Week 1-3 Introduction to Risk Management PDF

Humber – The Business School Sanjiv Sawh RISK MANAGEMENT & INSURANCE 1 Insurance manages risk Life insurers weigh the proposed risk of the person to be insured against the fee (premium) that they will receive....

Humber – The Business School Sanjiv Sawh RISK MANAGEMENT & INSURANCE 1 Insurance manages risk Life insurers weigh the proposed risk of the person to be insured against the fee (premium) that they will receive. Risk and risk management Objective of insurance is to manage the cost of 3 predictable risks efficiently Death Disability Old age 2 1  Risk Management Risk – the probability of harm, injury, loss, danger or destruction, occurring in the future. Losses can be emotional, physical or financial 3 Risk Management Speculative Risk vs. Pure Risk 1. Speculative Risk- has three alternatives Loss No change Gain 2. Pure Risk- has two alternatives Loss No change 4 2  Risk Management Pure Risk – 4 types 1. Personal Risk- death, disability & unemployment 2. Property Risk- direct and indirect losses due to material possessions 3. Liability Risk – due to carelessness or negligence 4. Failure of others –performance of service(s) 5 Risk Management Perils and Hazards Losses are caused by perils 1. Peril – source of risk i.e. death, disability, illness, accident, lawsuit & dishonesty All pure risks exist because of perils. 2. Hazard – an act or condition that increase the probability of a peril or the severity of a loss. 6 3  Risk Management Perils and Hazards 2. Hazard – Physical, Morale or Moral 1. Physical – 2. Morale – a persons’ attitude /carelessness that increase probability of a loss 3. Moral – dishonest behaviour i.e. falsifying insurance application 7 Insurance manages risk Risk is measured by severity and frequency More severe risks occur less frequently Look at financial implications – most severe can cause financial ruin while less severe may require financial adjustments that result in a lower standard of living  When the severity of a risk may lower the standard of living – material  Frequency may be low or medium and severity has some financial implication but does not impact standard of living – minor 8 4  Risks Faced By Individuals Loss of income during the period of family obligations Premature death eliminates a source of income Disability reduces/eliminates income temporarily or permanently Loss of wealth Medical expenses not covered by provincial plans Inadequate coverage -government health care coverage Travel Medical expenses while travelling abroad Long-term care 9 Loss of Income Can occur permanently or temporarily Permanent loss – death of an income earner Expenses experienced by family Final expenses Continuing expenses Temporary Loss Risk of sickness or an accident creating disability is greater than the risk of premature death Living expenses and obligations continue while income is reduced or eliminated 10 5  Private Coverage Individual coverage through insurance companies Group Insurance Benefits Coverage through group policies example employee benefits Government Insurance Benefits CPP Veterans Affair Disability Pension Employment Insurance (EI) Workers’ Compensation 11 Risk Management Strategies Primary Strategies 1. Risk Control Risk reduction Risk Avoidance 2. Risk Financing Risk Retention Risk Transference 12 6  Risk Management Strategies Risk Avoidance Used when high frequency of risk and severity is critical Since coverage would be very expensive alternative is to avoid activity. Risk Reduction Used when low-high frequency of risk and severity is minor, material or critical Practiced daily – hard hats, maintenance of vehicles, vaccinations etc. Control may not eliminate risk but reduces 13 Risk Management Strategies Risk Transfer Used when low or medium frequency of risk and severity is critical or major Transfer financial implication to a third party Risk Retention Used when low or medium frequency of risk and severity is minor Deductibles Transferring risk Insurance transfers financial risk from the policy owner to the insurer 14 7  Risk Management Strategies Insurer will assume risk based on its underwriting process Actuaries will base their estimates of payout for premium calculations Will use statistics to Law of large numbers Law of probability Mortality tables Morbidity tables Insurers will then predict returns on investments for the premiums they will collect Benefits that the insurer will payout is from a combination of premiums and investment returns 15 Risk Management Strategies Controlling Risk Insurers control risk they assume by charging premiums according to the risk the insured represents Risk is classified Preferred risk Standard risk Sub-standard risk/special risks Rated policies Permanent or temporary basis Flat-dollar or % increase (table ratings) Exclusion riders or waivers 16 8  What do the following mean? Accept the risk Reject the risk Rate the risk Rated premiums Exclusion riders 17 What is insurance? Insurance can be purchased by individuals, groups and businesses Insurance agents sell life insurance, disability income insurance, health insurance (accident and sickness) and investments Coverage is the face amount of a life insurance contract or the benefit received from a disability income contract or reimbursement amount from a Health insurance contract. Agents are required to purchase personal liability insurance – Errors and Omissions Insurance. Protects them from claims that arise from dissatisfied clients 18 9  Actual Authority and Apparent Authority Actual Authority the authority given to an agent to perform certain tasks