Financial Strategies and Analysis: Insurance

This article provides an overview of the financial strategies and analysis that are a part of the insurance industry. The article provides an introduction to the financial management of insurance companies, including the definition of an insurance company, the most common types of insurers and the unique financial considerations for insurance companies. In addition, this article also provides a financial analysis of insurance companies. This analysis includes explanations of the components of insurance company income, common insurance company dividend policies and the modern development of dynamic financial analysis. Further, the investment strategies of insurance companies are described, such as the variables that are involved in investment strategies, risk management techniques and the various investment portfolios held by insurance companies. Finally, this article explains some of the most important financial considerations facing insurance companies, such as the identification of loss exposures, contractual risk control measures and the identification of security risks.

Keywords Claim; Conditions; Damages; Liability; Premium; Reinsurance; Risk; Underwriting

Actuarial Science > Financial Strategies & Analysis: Insurance

Overview

The central objective of insurance companies is the to eliminate certain financial risks for businesses and individuals by transferring liability for the risk from businesses and individuals to the insurance company. To limit the scope of their liability, insurance companies specify the activities and events that they will insure, and may even specify activities or events that they will not insure. Thus, insurance functions as a means by which certain known, probable or potential risks are converted from an individual or business risk to an individual or business expense in the form of insurance premiums. The premiums, or payments, that the insurance companies charge insureds and the income received from investments held by the insurance company compose the reserves from which insurance companies pay benefits to insureds who suffer losses covered by a valid insurance policy.

In addition to underwriting insurance policies, insurance companies also act as financial intermediaries in other ways. Insurance company agents now market and sell various financial products such as mutual funds, IRAs, annuities, money market funds, investment securities and tax shelters. Insurance companies also manage large sums of money in the form of employee benefit, pension, retirement and profit-sharing plans. Thus, insurance companies play an important role in today's financial world, and as a result, must be carefully managed for proper growth and profitability. The following sections provide an overview of the financial strategies and analyses that play a central role in the insurance industry.

Financial Management of Insurance Companies

Financial management involves implementing the techniques, research and analysis necessary to provide a company's management team with sufficient information to make sound financial decisions on behalf of the company. At least three kinds of financial management decisions are essential in the development of successful insurance companies: Investment decisions, financing decisions and dividend decisions.

• Investment decisions involve the most efficient use and replacement of current and fixed assets and take into account the time value of money, cash flows and the risks and returns of various investment and insurance underwriting options. Investment decisions are also referred to as capital budgeting.
• Financing decisions deal with identifying and selecting the sources of funds that will operate the insurance company and implement its various goals and projects. Financing decisions involve current liabilities, long-term debt and equity.
• Dividend decisions refer to the percentage of earnings to be paid as dividends to stockholders. These decisions are closely related to financing decisions, but are also concerned with the stability of dividends over time and the impact of periodic dividend payments on the company's net worth.

The combination of these decisions allows a company's management team to put in place the necessary changes to achieve the financial goals of the insurance company and its owners, which are often different than owners of a typical for-profit corporation. Many insurance companies are known as mutual insurance companies and are owned by policyholders, not stockholders. Regardless of the owners, a company's management team most likely has as its goal to create profit or economic surplus while sustaining a healthy level of growth and productivity for the organization. Like stock companies, insurance companies must grow at least as rapidly as inflation to maintain their profitability and service to policyholders. However, the insurance industry is governed by certain regulatory guidelines that establish certain financial requirements for insurance companies. Thus, for any type of insurance company, the goal of financial management is to maximize the surplus of policyholders while complying with regulatory guidelines.

The following sections provide a more detailed explanation of the financial management of insurance companies, including a definition of insurance companies, the most common types of insurers and unique considerations for insurance companies.

