Of course, an agent would have nothing to sell if it weren’t for the other functions taking place in the insurance company—at both its central, or home, office and its regional, or branch, offices.
Loss, Expense, and Combined Ratios
An insurance company evaluates its overall book of business for given periods to measure its financial performance during those periods and to look for trends that may have occurred over an extended time.
An insurer uses three ratios to evaluate its book of business: loss ratio, expense ratio, and combined ratio.
The loss ratio is used to compare the company’s operations from year to year.
It shows the percentage of losses the company incurred for every dollar of earned premium.
It is calculated by dividing the amount of incurred losses by the amount of earned premium. Here is the loss ratio as a formula:
Loss ratio = incurred losses / earned premiums
Earned premium is the premium the company actually earned by providing insur- ance protection for the designated period.
Incurred losses include amounts paid on claims for covered losses and various expenses related to handling claims.
The expense ratio indicates the cost of doing business. The formula is:
Expense ratio = underwriting expenses / written premium
Underwriting expenses are the costs required to acquire and maintain a book of business.
They include expenses for advertising, commissions, salaries, and other administrative costs and regulatory costs such as taxes and licensing fees.
Written premium is the gross amount of premium income on the company’s books. It includes both earned and unearned premium. Premiums for new business, renewals, and policy endorsements make up written premium.
The combined ratio is simply the sum of the loss ratio and the expense ratio: Combined ratio = loss ratio + expense ratio
Traditionally, 100% is considered to be the breakeven point.
A combined ratio of less than 100% indicates that the company had an underwriting profit; a ratio of greater than 100% indicates a loss.
Underwriting is the process of selecting certain types of risks and rejecting others so the insurance company will have a book of business that will produce the company’s desired results.
The underwriting department is usually made up of many individual underwriters, who decide whether to accept or reject the applications sent in by agents on the basis of the company’s standards and their own judgment.
They may also be called on to review loss experience, provide judgment rates, and specify the particular policy forms required to provide the coverages applicants have requested.
Policy Issue and Administration:
Once the underwriter has approved a new application or a change to a current policy, the application is checked by a policy analyst or screener to make sure all information is correct and complete.
It then goes to a rater, who computes the premium to be charged.
The policy forms may be printed by computer or assembled in an assembly and filing area. Copies of the policy will be mailed to the agent, the insured, or both.
In many companies, policy rating, policy issue, and assembly are combined with the underwriting function in a single unit. Each unit has responsibility for all of these functions within a specific geographic region or territory.
The claims department sees that the company’s insureds are adequately indemnified for their losses. Claim adjusters or representatives are used to inspect a loss, determine whether there is coverage for the loss, estimate indemnification, and, in some cases, pay for the loss immediately. Large companies have their own claim adjusters, whereas smaller companies may use the services of independent adjusters.
Actuarial and Statistical Department:
The actuarial and statistical department is the numbers department. Using the tremendous amount of data generated by computer, together with statistics available from other companies, actuaries determine the rates to be charged for various types of insurance.
As with any profit oriented business, the determination of financial condition is a very important function in an insurance company.
However, insurance companies must place special emphasis on this area because their finances are closely regulated by the state—for example, premiums must be credited to specific accounts, agents must be paid commissions, and proper reserves must be maintained. All of these functions are handled by the accounting department.
The investment department oversees the funds the company needs to invest to make sure adequate funds will be on hand to pay claims.
The investment department attempts to maintain a healthy rate of return while maintaining the safety of the investment. Because money must be on hand to pay future obligations, highly speculative stocks are not appropriate, and at least some of the investments must be readily convertible to cash, as needed.
Because insurance policies are legal contracts, it is not surprising that insurance companies maintain a legal staff.
This department interprets the various state insurance laws and helps the company keep its policies and practices in compliance.
A key role is the department’s involvement with court cases arising from claims.
The legal department is instrumental in helping determine fair indemnification for insureds and is involved in the company’s other legal actions.
For certain insurance coverages, a premium is determined after or during the policy term, instead of at the beginning of the policy term.
These after-the-fact premiums may be based on a number of factors such as payroll, number of employees, or amount of receipts.
The audit department checks the accounting records of these insureds at the required intervals to obtain the necessary information used to determine these types of premiums.
Loss Control Department:
Although insureds are glad when insurance pays for a loss, they would rather have no loss at all.
This is why prevention and control of losses are very important aspects of the insurance business
. The loss control department, or engineering department as it may be called in some companies, inspects factories, certifies boilers, and makes recommendations to insureds as to how risks may be avoided or reduced.
This department works very closely with, and directs the operations of, the agents who represent the company.
Its responsibilities include recruiting, appointing, and training, especially if an agent will be an exclusive agent.
The department must monitor the sales and marketing efforts of these agents and make sure that the number and quality of agents are closely tuned to the market the company serves.
Closely related to the agency department, the marketing department helps determine the company’s overall marketing strategy.
It develops advertising and sales aids or works closely with a separate advertising department to accomplish these goals.
Reinsurance Department: Insurance companies themselves often purchase insurance to cover their own exposure to loss.
This is called reinsurance. Reinsurance helps protect insurance companies from catastrophic losses and from wild fluctuations in underwriting results.
This coverage may be obtained on a policy-by-policy basis or on the basis of a whole block of policies.
The reinsurance may cover the initial insurer for losses above a certain amount or may call for losses to be shared on a pro rata basis.
Like other businesses, insurance companies have departments whose contributions help all other departments operate smoothly.
They include personnel, training, information systems, adminis- tration, forms and filings, and building and maintenance.