildings that are next to one other may result in a scenario where a fire in one can spread to cause fire damage in the neighbouring property. To calculate the probability, the insurer/underwriter simply multiplies the probability of one and the conditional probability of the other. Conditional probability is simply the probability of one event inherent from the probability of the other. Let us assume that the probability of a fire in building A is 0.005 and the conditional probability of a fire in building B is 0.00015. The probability of fire damage at both building is = 0.005 x 0.00015 = 0.00000075 If the underwriter/insurer calculated that the probability of fire to both buildings suffering a loss is 0.00000075 and the probability of a fire in building A is 0.005, the conditional probability is calculated by dividing the total probability by the probability of fire in A. Result: 0.00000075/0.005 = 0.00015 Outcome Calculation Probability Fire in Buildings A & B 0.005 x 0.00015 0.00000075 Fire in A and no fire in B 0.005 (1-0.00015) 0.00499925 Fire in B and no fire in A 0.00015 x (1-0.005) 0.00014925 No fire in both 1-0.00000075-0.00499925- 0.99490000 0.00014925 1.00000000 SATO Building is located next to a very busy fuel station. It is estimated that if a loss were to occur at the fuel station, a subsequent loss will be highly likely at the building and vice versa. Given that the probability of a fire at the fuel station is 0.0002 and at SATO Building, it is 0.00005, calculate the probabilities for the outcomes in the table below. Page 12 of 157 Outcome Calculation Probability Fire in SATO Building & fuel station Fire at SATO Building and no fire at the fuel station Fire at the fuel station and no fire at SATO Building No fire at both premises 1.00000000 Probability Distribution Probability distribution explains the probability of occurrence of each outcome. It shows the probability of the occurrence of a certain number of losses. When a probability distribution shows the Rand amount of losses and the probability, that Rand amount probability distribution is a conditional probability in the sense that it reflects the Rand value of the losses based on the probability that the losses occur.. As an example, you (as the Underwriter) and asked to consider insuring 3 motor vehicles. The following distribution of the possible Rand value losses apply: Cost of Repairs (Rand) Probability 0 0.606 10 000 0.273 20 000 0.100 40 000 0.015 100 000 0.003 200 000 0.002 400 000 0.001 Note that the quantum of the losses are mutually exclusive therefore the total of all the probabilities will be 1. Assume that you, as an underwriter, has defined the acceptable Maximum Probable cost to be 0.002. On the table above, the underwriter will apply a Maximum Probable cost of R200 000, as there are 0.001 chances that the losses will exceed this amount. For values lower than R200 000, the probabilities will exceed the tolerance level of 0.002. For example, at Maximum Possible Cost (MPC) of R100 000, the probability that the losses will Page 13 of 157 exceed that amount is (0.002+0.001) = 0.003 which will be higher than the desired probability that the losses will exceed the MPC. Distributions of Probability and Risk Measures While the concept of probability gives the underwriter the mathematical calculations, distributions help us actually visualize what is happening underneath. Before considering distributions, the underwriter must first understand what kind of data he/she may encounter. The data can be discrete or continuous. Discrete Data, as the name suggests, can take only specified values. For example, when you roll a die, the possible outcomes are 1, 2, 3, 4, 5 or 6 and not 1.5 or 2.45. Continuous Data can take any value within a given range. The range may be finite or infinite. For example, a girl’s weight or height, the length of the road. The weight of a girl can be any value from 54 kgs, or 54.5 kgs, or 54.5436kgs. In mathematical calculations, there are six types of probability distributions:  Bernoulli  Uniform  Binomial  Normal  Poisson  Exponential. A Bernoulli distribution has only two possible outcomes, namely 1 (success) and 0 (failure), and a single trial. Uniform Distribution When you roll a fair die, the outcomes are 1 to 6. The probabilities of getting these outcomes are equally likely and that is the basis of a uniform distribution. Binomial Distribution A distribution where only two outcomes are possible, such as success or failure, gain or loss, win or lose and where the probability of success and failure is same for all the trials is called a Binomial Distribution. Normal Distribution Page 14 of 157 Normal distribution represents the behaviour of most of the situations in the universe. The large sum of (small) random variables often turns out to be normally distributed, contributing to its widespread application. Poisson distribution A distribution is called Poisson distribution when the following assumptions are valid: 1. Any successful event should not influence the outcome of another successful event. 2. The probability of success over a short interval must equal the probability of success over a longer interval. 3. The probability of success in an interval approaches zero as the interval becomes smaller. Exponential Distribution Exponential distribution is widely used for survival analysis. From the expected life of a machine to the expected life of a human, exponential distribution successfully delivers the result. Pooling In insurance, the term "risk pooling" refers to the spreading of financial risks evenly among a large number of contributors to the program. Insurance is the transference of risks from individuals or corporations who cannot bear a possible unplanned financial catastrophe to the capital markets, which can bear them easily – at least in theory. The capital markets, meanwhile, are generally happy to take on risk from individuals and corporations – in exchange for a premium they believe is sufficient to cover the risk. Risk pooling is essential to the concept of insurance. The earliest known insurance policies were written some 5,000 years ago, to protect shippers against the loss of their cargo and crews at sea. Any one of them would be devastated by the loss of a ship. But by pooling their resources, these ancient businessmen were able to spread the risks more evenly among their numbers, so each paid a relatively small amount. Under the Babylonians, those receiving a loan to fund a shipment would pay an additional amount in exchange for a rider cancelling the loan if a shipment should be lost at sea. The insurance industry has grown enormously, as individuals and businesses now seek to protect themselves from economic catastrophe by transferring their risks to an insurance pool. Page 15 of 157 As identified in Module 2, actuaries attempt to predict the probability and severity of risk. They also take lapse rates and interest rates or other expected rates of return on investment assets into account, with the goal of setting acceptable premiums. The premium is the cost of pooling one's own risk with that of others via an insurance company and includes the insured's share of expected claims costs, administrative expenses, sales and marketing expenses, and a profit for the insurer. If a premium payer is affected by a covered risk, the insurance company, and not the insured, takes the hit. If claims are higher than expected, however, the insurance company may have to raise rates on policy holders across the board. Not every negative economic event is insurable. For risk pooling to be effective, the risk should be unforeseen and infrequent. If a negative event can be predicted in a certain case, it's not a risk, but certainty – and certainties are not insurable (with the possible exception of death, which is insurable because its timing is uncertain). Furthermore, if a risk is too frequent, it cannot meaningfully be transferred to an insurance company, since the insurance company would only pass on the cost of the