Definition of Insurance Company

Insurance companies provide a medium through which individuals and businesses may transfer an element of risk in exchange for payments, called premiums. However, to actually form and maintain an insurance company, an organization must comply with special state statutes, regulations and common-law principles that govern insurance companies and insurance law. The insurance industry is largely regulated by state laws. Each state has a state insurance department that is charged with the power to oversee and regulate insurers. These insurance departments, among other things, certify that newly formed insurers comply with special statutes governing business organization and formation; license out-of-state insurers who satisfy certain requirements to operate in the state; require the filing of detailed annual statements showing the insurer's assets, liabilities, income, losses and expenses; and supervise the general conduct of insurers. To support the administrative and regulatory costs of maintaining insurance departments, states levy premium taxes on insurers. At the federal level, Internal Revenue Service ("IRS") regulations mandate that to be taxed as an insurer, the majority of a company's business must be issuing insurance. Key elements in the definition of an insurance company are the transfer of risk and the distribution of losses.

Transfer of Risk

An insurance policy transfers some risk from the insured to the insurer. To effectuate a legally cognizable transfer of risk, there must be a binding contract between two or more parties that states the terms of the risks that are transferred between or among the parties and the consideration that supports the risk transfer. If these elements are not met, an activity that purports a transfer of risk may not fall within the scope of the definition of insurance. For instance, deposits that are made into a fund administered by another party would not constitute insurance if the insured entity was essentially paying toward its own losses because this arrangement does not involve a transfer of risk.

Distribution of Losses

The IRS also defines insurance as involving the pooling of exposure and the proportional sharing of losses. Traditional insurance companies distribute the costs of losses among a group of insureds exposed to such losses. Certain distribution arrangements are often made, however, to adjust the premiums paid by the insureds to reflect the individual losses. These arrangements are generally subject to maximum and minimum limits. Otherwise insurance companies would be acting as a type of financial organization in distributing and redistributing the flow of cash flows among insureds, and this activity would fall within the realm of banking rather than insurance. Thus, financial managers must pay careful attention to the activities of insurance companies to ensure that they continue to operate within the prescribed activities of insurers, or the companies may risk losing their tax status as insurance companies.

Types of Insurers

The legal form of organization of a company acting as an insurer is also an important factor in the financial management of insurance companies. The major types of insurers are stock companies, mutual companies and reciprocal exchanges.

Stock Insurers

Stock insurers are corporations engaged in the insurance business and owned by stockholders, who are not necessarily policyholders. The stockholders elect the board of directors, which appoints the executive officers, who in turn hire the remaining managers and personnel. The stockholders share the gains or losses from operations through stock dividends established by the board of directors as well as through ups and downs in the market value of their shares of stock.

Stock insurers write almost three-fourths of the property and liability insurance premiums written by United States private insurers. Stock property and liability insurers range from small insurers writing only one line of insurance to large insurers writing practically all kinds of insurance.

Mutual Insurers

Mutual insurers are corporations owned by their policyholders. They elect the board of directors. The board of directors appoints the executive officers, who then hire the other employees. There are two types of mutual insurers: Assessment mutuals and advance premium mutuals.

Assessment mutuals operate by taking a cash deposit, or premium, from members in exchange for insurance protection. If the company's losses and expenses exceed these deposits, the company can assess members for additional monies to cover losses. On the other hand, advance premium mutuals have no legal right to assess their policyholders. Some advance premium mutuals pay dividends at the discretion of the board of directors. Most of these insurers charge more than they expect they will need and thus return some of the excess premium as dividends on a regular basis. Others pay policyholder dividends only under certain specified circumstances. Instead they set a price that is close to their expected needs and the "dividend" takes the form of a lower initial premium. Advance premium mutuals write a significant portion of the life insurance and property and liability insurance policies in force today. Many of the nation's largest insurers are advance premium mutuals.

Reciprocal Exchanges

Unlike mutual insurers, reciprocal exchanges are not corporations but are unincorporated associations that involve individuals writing insurance as individuals, not as an organized business affiliation or as joint owners. Each subscriber agrees to insure individually all of the other subscribers in the exchange and is in turn insured by each of the other subscribers. Thus, there is a "reciprocal exchange" of insurance promises. Instead of writing a separate contract for each promise, the reciprocal exchange issues one contract to each subscriber that states the nature of the association and its business protections and operations.

Reciprocal exchanges write only a small fraction of the property and liability premiums today and they seldom write life insurance policies. Many reciprocal exchanges specialize in one type of insurance, such as auto insurance, although a few do offer multiple lines of insurance. Some reciprocal exchanges are affiliated with trade associations and write insurance only for members of the association.

