Aplicatii seminar

Insurance and Reinsurance

Risk

Describe briefly the five major methods of handling risk. Give an example of each method.

Identify the types of financial losses likely to be incurred by each of the following parties.
a. A person who negligently injures another motorist in an auto accident
b. A restaurant that is shut down for six months because of a tornado
c. A family whose family head dies prematurely
d. An attorney who fails to file a legal brief on time for a client
e. A tenant whose apartment burns in a fire

Sarah operates a pawn shop in a large city. Her shop is in a high-crime area, and the high cost
of burglary insurance is threatening the existence of her business.
A trade association points out that several methods other than insurance can be used to handle
the burglary exposure. Identify and illustrate three different noninsurance methods that might
be used to deal with this exposure.

Case application 1
Tyrone is a college senior who is majoring in journalism. He owns a high-mileage 1910 Ford
that has a current market value of $1500. The current replacement, value of his clothes,
television set, stereo set, and other personal property in a rented apartment total $5000. He
wears disposable contact lenses, which cost $200 for a six-month supply. He also has a
waterbed in his rented apartment that has leaked water in the past. An avid runner, Tyrone
runs five miles in a nearby public park that has the reputation of being extremely dangerous
because of drug dealers, numerous assaults and muggings, and drive-by shootings. Tyrone's
parents both work to help him pay his tuition.
For each of the following risks or loss exposures, identify an appropriate risk management
technique that could be used to deal with the exposure. Explain your answer.
a. Physical damage to the 1990 Ford because of collision with another motorist
b. Liability lawsuit against Tyrone arising out of the negligent operation of his car
c. Total loss of clothes, television, stereo, and personal property because of grease fire in the
kitchen of his rented apartment
d. Disappearance of one contact lens
e. Waterbed leak that causes property damage to the apartment
f. Physical assault on Tyrone by gang members who are dealing drugs in the park where he
runs
g. Loss of tuition from Tyrone’s father who is killed by a drunk driver in an auto accident

Risk and insurance

Insurance Fraud Comes In All Shapes and Sizes
Here are some examples of the many shapes and sizes of insurance fraud.
 Staged auto accidents: Juan and Maria Lopez and their 2-year-old daughter were
killed in an auto accident that two men staged on the Long beach (Calif.) freeway to
collect insurance money in 1997. The scammers stopped suddenly in front of a
tractor-trailer the Lopezes were following. A gravel truck then rammed the Lopez car
 from behind, killing the young family instantly. Isidorio Medina Gomez and Esteban
Galves Solano each received 11 years in state prison in 1998 for staging the accident.
 Arson: Helen Tidwell hired two local teenagers to torch her Tampa restaurant so she
could collect the insurance money in 1996. But fumes from the gasoline poured in the
restaurant accidentally ignited, causing an explosion. One boy died and the other was
permanently scarred. Tidwell received 30 years in prison in 1999.
 Health Insurance Fraud (corporate): Columbia/HCA Healthcare has agreed to pay at
least $754 million after overbilling taxpayer-funded Medicare for years. The chain
(now named HCA) billed Medicare for unneeded lab tests, made improper diagnoses
to make patients seem sicker than they were, and disguising unreimbursable expenses
as reimbursable. Criminal charges are still pending.
 Health Insurance Fraud (individual): Massachusetts orthopedic surgeon Harold
Goodman routinely gave patients potentially harmful X-rays and steroid injections
they didn’t need so he could falsely bill Medicaid. Goodman spent as few as five
minutes with each patient, giving one patient 74 X-rays and 112 steroid injections in
less than three years. Goodman received six months in prison in 2000.
 Faked Death: Bonnie McCaslin bought 78 life insurance policies on her ex-husband
Timothy, who knew nothing about the policies. She then tried to collect $11 million
from dozens of life insurers by claiming he died in an earthquake in Mexico in 1995.
McCaslin received two years in jail in Nebraska, but blames Timothy for not
cooperating with her ruse. "He's such a jerk. If it weren't for him, I wouldn't be in
here," she told Forbes magazine.
 Murder for Insurance: Dina Abdelhaq killed her seven-week-old daughter Tara to
collect $200,000 in life insurance money to feed her gambling addiction in 1995.
Jobless and on welfare, the Illinois resident was deeply in debt from riverboat
gambling. Tara died in her crib just two weeks after Abdelhaq took out a life policy
on the child. Abdelhaq received 21 years in prison for insurance fraud in 2000.
 Insurer Fraud: Thousands of investors, many of them retirees left almost penniless,
were financially devastated when National Heritage Life Insurance Company
collapsed in 1995 after being looted of $450 million by company insiders. The
insiders lived lavish lifestyles while retirees who invested in the company lost their
entire life savings. Four major players were convicted in 1999, and dozens more are
charged in America’s largest insurer insolvency caused by fraud.
 Property Insurance: California software distributor Irwin Bransky had a lot of useless
merchandise on his hands. So when the Northridge earthquake struck California in
1994, Bransky ordered employees to jump on the software packages and bend them
with their hands to inflate an insurance claim. Bransky filed a $5-million claim, and
the insurer paid $840,000 before an employee blew the whistle. Bransky received 51
months in prison in 1998.