negative occurrence to the pool of insureds, along with their expenses and profits. Page 16 of 157 Benefits of underwriting to the insured and the insurer Continuous underwriting will empower insurers to positively improve their insureds’ lifestyles and to provide reduced underwriting risk. Accurate pricing results from continuous underwriting will also increase productivity. Benefits to insurer Benefits to insured Expert Risk Assessment Information symmetry Pooling with similar risks Profitability Equity between policyholders Maintains risk within Expert and sustainable Competitive rates mortality rates Pricing Spreads risk Access to cover Efficient Insurance Market Regarding probability and pooling I have learnt the following: Page 17 of 157 1.3 Principles of Rate Making Ratemaking is a key driver of insurance profitability and hence a primary actuarial responsibility. A rating manual is the document that contains the information necessary to appropriately classify each risk and calculate the premium associated with that risk. The final output of the ratemaking process is the information necessary to modify existing rating manuals or create new ones. The earliest rating manuals were very basic in nature and provided general guidelines to the person responsible for determining the premium to be charged. Over time, rating manuals have increased in complexity. For some lines, the manuals are now extremely complex and contain very detailed information necessary to calculate premium. Furthermore, many companies are creating manuals electronically in lieu of paper copies. Equitable When the Chinese merchants developed the concept of risk sharing, they each split their cargo into the vessels available so that there was a spread of risk and exposure.. In the event of a loss, each merchant would lose an equal portion of his or her merchandise in that vessel. This same principle is at the core of insurance rating today. It may seem like the company should be satisfied as long as the rates are expected to produce the desired aggregate target profit and should not, therefore, be overly concerned with individual rate equity. In reality, a company that fails to charge the right rate for individual risks when other companies are doing so may be subjected to adverse selection, and consequently, deteriorating financial results. Also, a company that differentiates risks using a valid risk characteristic that other companies are not using may achieve favourable selection and gain a competitive advantage. Page 18 of 157 Example: Noma is a female driver who owns a 2015 Tony owns a 2015 BMW 3 Series. In the BMW 3 series. In the past three years, she past three years, he has not had any has had four accidents amounting to R150 accident. 000. Assuming that Noma and Tony are the same age, live in the same neighbourhood and both have five years driving experience, Noma presents a higher risk than Tony and therefore her premium rate will be adjusted accordingly. In Rand terms, an equitable premium will be based on a cost per- Rand of cover not on a rand amount. This is because the values at risk are not the same therefore equitability will only be possible on the basis of the cost of proving cover for every Rand of insurance. Adverse Selection The goal of classification ratemaking is to determine a rate that is commensurate with the individual risk. Consider the situation in which a company (e.g., Simple Company) charges an average rate for all risks when other competing companies have implemented a rating variable that varies rates to recognize the differences in expected costs. In this case, Simple Company will attract and retain the higher-risk insureds and lose the lower-risk insureds to other competing companies where lower rates are available. This results in a distributional shift toward higher-risk insureds that makes Simple Company’s previously “average” rate inadequate and causes the company to be unprofitable. Consequently, Simple Company must raise the average rate. The increase in the average rate will encourage more lower-risk insureds to switch to a competing company, which causes the revised average rate to be unprofitable. This downward spiral will continue until Simple Company improves their rate segmentation, becomes insolvent, or decides to narrow their focus solely to higher-risk insureds and raises rates accordingly. This process is referred to as adverse selection. However, the speed and severity of the process depends on various factors, including whether purchasers of insurance have full and accurate knowledge of differences in competitor rates and how much price alone influences their purchasing decisions. Page 19 of 157 Favourable Selection Adverse selection deals with the case where a company fails to segment based on a meaningful characteristic that other companies are using, or fails to charge an appropriate differential for a rating variable that other companies are charging appropriately. Conversely, when a company identifies a characteristic that differentiates risk that other companies are not using, the company has two options for making use of this information: 1. Implement a new rating variable. 2. Use the characteristic for purposes outside of ratemaking (e.g., for risk selection, marketing, agency management). If the company chooses to implement a new rating variable and prices it appropriately, its new rates will be more equitable. This may allow the company to write a segment of risks that were previously considered uninsurable. If the company is already writing a broad spectrum of risks, then implementation of a new rating variable will have the opposite effect of adverse selection. In other words, the company will attract more lower-risk insureds at a profit. Some of the higher-risk insureds will remain; those who remain will be written at a profit, rather than a loss. Over the long run, the company will be better positioned to profitably write a broader range of risks. The motorcycle insurance market provides a good example of favourable selection. Originally, motorcycle insurers used very simple rating algorithms that did not include any variation based on the age of the operator. The first companies that recognized that the age of the operator is an important predictor of risk implemented higher rates for youthful operators. In order to keep their overall premium revenue neutral, they lowered rates for non-youthful operators. By doing this, the companies were able to attract a large portion of the profitable adult risks from their competitors. Furthermore, those youthful operators who chose to insure with them were written profitably. In some cases, the company may not be able to (or may choose not to) implement a new or refined rating variable. If allowed by law, the company may continue to charge the average rate but utilize the characteristic to identify, attract, and select the lower-risk insureds that exist in the insured population; this is called “skimming the cream.” If the company can effectively focus on attracting and keeping the lower-risk insureds, the company will be more profitable than the competitors. Ultimately, the company will be able to lower the average rate to reflect the better overall quality of the insured risks. In summary, the rate an insurance company charges must be adequate to cover all costs associated with the insurance policy. These costs include underwriting expenses (i.e., general expenses, other acquisition, commissions and brokerage, and taxes, license, and fees). Some of these expenses vary directly with premium and are called variable expenses; other expenses Page 20 of 157 are assumed to be the same for each risk (i.e., exposure or policy) and are called fixed expenses. There are three common approaches used to project underwriting expenses: the All Variable Method, the Premium-based Projection Method, and the Exposure/Policy-based Projection method. The first two approaches have historical precedence. The latter approach addresses some distortions that can result from the other methods if fixed expenses are a significant portion of total expenses. In addition to underwriting expenses, companies may also explicitly consider the cost of reinsurance as an expense in a ratemaking analysis. Companies are entitled to a reasonable expected profit. The two main sources of profit for insurance companies are investment income and underwriting profit. Traditionally, an underwriting profit provision is selected such that there is a reasonable expectation that the underwriting profit and investment income will generate total profit to appropriately compensate the insurer for the risk assumed. Possible Problems with Insurance Rating: Short Term Insurance  Insurance rate making is not the same as the pricing of other products (such as retail outlets) it is statistical and anticipatory  Influenced by regulation and public inspection; the rates must be justified to regulators and the public. This task can be very difficult.  