Unique Financial Considerations for Insurance Companies

The financial statements prepared by insurance companies differ from those prepared by other corporations for audits or tax purposes. Insurance companies have relatively few fixed assets, and most of these do not appear on the balance sheet as admitted assets. In addition, on the liabilities side of a financial statement, insurance companies utilize minimal debt, so their liabilities generally consist primarily of reserves. The equity of insurance companies is generally identified as policyholders’ surplus or, in the case of stock companies, capital and surplus.

The preparation of financial statements for insurance companies follows statutory accounting principles. These principles differ in several ways from the generally accepted accounting principles ("GAAP") used by other business entities. Most of the deviations from GAAP are due to requirements imposed by state insurance regulatory authorities or are accounting adaptations that have been created to accommodate the special characteristics of the insurance business. These special accounting principles tend to be much more conservative than GAAP.

In order to focus on a company's solvency, insurance accounting procedures apply special rules for the valuation of assets. While GAAP recognize all assets, statutory accounting principles only recognize what are called admitted assets, or assets that are readily convertible to cash. Furniture and fixtures, automobiles, premiums due over 90 days and other assets of an insurance company, which are referred to as nonadmitted assets, do not appear on the balance sheet. Unrealized capital gains or losses are recognized under the statutory system but not under GAAP.

Financial Analysis of Insurance Companies

Earning income is a major objective of all businesses that seek to attract and retain capital. This applies to all forms of insurance companies as well-stock, mutual or reciprocal. Even though these organizations do not vie for funds in capital markets in the same manner as other businesses, their ability to increase insurance operations is dependent on their earning capacity.

Thus, insurance company managers face the same decisions as stock company managers and executives. They must set growth objectives and determine how desired growth will be financed. Even if an insurance company does not increase the number of policies it underwrites, it has to expand its insuring capacity simply to provide coverage to existing policyholders as their insured assets increase in value. The following sections explain the financial analysis performed by insurance companies in pursuit of their growth and profitability objectives.

Components of Insurance Company Income

Income determination rules have a wide influence of the financial and operating decisions of insurance companies. In measuring income, a distinction is drawn between accounting income and economic income.

• Accounting income is the total income established through the application of a certain set of accounting rules, such as GAAP, to the financial events affecting a company.
• Economic income is the variation in the total value of a company’s net worth during a specific time period.

There are five sources of economic income for an insurance company: Underwriting gain; net investment income; realized capital gains and losses; unrealized capital gains and losses; and other income. Income is obtained from underwriting gain if premiums earned in an accounting period are greater than the losses contracted during the same period. Net investment income is the excess of interest, dividends and income earned from invested assets over expenses contracted while conducting investment activities. Insurers earn income through security investments. There are two main sources of funds insurance companies invest: The insurer’s net worth and retained earnings, and policyholder supplied funds, or reserves from premium payments.

Realized capital gains and losses function in much the same way as stock companies and have the same tax consequences. Net unrealized capital gains and losses are credited or charged directly to the insurance company's net worth and are not included as net income because these gains or losses might never be realized. Even though unrealized capital gains and losses are not included in accounting income, they do contribute to the total return earned by insurance companies because they affect the insurer's net worth. Any other income that an insurance company may generate consists of revenues and expenses that are not related to either underwriting or investment activities.

Insurance Company Dividend Policy

Financial management practices of insurers have important differences from those of nonfinancial companies and financial corporations that are not insurance companies. Creating dividend policies is complicated for insurers because of the unique aspects of insurance companies, such as the presence of stock, mutual and reciprocal insurers; regulation and competition within the industry; special income measurement rules; and unique asset and capital structures. Because there is more than one way to measure income of an insurance company, there is some question as to which income measurement applies in setting an insurer's dividend policy.

In addition, capital gains and losses may have a significant effect on the dividends paid by property and liability insurers due to the asset structures of insurers. Most assets of insurance companies are cash, securities and real estate. Large capital gains and losses from these assets have a significant impact on the ability of an insurance company to distribute its equity in the form of dividends, especially since such a distribution would have an even greater impact on the company's net worth.