Apparent Authority the implied or suggested authority granted to an agent , even if this was not the intention of the principal. Contract are set out so as to limit the agent’s apparent authority because apparent authority is a source of many problems May accidently or intentionally create a misconception that insurer has approved the action Principal is bound by agent’s apparent authority 19 Actual Authority and Apparent Authority Actual Authority –what the principal has instructed the agent to do Straightforward and certain tasks Soliciting insurance applications Collecting the initial premium Delivering the policy Also defines tasks the agent is prevented to do Apparent Authority –Implies or suggests that the agent has been authorized to do Grey are that is not defined by specific activities Applies to many job undertaken by the agent 20 10  Agents: Sign agency with a single insurance company or a number of companies – represents the products of the company or companies. Binds the agent to the company Captive agent if only ells the product of one company Must conduct themselves with highest degree of ethical behaviour Duties Find prospects who wish to apply for insurance Help each one assess which insurance products fits best based on their needs and how much Work with the applicant to correctly complete the application form Collect initial premium Deliver the policy 21 Brokers: Sells and services insurance policies directly or through agents to individual, group and businesses Provides consulting or advisory service for insurance or reinsurance Group of brokers form brokerage Do not have an agency contract with the insurance companies that they represent MGAs and AGAs 22 11  Insurers: Insurance companies issue the insurance policies Federally or provincially incorporated Mutual companies – owned by policy owners Stock companies – owned by shareholders Demutualization: conversion from mutual company to stock company Work with association to distribute insurance e.g. Alumni groups and other associations – offer discounts to these groups based on their size Other sale channels fraternal organizations-share same religion, profession or ethnic origin. e.g. Foresters Benefit consultants – advise employers about the management of their group insurance. 23 Role of the Agent Delivery of Policy Policy is not if force until all delivery requirements are met Premiums paid Changes in insurability acknowledged Receipt of delivery Recession: 10 Day Free Look Time to review and Can return the policy for a full refund 24 12  Role of the Agent During Application Cost Illustrations Should use a consistent and realistic interest factor Premium and non-guaranteed benefits should use current interest rates Agents must be trained to explain the current interest rate factor in a sales illustration Illustrations should contain appropriate disclaimer to indicate the benefits are not guaranteed Terminology used must be clear and consumer friendly 25 Role of the Agent During Application Sources of information Two-Party Contract Three-Party Contract (same person as life (applicant is different from insured) life insured) Personal Information Provided by applicant Provided by applicant and life inured Medical Information Provided by applicant Provided by life inured Details of Proposed Provided by agent; Provided by agent; Product understood by applicant understood by applicant 26 13  Life Insurance Industry Legislation most life insurance providers are regulated by both the federal and provincial governments federally-regulated insurers are governed by the federal Insurance Companies Act; foreign insurers operating in Canada are also subject to this legislation the Minister of Finance manages and directs the Office of the Superintendent of Financial Institutions (OSFI); OSFI administers the Insurance Companies Act, together with all orders and regulations 27 Life Insurance Industry Legislation: Federal Legislation federal legislation is mainly concerned with: requiring regular submission of reports on the financial situation of insurance companies ensuring that certain conditions are satisfied before a company enters the insurance business regulating investment activities regulating the calculation of policy reserves and assets protecting the interests of policyholders 28 14  Life Insurance Industry Legislation: Provincial Legislation provincial legislation regulates provincially- incorporated insurance companies generally, a life insurance contract is governed by the province or territory in which the insurer and insured entered into a binding agreement the 9 common law provinces (excludes Québec) operate under ULICA Québec follows the Civil Code the territories have insurance ordinances very similar to the Uniform Act 29 Life Insurance Industry Legislation: Provincial Legislation provincial legislation regulates the insurance contract and transactions including the following: contents of the insurance policy insurable interest effect of the contract premium payments designation of beneficiaries duty to disclose and unfair practices incontestability and reinstatement insured dealing with the contract licensing of agents claims procedures 30 15  Choosing an Insurance Company both the insurance company and the agent need to be selected carefully some of the factors that should be considered when selecting an insurance company are: consumer protection rating services continuing customer care fees commitment to service 31 Choosing an Insurance Company: Consumer Protection Assuris administers the insurance industry's consumer protection plan it is a federally-incorporated