Fernando MonteiroThe Business of Insurance
October 29th 2009 14:12
Did you ever want to know all about the insurance business but were afraid to ask? Well, in this condensed article I present all the most relevant aspects of insurance in a made easy format, just for you.
Your first question might be just what is insurance? Insurance is about sharing risks. Insurance companies insure a large number of people, from whom they receive premiums, while only few make claims. This way insurance is about the many sharing the risk of the few.
Insurance started in England when ship captains shared their ship cargoes with other ships. If one ship sunk, only a fraction of the cargo would be lost. These arrangements were made in cafes in London and this was the beginning of the Lloyd’s of London. Insurance businesses started as mutual companies and non-profit organisations.
Some insurance lines are: motor vehicle (CTP, Green Slip, Full Cover, etc); professional indemnity (for error or incompetence related to the professions such as lawyers, engineers, doctors and accountants); niche markets (mobile homes in the US); property damage (fire, earthquake), work related (Worker’s Compensation), etc.
Insurance lines are typically: “short-tail” -- insurance products such as car insurance which expire in one year -- and “long-tail” -- insurance such as workers compensation, being the asbestos related compensation, 20 years after it was written, an example.
Typically, insurance companies share their risks with Reinsurance companies who charge a premium for the risks assumed. Suppose that an insurance company insures 40 per cent of the houses in a particular suburb. That may represent a high risk for that insurance company and it may want to share a large part of that risk with a reinsurance company which may take the most of it.
An insurance company pools the premiums received from insureds and must, at the beginning of each year, make provisions for the eventuality of a claim being made. This is a job for the actuary profession who, based on statistics and other calculations, must determine how much should be provisioned each year to pay future claims. Typically these reserves are 15 to 20 per cent of premium income.
It results obvious that the insurance business is one to be run by very conservative people and, in fact, the most conservative of them even use, on top of their reserves, another layer of reserves called prudential margins or, as the Swiss call them, “cushions”. Incidentally, instead of cushions, some insurance companies like using financial reinsurance, which may be questionable.
The reserves get consumed through the year, and sometimes in a following year, but while they are just laying there insurance companies invest them so as to make some gains from that money. The investment of reserves is typically ¾ fixed-interest securities and the rest equities. Fixed-interest securities are bonds and cash deposits which provide no or little risk and are easily convertible into cash. Equities are shares of stock which are more risky.
The reader might ask at this stage: how does an insurance company make a profit? It’s very simple: from the collected pool of premium it takes the reserves, adds to it the income from investing them and puts this final figure down as profit. This simple. Naturally, in a bad year, when it has to increase reserves, it may not have a profit, but then the invested reserves might have made some gains which then will help the bottom line.
QBE is an Australian insurance company based in Queensland. QBE’s Net Earned Premium stands at $11,087 million. Underwriting Profit is $3,184 million and has been positive in the last six years. Investment Income is $1,324 million, which is considerable. Net Profit is $1,859 million and Equity is $11,159 million having grown 3.4 times in the last six years. QBE’s EPS is $2.055 and its share price is $22.13, which represents a P/E of 10.8 times.
Your first question might be just what is insurance? Insurance is about sharing risks. Insurance companies insure a large number of people, from whom they receive premiums, while only few make claims. This way insurance is about the many sharing the risk of the few.
Insurance started in England when ship captains shared their ship cargoes with other ships. If one ship sunk, only a fraction of the cargo would be lost. These arrangements were made in cafes in London and this was the beginning of the Lloyd’s of London. Insurance businesses started as mutual companies and non-profit organisations.
Some insurance lines are: motor vehicle (CTP, Green Slip, Full Cover, etc); professional indemnity (for error or incompetence related to the professions such as lawyers, engineers, doctors and accountants); niche markets (mobile homes in the US); property damage (fire, earthquake), work related (Worker’s Compensation), etc.
Insurance lines are typically: “short-tail” -- insurance products such as car insurance which expire in one year -- and “long-tail” -- insurance such as workers compensation, being the asbestos related compensation, 20 years after it was written, an example.
Typically, insurance companies share their risks with Reinsurance companies who charge a premium for the risks assumed. Suppose that an insurance company insures 40 per cent of the houses in a particular suburb. That may represent a high risk for that insurance company and it may want to share a large part of that risk with a reinsurance company which may take the most of it.
An insurance company pools the premiums received from insureds and must, at the beginning of each year, make provisions for the eventuality of a claim being made. This is a job for the actuary profession who, based on statistics and other calculations, must determine how much should be provisioned each year to pay future claims. Typically these reserves are 15 to 20 per cent of premium income.
It results obvious that the insurance business is one to be run by very conservative people and, in fact, the most conservative of them even use, on top of their reserves, another layer of reserves called prudential margins or, as the Swiss call them, “cushions”. Incidentally, instead of cushions, some insurance companies like using financial reinsurance, which may be questionable.
The reserves get consumed through the year, and sometimes in a following year, but while they are just laying there insurance companies invest them so as to make some gains from that money. The investment of reserves is typically ¾ fixed-interest securities and the rest equities. Fixed-interest securities are bonds and cash deposits which provide no or little risk and are easily convertible into cash. Equities are shares of stock which are more risky.
The reader might ask at this stage: how does an insurance company make a profit? It’s very simple: from the collected pool of premium it takes the reserves, adds to it the income from investing them and puts this final figure down as profit. This simple. Naturally, in a bad year, when it has to increase reserves, it may not have a profit, but then the invested reserves might have made some gains which then will help the bottom line.
QBE is an Australian insurance company based in Queensland. QBE’s Net Earned Premium stands at $11,087 million. Underwriting Profit is $3,184 million and has been positive in the last six years. Investment Income is $1,324 million, which is considerable. Net Profit is $1,859 million and Equity is $11,159 million having grown 3.4 times in the last six years. QBE’s EPS is $2.055 and its share price is $22.13, which represents a P/E of 10.8 times.
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