One alternative way insurance companies distribute their profits to owners is to repurchase their own shares of company stock, which results in a permanent reduction in the total future dividend payments and often leads to an increase in the market value of outstanding shares. A second alternative to paying cash dividends is to acquire ownership interests in other companies. Insurance companies are more likely to acquire other companies when investment opportunities within the scope of the company's current operations fail to justify the use of its reserves or surplus capital.

Dynamic Financial Analysis

Dynamic financial analysis ("DFA") is a systematic approach that uses computer simulations of financial models to aid insurance companies in assessing the risks and benefits associated with strategic decisions. “DFA models an insurance company’s cash flow in order to forecast assets, liabilities, and ruin probabilities, as well as full balance sheets for different scenarios. In the last years DFA has become an important tool for the analysis of an insurance company’s financial situation. In particular, it is a valuable instrument for solvency control, which is now becoming important as regulators (Eling, 2007, p.1)” have taken a closer look at the role insurance companies play in responding to catastrophic or widespread losses.

Thus, DFA is an important tool insurance companies now use for risk management and strategic decision support. DFA functions as a type of flight simulator for the management team of insurance companies that helps them understand and analyze the potential impact of their decisions before making any actual financial changes or investments. Use of DFA, in particular, focuses on financial analysis and strategy involving issues insurance companies face, such as capital management, investment strategies, reinsurance strategies and strategic asset-liability management. The financial models that are created using DFA technologies allows insurance companies to make informed decisions regarding growth, strategic investments and overall profitability.

However, Yu, Tsai, Huang, and Chen (2011) found that while DFA is a useful decision-support system for the insurer, it lacks optimization capability. The authors applied a simulation optimization technique (a genetic algorithm) to a DFA system and used the enhanced system to search an asset-liability management solution for a property-casualty insurance company. "The optimization problem," they wrote, "is a constrained, multi-period asset allocation problem that takes account of insurance liability dynamics," and they found that coupling a DFA system with simulation optimization results in "significant improvements" over typical search methods. Applying simulation optimization to a DFA system "is therefore promising" (Yu, Tsai, Huang & Chen, 2011).

Investment Strategies of Insurance Companies

An important aspect of insurance company financial management is its investment strategy. The variables in common investment strategies are the expected return, the standard deviation, the mean-variance criterion and the coefficient of variation. The following sections describe these concepts in greater detail.

Variables in Investment Strategy

Investment strategy attempts to balance several important variables such as the expected return of an investment, the standard deviation, the mean-variance criterion and the coefficient of variation. The expected rate of return of an investment refers to the change in price of an asset, whether realized or unrealized, plus cash income divided by the price of the asset at the initial financial period. The rate of return of investments or asset acquisitions is one of the most important variables that is used to assess various investment strategies. Another important variable is the standard deviation of returns, which is a determination of the risk associated with an investment. Standard deviation measures the degree to which returns vary from a mean rate of return. If the returns show little fluctuation from the mean, there is a low level of risk.

Economic events, such as changes in the financial markets, can affect the standard deviation of risks and returns associated with an investment. In addition, external events can affect investment strategies for insurers. For instance, for property and liability insurers, a series of catastrophic events, such as a high number of fires, storms or floods, may cause an increase in the number of claims filed, which could lead to reduced earnings and investment options for the insurers who must replace or cover damage to property affected by these events.

Another variable is known as mean-variance criterion, and this is a factor that is used by insurance companies in selecting investment options. When insurance companies choose investments on the basis of the average return and risk, this is known as the mean-variance criterion. Since many insurance companies prefer to minimize risk exposure, investment strategies with higher returns or lower risk are preferred to lower returns or higher risk.

The coefficient of variation is the standard deviation of return dividend by the expected rate of return, and is a measure of risk per unit of return. This statistic is used by insurance companies when they are considering choosing the best investment strategy or opportunity. Thus, if an insurance company is considering investing in two different securities, and in each case a higher return is associated with higher risk, choosing between the securities based on a return and risk assessment by calculating the coefficient of variation can help an insurance company select the right security for its investment strategy.