Reconciling between the need for an adequate rate and an equitable rate in the context of the fiduciary role of insurers is difficult.  Statistics may not be adequate for accurate rates to be determined. Therefore, rates are based on market performance. The use of market performance can be viewed as a price cartel, which may attract penalties and negative publicity from the consumers.  Reasonableness and equity are difficult to measure  Moral hazard: Without insurance, the losses of businesses will be absorbed by the business and its owners therefore business owners will implement all possible risk control measures to reduce the exposure of their wealth. However, if the costs are too high and the consequences of losses can be transferred to an insurer, the businesses may not engage in costly risk control measures when the resultant losses can be borne by insurers. While insurers can curb this by imposing warrants and conditions, it is difficult (but possible with regular risk surveys) to continually monitor adherence to these. Page 21 of 157 Rating Problems Life Insurance Since the March 2011 gender ruling in the European Union, access to personal information such as AIDS status, genetics, foreign travel, sexuality, and disability now has constraints. H. Anti-discrimination laws prevent underwriters from discriminating certain risks in a fair way. In South Africa, the rating of medical schemes products cannot discriminate based on health status and age of the insured. This results in some of the challenges mentioned above as well as those mentioned specifically under the medical schemes underwriting section. Components of a Premium Rate A premium consists of two components, pure premium, and a loading. The pure premium is the component that covers the loss as well as loss adjustment expenses. Any additional premium is known as premium loading. This loading caters for other expenses as well as the insurer’s profit margin. The addition of the pure premium and the loading equals the gross premium, which is what the insured will pay. Page 22 of 157 The Premium Loading Component includes  Marketing  Sales/commissions  Salaries  Rent  Reinsurance  Electricity  Product development  Risk surveys  Profit margin Regarding rating principles I have learnt the following: Page 23 of 157 1.4 Rating Methods The three methods of rating insurance risks are: 1) Judgement/Individual rating, 2) Class/Manual rating and 3) Experience rating. Judgement/Individual Rating This method is used on individual risks and is reliant on the judgement of the underwriter. This method is adopted due to the uniqueness of each risk, which makes class rating unreasonable. Each risk exposure presents unique possible losses that differ from risk to risk. The judgement of the underwriter will be based on all available statistics, all factors that affect risk exposure as well as competition. This method exposes the particular class of business to “risky business” which may present challenges if the underwriter lacks exposure to the line of business and is less informed on the rates that competitors are charging. Discuss your opinions on this method of rating based on the principles of ratemaking. Page 24 of 157 Class/Manual Rating This method entails grouping similar risks and determining rates based on loss ratios. The grouping of risks is based on the similarity of factors that affect the risk. For example, houses may be grouped as follows: new with zinc, built of brick with alarm systems or old with zinc, built of wood with no alarm systems. The strength of this method lies in its simplicity when it comes to application as well as quick generation of quotes. It is more suitable in the following lines of business:  Personal lines - The underwriter complied with the rates in the underwriting manual to determine the category  Motor of the risk  Workmen’s compensation - When the category of the risk is identified, the  Life rate stated in the manual applies.  Health and  Commercial/fire Two approaches are used in class rating: Class Rating Approaches Pure Premium Approach Loss Ratio Approach Pure Premium Method This method considers the cost of claims and loss adjustment expenses. The total Rand value of the losses paid and the loss adjustment expenses is divided by the number of exposures. Incurred losses + Loss adjustment expenses Pure Premium = Number of Exposures Page 25 of 157 Assume: Motor losses (including loss adjustment costs) R300 000 000 Number of vehicles 700 000 Pure Premium = R300 000 000/700 000 = R428.57 In order to arrive at the final rate, the insurer adds a loading for profit and expenses. The formula below will be used to arrive at the final premium. Pure Premium Final Premium = 1 − Expense Ratio Assuming a 30% expense ratio, the final premium will be: Final Premium = R428.57/(1-0.3) = R428.57/0.7 Management of expenses related to = R612.24 the business of insurance is a critical component in determining profitability as well as affordability of premium. Assume Losses of cell phones R1 000 000.00 Number of cell phones 2000 Expenses ratio 40% Calculate the final premium per customer/cell phone. Page 26 of 157 Loss Ratio Method Under this method, the actual losses are compared with the expected losses. Loss Ratio Rating Formula A−E Rate = E Where: A = Actual Loss ratio & E = Expected Loss Ratio Assume: Losses R800 000 000 Earned Premium R1 000 000 000 Expected Loss Ratio 60% Firstly, we need to calculate the actual loss ratio. Actual loss Ratio = Losses Paid/Earned Premium = R800 000 000/R1 000 000 000 = 80% Rate = (80% - 60%)/60% = 33.33%. This means that the premium rate must increase by 33.33% as the expected loss ratio is lower than the actual loss ratio. Assume that the actual loss ratio is 50% in the above case, what will be the effect on premium? Page 27 of 157 Merit Rating This method follows class rating.. It takes three forms namely; schedule rating, experience rating and retrospective rating. Forms of Merit Rating Experience Retrospective Schedule Merit Rating Schedule Rating The rate is adjusted up or down based on the positive or negative features of the risk. For example, commercial and engineering risk rates are adjusted based on construction, occupation, protection, exposure and maintenance. Positive features result in discounts while negative features attract a loading. Experience Rating The rate is adjusted based on the loss experience for the past three years. This past experience is used to determine the future premium. If the individual’s loss experience is worse than the class, the base rate is loaded and when the loss ratio is lower than the class rate, the class rate is discounted. Retrospective Rating The premium is not known at the beginning of the period of cover. It will only be known at the end of the period. There is a minimum and a maximum premium payable. A provisional premium is charged and as the losses increase, the premium will be increased accordingly. Page 28 of 157 Where claims may take a longer than average time to settle, there might be the need to adjust the premiums accordingly. This