Insurance 101

Here are a few key definitions and concepts which might help those new to the insurance forum more rapidly understand the nature of the insurance problems our society faces. I will add more as time allows and hopefully we might combine them with other concepts.

What is Insurance?

One definition of insurance is a system to make large financial losses more affordable by pooling the risks of many individuals and business entities and transferring them to an insurance provider for a premium. More basically insurance is the process of the assumption of risk from one party to another for a fee.

The key to understanding insurance is the concept of risk assumption. In insurance terms risk is the chance of loss of that which is insured.

For the purposes of this web site the main type of insurance studied is property/casualty in general and catastrophe insurance (CAT) in particular. ISO defines a catastrophe as an event that causes $25 million or more in insured property losses and affects a significant number of property/casualty policyholders and insurers.

What is the role of insurance providers?

Insurance providers core function in society is that of helping to manage risk. Insurance plays a vital role in helping individuals and businesses prepare for and recover from the potentially devastating effects of a disaster such as a catastrophic hurricane or earthquake.

Insurance providers help society pre-pay for their risk needs. Catastrophic insurance providers have a special role in helping entire communities pre-pay for their disaster needs. Because their losses are more volatile the property/casualty insurers invest largely in high-quality liquid securities, which can be sold quickly to pay claims resulting from a major hurricane, earthquake or man-made disaster such as a terrorist attack.

Who are the leading providers?

Data from the National Association of Insurance Commissioners (NAIC) identifies the 10 leading writers of non-governmental property/casualty insurance by direct premiums written during the 2006 calendar year.

NAIC percentages were based on the U.S. total including territories before reinsurance transactions, excluding state funds.

  1. State Farm Group 10.0%
  2. American International Group 7.6%
  3. Zurich Insurance Group 5.6%
  4. Allstate Insurance Group 5.6%
  5. Travelers Group 4.4&
  6. Liberty Mutual Insurance Group 3.7%
  7. Nationwide Group 3.2%
  8. Berkshire Hathaway Insurance Group 3.1%
  9. Progressive Group 2.9%
  10. Hartford Fire & Casualty Group 2.4%

It should be noted the federal government is considered by many CEO’s of insurance and individuals as the insurer of last resort. The federal government is also the sole insurance provider for basic flood coverage in the United States.

How’s the Weather – Model?

Today we begin with the weather forecast but not just any weather forecast mind you. First off is this story from Reuters which proclaims our property and casualty insurance rates in the US will remain high due to the massive hurricane that is surely coming to destroy us all. As a result, the article concludes our P&C rates will continue to increase. So proclaims the popular press which by the way has never met a scientific story on global warming and Hurricanes they failed to butcher.

So what’s so complicated about the long range weather forecast? Easy, these high priced models that are periodically publicly released (and butchered) aren’t really worth the paper Reuters wrote the story upon:

One big problem is that catastrophe models are not reliable predictors of when or where a monster hurricane is going to strike, according to Karen Clark, vice chair of AIR Worldwide, one of the leading modeling firms.

“A model is just that—a model. It is still based on many simplifying assumptions, with a high degree of uncertainty,” she said. “It can tell you, given where you have your insureds, what the maximum probable loss would be should a storm of a certain strength hit a certain area, but the question of frequency is more vexing.”

However, she noted that “while there is no consensus at all on climate change and the frequency of hurricane landfalls, most scientists agree that when storms do hit these days, their intensity is likely to be greater and will cause more damage.”

So here, in the National P&C Underwriter, an insurance industry trade publication, we discover a deeper truth about these climate models and as borne out by the last two Hurricane seasons which have also come complete with prediction of coastal doom; namely that weather models are notoriously unreliable predictors of when or where a windstorm may strike.

This basic fact does not stop insurers, especially those in reinsurance from paying big bucks for weather forecasting as most have their own in house forecasting units like this one. We submit that despite the limitations of weather modeling there has to be good reason the insurance industry keeps such a close eye on the weather. However, insurance seems to be one business that profits handily even when they completely miss on the extended forecast like these past two years.