Risk Management

An effective risk management program depends on many factors. For instance, insurance companies must consider such factors as having a sound administrative framework and a clear understanding of the organization's overall strategy and goals in order to formulate solid risk management policies. Key elements and attributes of effective risk management include a formal, written and widely disseminated risk management policy statement; a written manual that outlines business processes, procedures, responsibilities, systems and documents that support the risk management program; and a risk management information system for tracking costs and trends and providing timely, accurate and actionable information for management decision making.

Operational risk is increasingly important in the management and corporate governance of insurance companies (Martinez Torre-Enciso & Barros, 2013). The management and analysis of operational risk are necessary activities for insurers, presenting many opportunities for development and a "major field of study on conceptual and practical issues due to the particularity and complexity implied in this type of risk" (Martinez Torre-Enciso & Barros, 2013).

In addition, sound criteria for selecting brokers and other service providers and a structured process for collaborating with them are also important elements of good risk management. Finally, regularly scheduled audits to evaluate the effectiveness of the current risk management business processes are important in adapting an organization's ongoing risk management procedures.

Birchfield, referencing a KPMG report in 2013, contended that catastrophic events of the prior few years "shone a light" on risk management and insurance "like never before" (2013). The year was another challenging one in the insurance industry, Birchfield and KPMG stated, and more of the same was predicted for 2014. "Last year saw insurers re-examine their risk exposures and respond by revising geographic exposures, increasing premiums to match risk, and/or adapting their products with, for example, the emergence of fixed-sum cover for new homes rather than traditional open-ended replacement," according to Birchfield (2013). He and KPMG also predicted that insurers who embraced challenges posed by the "four megaforces" (products and markets, distribution and operations, regulation and capital management, and governance and people) would both "survive and thrive."

Investment Portfolios

Just as diversification is important for the portfolios of investors and financial advisors, the benefits of diversification also apply to the investment portfolios of insurance companies. To determine the ideal investment portfolio composition for insurance companies, the company's manager or financial advisor will examine the return and risk parameters for each investment option as it relates to the operating objective of the insurance company. Using this information, informed decisions can be made as to the best options and the ideal composition of investment alternatives. In addition to portfolio composition, investment strategies must also take into account the risk of interest-rate fluctuations and the duration, or maturity dates, of investment options. Ideally, an insurance company's portfolio should be balanced to match durations with interest rate changes.

Application

Financial Considerations Facing Insurance Companies

Insurance companies face unique financial considerations. For instance, since insurance involves the transfer of risk, insurance companies must continually identify the exposure they face to significant losses of covered assets. To minimize the impact of excessive losses, insurance companies can contractually assign various risk elements so that potential losses are diffused among a number of different parties. Finally, insurance companies must also remain vigilant about security risks that could cause harm to their own assets or to the assets owned by insureds that are covered by insurance policies. The following sections provide further explanations of these considerations.

Identification of Loss Exposures

The identification of loss exposure is an important element in the risk management process of an insurance company. Loss exposure involves three elements:

• The type of asset exposed to loss;
• The peril causing loss;
• The financial consequences that result from that loss.

Insurance companies have to develop techniques that systematically identify the risks raised by each of these elements. Without a systematic approach, some loss exposures would not become evident until after they have occurred.

There are a variety of techniques that insurance companies can use to systematically identify loss exposures. These include surveys and questionnaire's regarding the organization's operations, analysis of past losses, financial statement analysis, review of documents and other records, personal inspections and consultations with experts inside and outside the organization. When these techniques are implemented, loss exposures can be more readily identified and categorized.

Typically, loss exposure assessments reveal that most losses occur in one of three categories.

• First, property losses generally occur where the assets of the organization are exposed to loss or damage, which may result in direct or indirect damage to the assets and or loss of income to the company.
• Second, liability losses may arise when an organization's operations and activities cause injury or property damage to third parties.
• Finally, personnel losses may involve the negative effects to an organization from the loss or actions of its employees.