method is suitable for big organisations where the chances of loss fluctuations are very high. Consumers with very low loss ratios may also find this method of rating attractive. An organisation that anticipates the loss ratio to improve may also opt for this method. Insurers however may also adopt this method where they expect the loss ratio to be high or to worsen. This method works like a self-insurance and may look like an open credit line provided by the insurer. Retrospective Rating: Premium-Loss Relationship Maximum Premium Premium Minimum Premium Losses A variation of the retrospective rating is called the paid loss retro. Whereas under the standard retrospective rating the insured’s premium is adjusted when the loss ratio exceeds a certain amount and at the time of acknowledging this liability by the insurer, the insured will pay the additional premium. Under the paid loss retro, the insured pays the insurer only for losses that have been settled. Regarding rating methods I have learnt the following: Page 29 of 157 Page 30 of 157 LEARNING UNIT 2: INSURANCE PRODUCTS AND SUPPLIERS On completion of this learning unit you will be able to:  Identify and compare benefits, exclusions and cover of similar products from different product suppliers in Short Term, Long Term and medical, distinguishing between direct insurers, insurers and brokers in all three sectors  Explain the use of different insurance Product types (group, pension benefits, long term, short term and medical) including compulsory insurance in existence and proposed (Road Accident Fund (RAF), Unemployment Insurance Fund (UIF), South African Special Risks Insurance Association (SASRIA), Compensation for Occupational Injuries and Diseases Act (COIDA), National Health Insurance (NHI)). Page 31 of 157 2 SHORT TERM INSURANCE UNDERWRITING 2.1.1 Fire Insurance The acronym COPE is useful in assessing the risk. C Construction What materials are used in the construction of the building? Combustible materials such as wood and plastic increase the chances of a fire whereas; brick and zinc are less susceptible to fire. O Occupation The business activity at the premises will determine the chances of a fire. Businesses such as filling stations or steel products manufacture where there is use of open flames present a higher fire risk than churches and universities P Protection Considers measures that are in place to reduce chances of occurrence (strict and regular removal of waste, separation of rooms using firewalls or prohibition of smoking) and measures that limit severity of risk if a fire actually occurs (e.g. proximity to the fire station, automatic sprinklers, fire extinguishers, fire alarms etc.) E Exposures Arising out of the neighbouring building. A less hazardous risk such as a school located next to company manufacturing explosives will pose higher risk due to the neighbouring building. This is critical when considering shared buildings. The underwriter needs knowledge of all the business activities in the building in order to establish the right level of risk or exposure to risk. The approach may involve rating the risk using the highest risk in the building or adopt an average rate based on all the risks in the building. In addition, the following factors must be considered:  Loss ratio  Sum insured: Higher sums insured present a higher severity risk.  Special perils covered: These increase the obligation of the insurers and may present unique exposures. Care should be exercised where there is lack of statistics or experience on special covers. Page 32 of 157   Accumulation risk: this will arise from a concentration of risks covered by the same insurer in the same place. If a catastrophe, i.e. a tornado - hits that area, the insurer will suffer catastrophic losses, which may threaten the survival of the insurer. Technologies are now available where the underwriter can identify similar risks in the same location when new cover is accepted. The existence of catastrophic excess of loss reinsurance covers also pay a critical role in controlling the exposure in respect of accumulation risk.  Piling: The height of stakes may cause fire detectors and sprinkler to malfunction when they are needed the most (in the event of a fire).  Stock: Linked to occupation but consideration is made of the nature of stock in term of combustibility. Stock such as plastic, towels, and paper are high fire exposure risks. Discounting Factors An underwriter should obtain further information (ideally in the form of a Risk Survey) on the following to determine where/when discounting should be applied: - Fire resistant construction - Fire alarms linked and serviced regularly - Hose reels and fire extinguishers that are serviced regularly - Fire sprinklers - Separate storage of hazardous materials. Where additional covers are incorporated, care must be exercised since these may increase the exposure. These other covers include explosion, earthquakes, special perils; impact by animals and trees, aircraft and aerial devices dropped therefrom, leakage, landslip and subsistence, malicious damage and riot and strike. Regarding landslip and subsistence, a special report may be required from an engineer and a limit of cover must be set to limit the insurer’s exposures. Certain geographical locations in the Westrand and Cape Town are prone to landslips and subsidence. Suggest ways of managing the accumulation risk in fire insurance. Page 33 of 157 2.1.2 Theft Insurance Caters for loss of or damage to property accompanied by forcible entry or exit from the building. The threat of violence is also normally covered. Cover is for the following:  Contents  Building, as listed on the schedule  A break-in  Armed robbery. Theft Insurance Extensions a. Concealed thieves before close of business b. Use of skeleton keys/devices and NOT duplicate keys c. Damage to buildings during theft d. Theft of buildings, fixtures and fittings e. Replacement of keys and locks f. Personal items belonging to employees up to a certain limit on condition that the items are not insured elsewhere. g. Replacement of lost records excluding the value of the records. h. Fire policy covers related to theft i. Glass insurance cover related to theft j. Property specifically insured elsewhere k. Theft by employees or family members The alarm is required to be fully operational when there is no one in the building. Further it must be fully maintained. Use of alarm key or code is excluded unless force was used to obtain it. Page 34 of 157 Theft Insurance Underwriting The following factors are used to assess the level of risk in theft insurance:  Insured’s credibility: determine the moral hazard associated with the risk. Where the insured has a history of dishonesty or has a propensity to cause the loss, then the risk is higher.  Nature of goods covered: the question here is whether the goods will attract thieves. Goods such as jewellery and cigarettes are more prone to theft than vegetables and books.  Protection against theft: The presence of burglar bars and linked alarms will reduce the theft exposure.  Whether the building is a lock-up (where it is just storage) or it is occupied. A lock-up will be more exposed than an occupied building.  