How to Understand Insurance

How to Understand Insurance 2016-12-16T15:55:00+00:00

Want to understand more about insurance? This is a glossary of frequently used terms in the insurance industry

  1. Acts of God: natural disasters that could not have been reasonably prevented or avoided.
  2. Acquisition/expense ratio: The ratio of acquisition and other insurance-related expenses to net premiums earned. This ratio measures the company’s efficiency in securing new business.
  3. Asset allocation strategy: The mix of various types of investments in an insurance company’s portfolio, which usually consists of investment grade debt, high- and medium-risk debt and equities. An insurance company typically attempts to achieve a balance between return on capital and preservation of capital, as each is needed to continue to maintain long-term stability.
  4. Balance sheet: An accounting term referring to a listing of a company’s assets, liabilities and surplus (or equity) as of a specific date.
  5. Claim: a demand made by the insured in the event of the occurrence of a loss for payment of the benefits as provided by the policy.
  6. Combined ratio: The sum of the loss ratio and acquisition/expense ratio, without the addition of investment income or income taxes. This ratio measures the company’s overall underwriting profitability, and a combined ratio of less than 100 indicates an underwriting profit.
  7. Deductibles: amounts you pay to cover a loss before you are entitled to payment by your insurer. It’s called the insured participation in the loss.
  8. Equities: Investment instruments in the portfolio of an insurance company that consist of shares (ownership stakes) in various public and private companies.
  9. Exclusions : items, perils or situations that are not covered by your policy.
  10. Cash flow: Refers to the measurement of the amount of cash an insurance company brings in minus the amount of cash pays out in the form of claims payments and other expenses, over a certain period of time. A positive cash flow generating company is considered to be building strength and therefore able to better withstand large loss-generating events (such as hurricanes and earthquakes).
  11. Insurance: a contract between two parties, in which the buyer of insurance pays a small amount (the premium) and in return, the seller of insurance accepts to guarantee a payment to the buyer in case of realization of the type of loss defined in the contract.
  12. Investment-grade debt: Refers to the high quality of bonds and other fixed-income investments (based on internationally recognized ratings by Moody’s, Standard & Poor’s and Fitch) made by an insurance company from the cash generated from its premiums. Typically, an insurer is required to keep a broad range of generally conservative high quality investments in its portfolio, such that policyholders funds are protected in the event of a large stock or bond market driven shock.
  13. High- and medium-risk bonds: Refers to bonds and other fixed-income investments that do not meet the criteria of high investment-grade investments (based on internationally recognized ratings by Moody’s, Standard & Poor’s and Fitch), but carry a return for the insurance company that is higher than investment-grade debt, thereby generating more income for an insurance company and adding more stability to its capital base over time. A diversified combination of both investment-grade and high- and medium-risk debt is found in the portfolio of an insurance company, providing a combination of both stability and returns.
  14. Lapse ratios: The ratio of the number of life insurance policies that lapsed (or were not renewed) within a given period to the number in force at the beginning of that period. Also known as the renewal rate.
  15. Liability: liability insurance protects against pecuniary loss that third party claims for bodily injury and property damage caused by you.
  16. Loss ratio: The ratio of losses and related expenses to net premiums earned. This ratio measures the company’s underlying profitability, or loss experience, on its total book of business.
  17. Losses & Expenses: Represents the total amount of claims submitted by policyholders for losses that they incur from their policies, and expenses include all costs associated with the core insurance operations including loss adjustments.
  18. Low risk bonds: See “Investment-grade debt”
  19. Money market securities: Consist of short-term, very liquid (easy to sell) and conservative investment instruments in Government and quasi-Government securities whose returns are typically small but offer extreme stability for a portfolio.
  20. Net earnings: The total after-tax earnings (revenues minus losses and expenses) generated from operations and investment income, as well as any other income generated by the insurance company, over a certain period of time.
  21. Operational earnings: Income (revenues minus losses and expenses) generated from an insurance company’s principal insurance business, and not including other income such as investment income, over a certain period of time.
  22. Policy: the written contract effecting insurance, or the certificate thereof, by whatever name called, and including all clause, riders, endorsements, and papers attached thereto and made a part thereof.
  23. Portfolio: every insurance company invests its premiums in a variety of money-market instruments, bonds and equities so that the capital base of the company continues to strengthen and thereby providing greater stability to manage through loss events. The sum of all these financial instruments is called the portfolio.
  24. Premium: the price of insurance protection for a specified risk for a specified period of time. Policy holder: An individual, a company or a counterparty who enters into a contract with an insurance company, who in turn promises to make payment in the event of a loss.
  25. Reinsurance: insurance that an insurance company buys for its own protection, so that the full extent of a loss is not fully absorbed by one company. Reinsurance allows an insurance company to expand its capacity to write more policies, but also to secure catastrophe protection against pic losses.
  26. Revenues: The amount of premiums that are received by an insurer (total premium paid by insured for a policy net of taxes). Revenues are categorized by two main branches. Earned and unearned premiums. Earned Premium is the portion of the premium that has been paid for in advance that has been “earned” by virtue of the fact that time has passed ( this is the real income of an insurance company). Unearned premium is the portion of the premium that is not yet earned as time has not passed yet. It’s considered as a liability for the insurance company whom has to provision for reimbursement for example in case client decides to cancel the policy. For instance, a 12 months policy that has been paid in advance and is two months old would have only partly earned the premium.
  27. ROAA: For a certain period, net earnings as a percentage of the average assets of the insurance company over that same period. Demonstrates how effectively an insurance company is utilizing and building on its asset base.
  28. ROAE: For a certain period, net earnings as a percentage of the average equity of the insurance company over that same period. Demonstrates how effectively an insurance company is utilizing and building on its capital base.
  29. Short term assets: Assets that are owned by the insurance company, and are readily available to be utilized to pay any claims or losses of policyholders.
  30. Solvency 1: A standard formula adopted by the global insurance sector that allows an insurance company to calculate the minimum level of capital and reserves that it must have to protect policyholders in the event there is a large destabilizing loss event in the market. A company with a higher solvency ratio is considered much more stable and with a greater likelihood of withstanding high loss generating events (such as hurricanes and earthquakes).
  31. Underwriting: the process of selecting risks for insurance and classifying them according to their degrees of insurability and risk so that the appropriate rates/pricing may be assigned. The process also includes rejection of those risks that do not qualify under the guidelines of a company’s risk tolerance.
  32. Retention: The amount of insurance risk (or coverage amount) that is kept by and insurance company on its books after any portion is reinsured
  33. Total assets: Refer to all the available properties of every kind or possession of an insurance company that might be used to pay its debts.