Once losses have been identified and categorized, techniques can be developed to prevent or minimize their occurrence. For instance, developing and practicing emergency plans or eliminating insurance coverage for certain high-risk activities are steps that insurance companies can take to minimize their loss exposure. Also, segregating or separating operations, activities or assets can also help control potential losses. An example would be moving a plant that manufactures finished materials to a geographically different area than the company headquarters so that both facilities would not be subject to the same loss should a catastrophic event occur in that area. Finally, an ongoing monitoring program is an important part of identifying and managing loss exposure, as vigilant observation of trends and patterns may reveal the possibility of a potential loss before it occurs so that proactive steps may be taken to prevent its occurrence or the extent of its harm.

Contractual Risk Control

Insurance is a contractual transfer for risk financing. Other risk transfer techniques include indemnity agreements, requirements for other parties to provide insurance protection, surety and guarantee arrangements and waivers and releases. Insurance companies use these options in drafting insurance policies to limit the degree of their exposure for certain events and to shift liability to other parties for activities or assets that fall outside of the scope of the insurance policy.

An indemnification agreement is an agreement to compensate, or indemnify, another party upon the happening of a particular set of circumstances. The type of indemnity language chosen will depend on the relative sizes and bargaining power of each of the parties and the subject matter of the contract. The indemnification obligation in a contract is paramount because it states which party must assume the risk and cost of losses. However, the indemnity agreement is only as good as the financial solvency of the party that has assumed the obligation, as an insurance company may be unable to seek indemnification from a party that is bankrupt or judgment proof.

Some insurance companies write policies that contain restrictions or requirements for others to provide insurance protection for specified activities. This may be because the activities fall outside the scope of coverage normally included in an insurance company's policies or because the activities are unusually dangerous, thus requiring additional insurance protections.

Surety and guarantee arrangements also minimize an insurance company's exposure through contractual transfer of risk. A surety is a person or organization that contractually guarantees to one party that another party will perform as promised. The surety mechanism is called a bond, and the surety is also known as the bonding company. While this arrangement is similar to insurance, the surety arrangement is a three-party contract. Unlike insurance, the surety does not anticipate that losses will occur, only that the party will perform as promised. If there are losses, the surety has the legal right to recover from the contractor that they have bonded. In addition, the surety's primary obligation is to perform as promised for the obligee, not to pay money to compensate the obligee for the principal's breach of contract.

Finally, insurance companies may use waivers and releases to manage risks contractually. A waiver is a relinquishment of a known right, such as the right to sue. After such a waiver has been given, the insurance company no longer faces an exposure to legal actions that were waived. However, to be effective, a waiver must be obtained fairly as waivers that are improperly obtained or contrary to public policy may be nullified by court. A release arises when the party granting the release agrees to absolve, or "release," the other party from future liability. To be binding, the release must be accompanied by legal consideration. Most insurance settlements offered by insurance companies will require that a release be executed as a condition of payment.

Identifying Security Risks

Breaches of security can cause substantial damage to an organization or property. While insurance may cover these losses, some losses may fall outside the scope of the relevant insurance policy. Thus, both insurance companies and insurance policyholders have an interest in identifying and minimizing security risks. To combat security risks, an organization or individual may develop a security program that is designed to protect assets, income, employees or other individuals and business operations and activities. Security risks may take the form of injuries, loss or damage resulting from theft, arson, fraud, malicious damage and other dishonest or illegal acts. Effective security planning can result in the identification of an organization's vulnerabilities and the development and implementation of appropriate countermeasures to strengthen these vulnerabilities.

In order for a sound security program to be developed, an organization or individual will need to gather information regarding the location and security of physical assets and any current protective measures such as lighting, alarms or access or egress controls. In addition, intangible assets must also be surveyed. This may involve determining what information each person or employee controls and how information flows through an organization. Certain internal practices, such as educational programs covering security and crime control topics, appropriate hiring and training policies and tough prosecution measures for offenders can minimize potential security risks from within an organization.

However, securing assets is an ongoing process. Although insurance coverage may be an important element of protecting vital assets, insurance policies may not be comprehensive or may contain certain provisions that limit its coverage in the event of security breaches or internal control failures. Thus, both insurance companies and insurance policyholders play important roles in creating and maintaining sound security programs for organizations, individuals or assets that may be covered by insurance policies.