Location: Cities like Johannesburg and other industrial sites present the highest risk when compared to the rest of the country  Sum insured: The higher the value insured the higher the risk assumed. Note that cover might be on full value of first loss.. A first loss basis of cover is based on the premised that it is impossible for all the contents/stock of a building to be stolen at once. Therefore, the insured estimates a maximum amount of goods that may be stolen at any point in time. This amount is less than the full value of the contents. For example a warehouse containing groceries worth R500 000 000.00 may suffer a loss of up to R1 000 000.00 in any one incident.. Thus, the cover will be up to R1 000 000.00. Page 35 of 157 2.1.3 Business Interruption Insurance Business interruption insurance is a type of insurance that covers the loss of income that a business suffers after a disaster. Fire Risk This is based on the exposure to the fire risk. Refer to the fire section. The higher the fire risk the higher the risk of business interruption. Indemnity Period The indemnity period defines the period beginning with the loss until the business resumes normal operation after a loss. Indemnity Period Premium Loading (average) Indemnity Period Loading to the Basic Rate 3 Months 50% 6 Months 60% 9 Months 80% 12 Months 90% Interruption Risk Based on the nature of the business, availability of equipment, business continuity plan and other factors, some businesses will take longer to resume business while others will take a shorter time. The longer it takes to resume business the higher the exposure faced by the insurer and vice versa. Separation of Risks This is in relation to the extent to which all properties belonging to the insured will suffer losses at the same time. Seasonality While some businesses such as bread producers have an almost uniform demand throughout the year, other businesses are prone to seasonality of demand. Businesses such as Hoteliers experience huge dwellings around the Festive/Christmas Holidays. Thus, the estimation of the risk must bear in mind the fact that the loss may occur when the business is at its peak in terms of profit/revenue. This will present a higher than normal exposure in the off-peak period. The sum insured (gross profit) must also be estimated based on the seasonality of the business. Page 36 of 157 Other Factors The following factors must be evaluated: - Possibility of loss of consumers to competition. - Value of the building. - Extensions sought: - Dependency on other sites (consumers or suppliers): The insured may experience a loss of profits due to a fire at a significant customer or supplier. An underwriter must seek to establish the level of dependency. - Material damage cover. Research the importance of the use of the material damage clause in business interruption insurance. (Also obtain detailed information on the clause itself and the conditions that come with it). Page 37 of 157 2.1.4 Fidelity Guarantee Insurance Cover and Definitions Fidelity guarantee insurance covers theft of money and/or property of the insured or for which the insured is responsible by an insured employee. Cover will only attach if there was a financial loss to the insured and a financial gain on the part of the insured employee. If the loss cannot be quantified then there will be no cover. Most insurers stipulate that the loss must be discovered within 24 months of the event or 12 months after the termination of cover or the employee leaving the organisation whichever occurs first. An employee refers to:  A contract service  Apprentices  Hired or seconded by another to the insured  The above must be governed, controlled and directed by the insured. Basis of Cover It can be either blanket basis or named/positions basis Blanket Policy - Covers all employees - Sum insured is per event and it does not matter how many employees where involved Named/Positions Policy This policy identifies individuals who handle money or property, which they may have the potential to steal. The names or positions are listed for example chief accountant or cashiers. The sum insured is per person so if there were more than one person involved in a fraud case, the sums insured will be aggregated. Fidelity Guarantee Rating Due the higher possibility of theft under the named/positions basis, it attracts a higher premium than the blanket basis. Fidelity Guarantee Underwriting Factors  Nature of the business Page 38 of 157   Internal control measures  Employee selection and screening processes  Separation of tasks to inhibit the ability of an individual to manipulate processes  Do certain individuals work alone  Internal and external audits frequency.  Extensions sought  Past claims: Moral hazard measured against the measures that have been put in place to limit recurrence of losses in the future by the insured. Fidelity Guarantee Insurance Exceptions Excluded perils are: a. Theft by a partner, principal, director or member unless as an employee or an employee who has already committed some fraud. b. Consequential loss c. Computer fraud by people working in the information technology section unless the computers are not linked/networked. Important Points During the period of insurance, the insured may change his business model but must maintain strict controls to reduce the exposure of the business to losses. Typical Fidelity Guarantee Clauses and Extensions Extension Description Accountants clause In the event of a loss, the insurer will rely on the records from the insured’s auditors or accounts. This removes the need to have other accountants doing the same task that has already been done by the insured’s accounts. Past Employees Covers fraud by employees who have left the organisation for any fraud that they commit within 30 days of leaving employment at the insured. Employees who leave the company may still commit fraud. It is possible that they will have left with the intention to commit fraud. Retroactive cover Where there was no cover before it allows for losses from 12 Page 39 of 157  months before inception of the policy but that are discovered within 24 months of the event. Load the premium for this extension. Superseded policy Absorbs losses that would ideally would have fallen under a previous policy. However, the losses are discovered late and cannot be recovered under the previous policy. Other insurance Allows the insured to be able to recover from other policies like money, pension policy or any other policy declared by the insured. Excesses: Example: Sum insured is R1 000 000 and loss is R200 000. First Excess: 2% of 2% of R200 000 is R20 000. sum insured Balance = R200 000 – R20 000 = R180 000 Second Excess: 10% Second Excess = 10% of 180 000 = R18 000 of balance of loss after deducting the first Total Excess = R20 000 + R18 000 = R38 000 excess Net loss = R200 000 – R38 000 = R162 000. Non-networked  Increase the second excess to 10% and second excess to computers 20%  Losses discovered within 12 months 4% and 15% for first and second excesses respectively.  Losses discovered after 24 months but within 36 months; 5% and 20% first and second excesses respectively with computer losses at 35%. Voluntary Excess This excess includes the compulsory excess. Deduct the compulsory excess from this amount. Reinstatement of Sum All losses will reduce the sum insured therefore this clause allows insured the sum insured to be reinstated for an additional premium. The premium will be pro rata to amount and not to time for losses within 12 months. Pro rata to time premiums will be charged on losses discovered after 12 months. Supposed that the sum insured is R1 000 000.00 and a loss of R200 000 an annual premium was R15 000. The reinstatement premium will be calculated as follows. × 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = × 𝑅15 000 = 𝑅3000 (𝑁𝑜𝑡 𝑝𝑟𝑜 − 𝑟𝑎𝑡𝑎 𝑡𝑜 𝑡𝑖𝑚𝑒) Page 40 of 157 Cost of recovery Provides funds for any investigations and court proceedings related to recovering monies from employees. Note for example that if the insured wants to recover from the insured employee’s pension funds, they can only do so if there is a court ruling that gives them the right to recover. Computer Losses Deletes the need to have non-networked computers requirement. A questionnaire must be completed before this cover is extended. Losses discovered Extends the discovery period to 36 months. The excess will go up after 24 months but and an additional premium will be charged however the insured within 36 months has go the option to limit his losses to those discovered within 24 months or even 12 months in order to avoid the higher excesses. For all the extensions above, the rate must be loaded since the cover and hence the risk assumed will be higher. Analyse each extension under fidelity guarantee insurance a rank them in order of the