GENERAL INSURANCE FUNDAMENTALS 2016

GENERAL INSURANCE FUNDAMENTALS 2016

PART 1 UNDERSTANDING INSURANCE BASICS WHAT AN INSURER DOES BASIC 

PRINCIPLES BASIC PRINCIPLES • 

The advantage of obtaining insurance is that it allows the pooling of risks and d th b bilit f t b i th ti t f l d re duces the pro b ability o f one par ty bearing the entire cos t o f a loss • Insurance policies originated in 17th century London coffee houses which became the place for sharing information on agreements of pooled risks between merchants, ultimately leading to the formation of Lloyds of London • In the aftermath of The Great Fire of London, Nicholas Barbon an English physician opened “The Fire Office” to insure London’s brick homes, and establi h d i li i k h d bli s h e d insurance poli cies as we know t hem to day • Toda y y( ) , an insurance contract is a contract in which one part y (the insurer ) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policy holder. (AASB 4) 4 WHAT AN INSURER DOES Diff t d th fi i l d t Differences to assurance an d other financial pro duc t s • Insurance pools the risk of uncertain future events. This is different to assurance models which pool the risk of events which will happen such as death, retirement or paying interest happen such as death, retirement or paying interest • The actual cost of providing the general insurance product is not known at the time of selling the product at the time of selling the product • The product being sold only has intangible attributes such as selling a promise to pay and the likelihood of a claim occurring selling a promise to pay and the likelihood of a claim occurring • The product is often a ‘grudge’ purchase and a ‘need’ rather than a ‘want’

 5 WHAT AN INSURER DOES BASIC PRINCIPLES BASIC PRINCIPLES SIMPLIFIED CONCEPT SIMPLIFIED CONCEPT 

– RISK OF A LARGE AND INFREQUENT LOSS RISK OF A LARGE AND INFREQUENT LOSS 

Every year 1 in every 1,000 houses suffers a fire at a cost of $100,000. An individual risks having to finance $100,000 if it is their turn for the 1:1000 loss. A group of 1,000 householders pooling together pay only $100 each to rebuild the house each each to rebuild the house each year. Even after 10 years the individual has only paid $1,000 to protect their risk of $100,000. 6 protect their risk of $100,000. WHAT AN INSURER DOES BASIC PRINCIPLES

SIMPLIFIED CONCEPT – RISK OF SMALL FREQUENT LOSSES BASIC PRINCIPLES 

SIMPLIFIED CONCEPT RISK OF SMALL FREQUENT LOSSES 

Every year 100 in every 

1,000 houses suffers a burglary at a cost of $1,000. An individual risks having to finance $1,000 if it is their turn for the 1:10 loss. A group of 1,000 householders pooling together pay $100 each to reimburse the cost of goods stolen. reimburse the cost of goods stolen. Over 10 years the individual has paid $1,000. 

7 WHAT AN INSURER DOES PRODUCTS SHORT TAIL LONG TAIL • Claims may not even be SHORT TAIL LONG TAIL • 

Claims usually known and • Claims may not even be reported within 12 months • Settlement can take 3-4 years • Greater complexity in • Claims usually known and settled within 12 months • Less complexity in managing claims • Greater complexity in managing claims • Higher risk in predicting final settlement managing claims • Less risk in predicting final settlement • Generally based around settlement • Generally based around medical and legal outcomes