Conclusion

Insurance companies provide a medium through which individuals and businesses may transfer an element of risk in exchange for payments, called premiums. In order to operate efficiently and profitably, insurance companies use various methods of financial analysis to measure income, risk, loss and growth. Insurance companies use specialized accounting techniques to prepare detailed financial statements and to track income, and develop dividend policies that allow them to distribute profits to owners while maintaining the solvency and financial stability of the company. Increasingly, insurance companies are using dynamic financial analysis to create computer models of various financial strategies so that their impact can be assessed before any funds are actually transferred or invested. In addition, insurance companies employ financial strategies that enable them to grow in profitability without assuming excessive levels of risk. These strategies include measuring or tracking certain variables to assess investment options, developing sound risk management policies and diversifying their investment portfolios. Insurance companies face unique considerations in developing their financial strategies. Insurance companies must continuously monitor their loss exposure, contractually transfer risk levels where possible and identify security risks to their assets and the assets of policyholders. Further, the investment strategies of insurance companies are described, such as the variables that are involved in investment strategies, risk management techniques and the various investment portfolios held by insurance companies. By using a range of financial strategies and analysis tools, insurance companies are able to ensure their financial stability for the security of their policyholders and the profitability of their owners.

Terms & Concepts

Absolute Liability: A situation where the party responsible for an extremely dangerous situation or operation is completely liable for all resulting harm.

Act of God: A situation usually considered caused by forces beyond human control, such as lightning, floods, earthquakes, etc. Also called force majeure.

Binder: A beginning agreement between an underwriter, agent or broker and a binding authority that guarantees the specified coverage until the official policy can be delivered.

Casualty: Any losses or liabilities incurred in an accident (except for when covered by fire or marine insurance)

Claim: A request for payment to cover a loss that falls under the purview of a predetermined insurance policy; estimated or actual amount may be demanded.

Condition: Part of an insurance policy which, in conjunction with the insuring agreements, helps define the rights and responsibilities of both the insurer and the insured in keeping with the policy.

Damages: Financial compensation recovered in court by any entity who has incurred loss through the unlawful act of another.

Exposure: Possibility of loss or hazard.

Guiding Principles: An established set of rules published and enforced by prominent property and liability trade associations for addressing complicated losses covered by several insurers, especially regarding the way in which losses should be divided under different circumstances.

Hold Harmless Agreement: Contract provision where a party with potential legal liability for damages payable in the occasion of a future loss is protected by another party to the contract which assumes that liability.

Insurance: Contractual relationship that exists when one party agrees to reimburse another for loss caused by certain events, activities or contingencies in exchange for payment.

Liability: Conditions of being bound by law to do something that may be enforced by courts.

Occurrence: Continued or repeated exposure to conditions that results in unexpected injury during the insurance policy period.

Premium: Payment required for insurance.

Reinsurance: Insurance involving two insurers: the reinsurer and the ceding insurer. The reinsurer agrees to assume part or all of the liability owned by the ceding insurer to reduce the ceding insurer’s vulnerability to risk.

Risk Management: A management discipline whose goal is to protect an organization from financial loss.

Umbrella Liability: A type of liability insurance providing excess liability coverage for third party losses over and above all types of "underlying" insurance, which includes commercial general liability, automobile liability and employer's liability plus other liability coverages that can be negotiated into the policy.

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Yu, T., Tsai, C., Huang, H., & Chen, C. (2011). Applying simulation optimization to dynamic financial analysis for the asset-liability management of a property-casualty insurer. Applied Financial Economics, 21, 505-518. Retrieved November 22, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=59600178&site=ehost-live

Suggested Reading

Lenckus, D. (2000). Modeling tool gives USAA broad business picture. Business Insurance, 34, 261. Retrieved November 18, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=3391970&site=ehost-live

Rooney, S. & Brennan, K. (2006). Securitization in the life insurance industry: Managing risk and capital requirements. Journal of Structured Finance, 12, 23-29. Retrieved November 18, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=21940600&site=ehost-live

Sclafane, S. (2006). Rating firms take giant steps. National Underwriter/Property & Casualty Risk & Benefits Management. Retrieved November 18, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=22013894&site=ehost-live