ones that will bring the highest risk to the one that will bring the least risk. Give a brief reason of your ranking. Extension Reason for ranking 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12 Page 41 of 157  Name your top five industries that you would expect to present a higher risk in fidelity guarantee insurance Industry Reason for inclusion in top five Page 42 of 157 2.1.5 Business All Risks Insurance Cover As the name states, this is an all risks cover, which means that everything that is not specifically excluded is covered. Cover is generally on a worldwide scale. Items covered include laptops, palm tops, and cameras to name a few. Business All Risks Exceptions a. Theft from unattended vehicles b. Items being cleaned, repaired or dyeing, bleaching or alteration or restoration c. Vermin, insects, damp, mildew, rust or inherent faults d. Wear and tear e. Dishonesty of employees f. Confiscation, detention or retention by authorities g. Mechanical, electrical or electronic breakdown Important Points Average does not apply. Indemnity is based on replacement – i.e. like for like.. If the replacement item is more expensive, betterment will apply as follows: 𝑆𝑢𝑚 𝐼𝑛𝑠𝑢𝑟𝑒𝑑 𝐵𝑒𝑡𝑡𝑒𝑟𝑚𝑒𝑛𝑡 = × 𝐿𝑜𝑠𝑠 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 Business All Risks Exceptions  Perils excluded by other insurances including excesses and shortfalls  Detentions, retention and confiscation by authorities  Trade and business risks such as errors and omissions  Fraud committed against the insured, or by the insured’s principals or agents  Overheating, implosion (bursting inwards) cracking, fracturing, weld failure, nipple leakage or other failure of vessels, pipes, tubes or similar apparatus  Breakdown, electrical, electronic and/or mechanical  Working on property in any way;  Inherent faults, and gradually operating causes;  Denting, chipping, scratching or cracking that does not affect the operation of the item Page 43 of 157  Termites, moths and other insects, vermin, inherent vice, a characteristic of property or goods that leads to deterioration, fumes, flaws, latent defect, the action of light, fluctuations in atmospheric or climatic conditions  Settlement or bedding down, ground heave or cracking of structures, removal or weakening of support  Loss of or damage to chemicals, liquids, gases or fumes due to leakage from the container  Failure, withholding, or lack of supplies of water, steam, gas, electricity, fuel or refrigerant;  Collapse of plant and machinery, buildings and structures, other than shelving or storage platforms. Property means tangible property Page 44 of 157 2.1.6 Group Personal Accident Insurance Underwriting While most short term insurance is based on the principle of indemnity, group personal accident is based on the principle of compensation. Group personal accident has two forms. These are personal accident and stated benefits. Personal Accident - It states the actual amount of cover for death, permanent disability or temporal disability and medical expenses. - The rate will be applied on the sum insured rather than the wage/salary bill. The nature of the income for people covered under this basis is such that it is difficult to have fixed salaries on which to base the premiums. - Cover obtained is not added together with other covers in order to limit cover to certain percentages. Stated Benefits Benefits are described in the form of multiples of the annual salary or proportions of the annual salary. Example: 3 x Annual salary for death and permanent disability or 1/52 of annual salary for temporary disability. The rate is applied on the annual wage bill. The temporal disability benefits are added to other benefits and limited to 75% of the salary in order to encourage employees to return to work for a 100% salary. Important Definitions Loss: Death and bodily injury due to accident, violent, external and visible means to insured persons within 24 months of the event. Insured: The employer is the insured but the employees are beneficiaries. In the vent of death, the benefits go to the estate of the employee or to his beneficiaries Permanent Disability: Refers to inability to pursue current occupation or alternative occupation. Partial losses are ranked based on the percentages attached for loss of different body parts. An independent assessment is required to avoid exaggeration of the claim. Page 45 of 157 Temporal Total Disability: Total and absolute inability to do one’s current job or business. Cover is subject to a time franchise, which after it passes; the insurer will absorb all losses from the beginning of the incapacity. Medical Expenses: Includes medical, dental, hospital treatment, aids and prostheses because of an accident. Annual Earnings: Included are other benefits like overtime, commissions, bonuses etc. Working hours Cover: Cover the employee only for accidents related to his occupation and excludes cover outside the occupation. 24 hour cover: It does not discriminate losses based on whether the loss occurred in course of employment. Losses are covered even when the insured is injured at home. Cover is broader and therefore the rate must be higher than the business related accident cover. Certain jobs are excluded like the army but when off duty the cover will be effective. Passive War Cover: War is excluded but when an insured is traveling to war torn areas, temporal cover can be extended for the period of the visit. Group Personal Accident Extensions - Exposure; due to thirst, starvation or exposure to elements, either directly or indirectly due to a mishap. - Disappearance of individuals due to abductions or where bodies were never recovered for example people who died in the missing MH70 plane crash. - Burns and disfigurement; it can be for treatment and compensation for disfigurement. - Life support; the 24 months loss limitation will exclude any losses delayed by less than 3 days on the life support systems. Group Personal Accidental Exclusions a. Air travel as part of the crew b. Suicide and self-injury Page 46 of 157 c. Pre-existing physical infirmities d. Riot, strike and civil commotion participation but cover exists if loss occurs as a bystander or while trying to control the strike. e. Losses related to pregnancy, child birth, abortion, miscarriage or obstetrical procedures f. High-risk activities like hang gliding, mountaineering, professional rugby or football etc.… As a class decide on an underwriting criteria for group personal accident insurance. Page 47 of 157 2.1.7 Goods in Transit Insurance It can arise in the following: - Customer’s own goods in their own motor vehicle with a limit per vehicle - Customer’s own goods in their own motor vehicle with a limit per consignment - Customers’ goods carried by a transporter - Cover is either to or from the insured premises/risk address. Goods in Transit Covers Cover can either be on an all risks bases on specified/restricted perils basis. All Risks Good in Transit Cover Covers loss or damage to goods that are not specifically excluded. Cover is up to a limit of indemnity subject to an excess. Transit begins with the loading of good at the consignor until they are offloaded at the consignee. In the event that the consignee returns the goods or refuses to accept the goods, then transit will be completed only when the goods are back at the consignor. When goods are temporarily stored, they may also be covered. Specified Perils Cover - This cover is for fire, explosion, collision, overturning or derailment - Theft is excluded. Goods in Transit Underwriting Factors  Nature of goods being transported  Methods of transit (road, rail, air or water)  Security on the vehicles  Limit per load/consignment  Location including the routes and addresses for delivery  Reputation of the insured to measure moral hazard  Driver screening processes and operating policies  Cover: whether it is all risks based or it is on specified perils basis. All risk cover will be broader and therefore the risk will be higher. Rating Options  Based on a