private company funded by the insurance industry Assuris insures, within limits, Canadian policyholders against loss of benefits in the event a member of Assuris becomes insolvent and is forced to wind up its affairs all federally licensed and most provincially incorporated life insurers in Canada are required to be members of Assuris 32 16  Types of Insurance Contracts there are 3 basic types of life insurance contracts: two-party contracts: the insured insures their own life with the insurer; the 2 parties are the insured and the insurer third-party contracts: the insured (owner) insures the life of a third person; the 3 parties are the insured, the life insured and the insurer group insurance contracts: the employer or association is the owner, the employee or member is the life insured and the beneficiary is designated by the employee or member third-party contracts require an insurable interest 33 Insurance Contract 4 basic documents form the insurance contract: application policy any document attached to the policy when it is issued any amendment to the contract agreed upon in writing after the policy is issued both the insurer and the insured have a duty to disclose any facts pertinent to the contract if certain misrepresentations exist, a contract can be rendered void or voidable—a void contract is invalid and cannot be corrected; a voidable contract has imperfections but it may be corrected 34 17  Misstatement of Age upon discovering an incorrect age was given at the time of application, the insurer must adjust the coverage amount to reflect what would have been provided for the same premium based on the applicant’s correct age if there is a limit on the insurable age and the life insured's correct age at the date of application exceeds that limit, the insurer may void the contract up to 5 years after the date of application a person who has attained age 16 may apply for life insurance on their own life or another life 35 Rights of the Insurer an insurer has the right to: charge interest where applicable (e.g. a policy loan) use dividends to keep the contract in force, except when otherwise directed by the insured deduct the amount of any premiums due out of the benefits payable require proof of claim before paying the insured sums be discharged of obligation after paying a claim in accordance with the documents possessed at the time of payment be discharged of obligation after paying a claim into court on behalf of a minor 36 18  Rights of the Insured the insured has the right to: continue the insurance for the stated premium until the end of the stated term cancel the insurance or discontinue premium payments reinstate the contract under certain conditions where the beneficiary is revocable, the insured also has the right to: designate and change beneficiaries deal with the contract with full independence according to its terms (e.g. CSV, policy loans and assignment) participate in the profits and to select from or change various dividend options if so provided by the contract 37 Rights of Beneficiaries: Revocable vs. Irrevocable with a revocable beneficiary, the policyowner has the right to name or change a beneficiary at their discretion a revocable beneficiary has no enforceable rights under the contract, even if he or she pays the premiums if the beneficiary predeceases the life insured, the designation is no longer in effect the designation may be changed at any time during the life of the beneficiary 38 19  Rights of Beneficiaries: Revocable vs. Irrevocable where an irrevocable beneficiary is designated, the irrevocable beneficiary must give written consent in order for the policyowner to: change the irrevocable beneficiary designation assign the policy surrender the policy take out a policy loan (except automatic premium loans) consent is not required for the policyowner to: receive policy dividends allow the policy to lapse allow premiums to be paid by automatic premium loan change the policy to a paid-up policy 39 Rights of the Life Insured & Rights of Creditors the life insured, if other than the policyowner, does not have any rights under legislation but may have certain rights set out in the contract itself or in a separate agreement where a beneficiary is designated, the death benefit is not part of the estate of the insured and is not subject to the claims of creditors generally, if the CSV is used as collateral for a loan from another financial institution, creditors will have a claim on the insurance monies to the extent of the outstanding loan 40 20  Proof of Claim and Payment Conditions 4 basic requirements to provide proof of a claim: proof of the happening of the event upon which insurance benefits are payable (e.g. a death certificate) proof of the age of the person whose life is insured proof of the right of the claimant to receive payment of the insurance monies (e.g. beneficiary or assignee) proof of the name and age of the beneficiary (if named) an insurer is allowed 30 days to make payment after receiving proof of a claim (interest may be paid) if a claim is rejected, a beneficiary has the statutory right to sue the insurer to force payment 41 Effect of Bankruptcy on Policy Values a policy with an irrevocable beneficiary and beneficiaries who have a specified family relationship to the life insured are exempt from seizure under the Bankruptcy Act where a policy does not meet the criteria that is required for exemption, ownership of the policy is transferred to the trustee in bankruptcy the trustee has the authority to surrender the policy and distribute the proceeds among the creditors 42 21