consignment  Per mode of transport  Annual value of goods (provisional premium adjusted based on declarations for the year)  Annual haulage charges can be included too as they increase the value at risk Page 48 of 157 General Goods in Transit Exclusions a. Theft from unattended cars unless the car is locked and secure b. Vermin, insects, damp, mildew, rust or inherent faults c. Wear and tear d. Dishonesty of employees e. Confiscation, detention or retention by authorities f. Transit by sea or inland transit as a result of sea transit g. Breakdown of refrigeration h. Mechanical, electrical or electronic breakdown i. Cash and cash equivalents j. Marine insurance cover k. Property otherwise insured except for shortfalls l. Consequential losses If you were rating goods in transit insurance on an all risk basis what factors will you consider to arrive at your final premium? Page 49 of 157 2.1.8 Money Insurance Cover It covers loss of/or damage to money in the stipulated territorial limits. Money being defined as notes and coins, cheques, postal orders, money orders, postage and revenue stamps, credit card voucher, or negotiable instruments belonging to the insured or for which the insured is responsible. This money must be at specified premises or in transit to and from these premises. Other premises where money might be taken to or collected from also need to be listed on the insurance schedule. This will assist in determining the actual level of exposure. A chain of supermarkets for example may have branches across the country and all the branches must be identified. Where money will be transported from one point to another, ideally, an unbroken transit is preferable and the mode of transport and the security should be stipulated. Several limits apply to money cover. These are namely major limit, minor limit, seasonal increase; cash float crossed cheques and safe limits. Major Limit: Maximum amount of money in transit or at the premises in a safe at any point in time. It excludes crossed cheques. Minor Limit: A limited amount either at the insured’s residence, or at the premises outside the safe, or outside working hours, or in an unattended vehicle, or in custody of a director, partner or employee on a business trip anywhere in the world. This limit is not subject to an excess. Seasonal Increase: Some business handle more cash in certain seasons especially holidays or month ends. If the limit repeats itself every month, then the insured must consider just increasing the major limit. Cash Float: Covers a stated amount of cash on individuals like cashiers or petrol attendances. Note that with changes in technology some tills now do not involve actual handling of money. The limits, in the future, may need to be per machine rather than per individual. Crossed Cheques: Limited to a certain amount Safe Limits: It depends on the type of safe and SABS standard on the maximum cash that is suitable for each type of safe. Page 50 of 157 Money Insurance Extensions  Receptacles and clothing  Locks and keys damaged in the theft or damage to money  Riot strike and civil commotion  Use of skeleton key (not duplicate keys)  Personal accident as a result of robbery or theft of money (only if stated in the policy). Money Insurance Exclusions a. Loss of /or damage to money as a result of the dishonesty of employees unless discovered within 14 days and excluded from fidelity guarantee insurance b. Errors and omissions c. Use of strong room key unless violence was used to obtain the key/code d. Safes that are left unattended or unlocked unless this was due to dishonesty which will need to be proven e. Unattended money f. Money in unoccupied vehicles with no one within five metres to look after the car. However, cover is available when occupants of the car are overpowered by robbers and are unable to protect the money. Page 51 of 157 2.1.9 Motor Insurance Three main covers are available namely; third party only cover, third party fire and theft and comprehensive cover. Third party insurance is the leanest cover that only pays for liability incurred when damage is caused to other people’s property or injury or death is caused to other people. Third party, fire and theft, cover incorporates fire, self-ignition, lightning, explosion, theft and attempted theft. Comprehensive insurance includes own damage as well as third party fire and theft cover. Cover is on an all risk basis, subject to certain general exceptions. Motor Insurance Underwriting Factors  Class of the vehicle whether it is a trailer, a motorcycle, a car or a truck. Risk varies with class of vehicle.  Owner of vehicle; this assists in establishing whether insurable interest exists.  Cover sought; the less comprehensive the cover the lower the rates.  The value of the vehicle shows the indemnity that the insurer may be called to pay in the event of a loss. The higher the value the more the insurer will pay in the event of a loss since repair costs and replacement costs will also be high. Some vehicles may be too expensive for insurers to assume the risk. Assuming such risks can cause the whole motor book to be unprofitable for several years. Check the decline list with your company.  Where the vehicle is parked at night and during the day and the security in those places?  Extensions requested such as car hire and credit shortfall will increase the premium required.  Other factors are no claims discounts, territorial limits, colour of vehicle, make of the vehicle, driving style (telematics based), tracker installed. Motor Underwriting and Claims Reduction - Assess driving conditions checking for late night driving as well as continuous hours driven, nature of business as well as how drivers are managed. - Speed capacity of the cars and any modifications for speeding. Page 52 of 157  - Check if the car is attractive to thieves. In South Africa certain makes and models i.e. Ford Rangers and certain Volkswagen’s, are on high demand by thieves. The chance of theft of hijacking is therefore higher. - Availability and expense of parts. Generally, if parts are difficult to get they become expensive. Parts for expensive cars will also expensive. - Operating area; less traffic can be good but if the area is remote, recovery of the vehicle in the event of a loss may be difficult. Reducing the Motor Risk The following can be done to manage the risk under motor insurance: - Utilize excesses based on the risk - Apply terms and conditions and warranties - Insist on tracking devices, which allow for collection of trip information and recover in the case of theft. The Vehicle Security Association of South Africa (VESA) must certify safety devices. - Reward consumers with security systems through discounts or imposing lower theft excesses. - Check for the accumulation risk and static risk in terms of where the vehicle(s) is/are parked. - Note each individual vehicles sum insured. Risks with a high sum insured may be outside the insurers risk appetite. - Bear in mind that liability claims are in frequency, but when they occurs the results can be catastrophic. - Ensure that at all times the risk assumed is in line with the risks and limits that the company’s reinsurance treaties permit. - If not covered by the reinsurance treaties, arrange facultative reinsurance. - Be familiar with the decline list of vehicles. Motor Insurance Exceptions a. Consequential loss including depreciation of value after a loss. b. Tyre bursts and damages unless they are damaged because of an accident. c. Detention, confiscation and retention of the vehicle by authorities. Telematics Notable trends in the motor insurance industry due to growing populations and growing economies in emerging markets are as follows: Page 53 of 157  - Growth in emerging markets - Decreasing accident frequencies - New business opportunities - Motor is still the higher contributor to the global gross written premium contributing 42%. - Car technologies are advancing everyday especially in automated driver assistance systems - As a result of the above technologies, less accidents occur due to technologies like blind spot detection, automatic breaking and ability to maintain a safe following distance even at very high speeds. - With connected cars, insures are now able to collect information on the frequency of use, driving style and even driving conditions. Drivers are more compelled to drive carefully as they are aware that they are being monitored. - As discussed earlier on, risk rating uses estimates based on the past experience, with telematics, real-time information is obtained from the consumer and rating is based on actual experience rather than expected risk performance. - Because of the fact above, information asymmetries between insurers and their customers are reduced. - Through telematics, insurer are able to offer additional value through other benefits like locate a parking spot, monitoring young and inexperienced drivers and improving claims processes and costs as well. Eventually insurers will be able to offer a product that adds higher value to their consumers. - With more reliance on technology, the manufacturers of cars will be more responsible for liabilities that arise. However insurers and their customers will still carry risks for natural hazards like hail and manmade hazards like theft. It looks like telematics defines the future of motor and other property underwriting. Insurers therefore need to embrace it and include it in their current and future strategies. In class evaluate the benefits of telematics in a South African context. Page 54 of 157 Page 55 of 157 2.1.10 Motor Traders External Insurance The cover is almost like that under motor insurance however; this cover is targeted at motor dealers and garages that handle other people’s cars. Cover is for the liability that they may incur outside their premises. This might be during testing the car on the road or taking it for specialised repairs somewhere or while delivering the car to the insured and any other situations away from the premises. Motor Traders External Underwriting Factors  Name of the insured: to establish their reputation in order to determine the level of the moral hazard.  Full occupation of the insured; this is required in order to judge the level and types of actual activities that take place at the premises. It is not enough to say car dealer. Details must be supplied on the exact processes and products that are dealt in.  Any additional benefits or special covers requested; have the impact of opening up avenues for claims that would not arise without the request.  Any request for cover for own vehicles and passengers must not be granted.  Excess: if the insured opts for a higher excess, they reduce the insurers’ exposure therefore there must be a discount for it. Theft of parts is excluded. However, if a car is stolen and it is found with parts missing. Rating of Motor Traders External Insurance The method for calculating the premium is stated in the policy schedule, with a condition noting that the insured must keep a wage register. Motor Traders External Extensions The table below summarises the extensions available under motor trader external insurance. Extension Description Higher indemnity limit - To cater for increased risk/value - Exercise great caution, as risk might be higher than the one that the underwriter was willing to assume. Social, domestic and pleasure Incorporates cover a named individual for social, Page 56 of 157 purposes for named persons domestic and pleasure purposes. other than the insured, member, or employee Transit Deletes the exclusion of transit or conveyance of vehicles by casual drivers. Loss of use by the consumer Consequential loss due to the accident. Consumers are compensated for lost profits. Unauthorized use Exclusion of passenger liability Motor cycles for tuition with no passenger Special cars for agriculture, Discount the premium for all these covers. forestry, horticulture, road and earth moving. Exclusion of own vehicles Demonstration risk exclusion Restricted cover Page 57 of 157 2.1.11 Motor Traders Internal Insurance Whereas motor traders external insurance covers liability for vehicles away from the premises, motor traders external covers vehicles at the premises. Motor Traders Internal Underwriting Factors In addition to the normal motor underwriting considerations, the following must also be checked and evaluated.  Location:  The age of the building: older buildings have their own fair share of problems, which may increase the chances of losses.  Floor area with a clear breakdown of the activities on the premises and how much space each occupies. Activities/use could include garage, service, showroom and workshop.  Other activities at the workshop must be noted as they may pose higher risk.  The size of adjacent open-air car parks.  Proximity to the highway.  Salary or wage bill size. This is the basis of the rate.  An estimate of the number of vehicles kept at the premises. It is also an estimation of the likely severity of loss.  In some instances, a survey of the risk will assist in clarifying certain information about the risk. Motor Traders Internal Cover The policy covers the following: Cover Description Damage to vehicles - On the premises - At market value - Excluding loss of use, depreciation, wear and tear, mechanical or electrical breakdown, failures, or breakages Liability - Accidental death or injury - Damage to vehicles held in custody - Property other than vehicles - At the premises - In the course of the business of the insured. Page 58 of 157  - Excluding injury to employees, family or property belonging to a family member - Insured’s own vehicles Motor Traders Internal Exceptions a. Damage as a result of fire and allied perils b. Theft or attempted theft c. Damage while the vehicle is being worked on. Chances of damage are higher when the vehicle is being worked on. d. Defective workmanship and its consequences. This falls under the liability policy. e. Death or injury due to animals, power driven cranes, elevators or lifts unless these are attached to vehicles. f. Loss or damage outside the premises. g. Weather related damage, for example flooding. h. Contractual liability. Assuming such a risk is writing an open cheque since the insurer will not be privy to the terms and conditions of the contract. Therefore, the assumed risk will not be known. Motor Traders Internal Extensions Extension Description Increased limits For accommodating increased, risk due to higher numbers of vehicles or higher value cars. Exercise caution and avoid over assuming higher risk. Work away risks Extends cover to other premises not controlled by the insured. E.g. roadsides. Hoists Automatic cover as almost used in all garages. Voluntary Excess Discount for it. Page 59 of 157 2.1.12 Motor Fleets Insurance This cover applies to a fleet of motor vehicles that are based on the insured premise. The fleet must be large enough so that the claims experience of a particular insured can be relied upon for purposes of rating. The claims ratio is believed to average out in the long run therefore any short term high losses are believed to disappear in the long run as other periods will be profitable. A minimum number of vehicles are imposed for fleet underwriting to apply. Cover can be arranged on a specified vehicles basis on non-specified vehicles. However, a schedule of vehicles is required which shows the limits of indemnity as well as the different categories of vehicles insured. Excesses and Aggregate Excesses Excesses could be individual excesses or could be aggregated. Aggregate Excess It involves a partial transfer of risk by the insured. The insured will carry all the total losses up to a certain amount. Insurer will only start to participate when the losses exceed aggregate excess limit. These are net claims and the insured will bear the loss adjusting expenses. The fleet could be self-insured or the fund can be insured. Important Points - Own damage claims must be monitored, and a register of claims must always be available for inspection. - An assess