Risk management

City But Corporation provides school bus transportation to private and public schools in
Lancaster County. City Bus owns 50 buses that are garaged in three different cities within the
county. The firm faces competition from two larger bus companies that operate in the same
area. Public school boards and private schools generally award contracts to the lowest bidder
but the level of service and overall performance are also considered.
a. Briefly describe the steps in the risk management process that should be followed by the
risk manager of City Bus.
b. Identify the major loss exposures faced by City Bus.
c. For each of the loss exposures identified in (b), identify a risk management technique or
combination of techniques that could be used to handle the exposure.
d. Describe several sources of funds for paying losses if retention is used in the risk
management program.
e. Identify other departments in City Bus that would also, be involved in the risk management
program.

Jennifer is a college junior who is majoring in business administration. She resides in a

college dorm and has a roommate, Karen. Jennifer has a part-time job to help pay her
miscellaneous expenses, but her parents are paying her tuition. Both parents must work to pay
her tuition. In addition to an extensive wardrobe, books and supplies for her courses, and
personal items, Jennifer owns an expensive stereo, a television set, and a trumpet that she
plays as a member of the college band. She also owns a late-model sports car that she drives
to and from her part-time job and to the beach and mountains where she loves to surf and ski.
Jennifer and Karen frequently visit a local college bar on Friday evening where they drink
and relax after a hard week of study and work. Jennifer sometimes drinks excessively, but she
will not allow Karen to drive her back to the dorm.
a. Describe briefly the steps in the personal risk management process.
b. Identify the major pure risks or loss exposures to which Jennifer is exposed with respect to
each of the following:
(1) Personal risks
(2) Property risks
(3) Liability risks
c. With respect to each of the pure risks or loss exposures mentioned, identify an appropriate
personal risk management technique that could be used to treat the exposure.

Insurance contract

Krishna purchased an automobile service station from Venkata Rao. The purchase price
included the building, equipment, and other assets. The business was financed by a loan from
National Bank, which held a mortgage on the building. Krishna also converted a one-car
repair bay into a short-order restaurant. When Krishna applied for property insurance on the
business, he did not tell the insurance company about the restaurant because his premiums
would have been substantially increased. Six months after the business opened, a car caught
fire and damaged the roof over a bay in the service station area.
a. Do any of the following parties have an insurable interest in the business at the time of the
fire?
1. Venkat Rao
2. Krishna
3. National Bank
b. Venkat Rao told Krishna he could save money by taking over Venkat Rao’s insurance
instead of buying a new policy. Would it be appropriate for Krishna to take over Venkat
Rao’s insurance without notifying Venkat Rao’s insurer?
c. Investigation of the fire revealed that the car owner knew the gas tank had a leak, but this
information was not disclosed to Krishna when the car was brought in for service. Explain
how subrogation might apply in this case.
d. Did Krishna show utmost good faith when he applied for property insurance on the
business? Explain.
e. Could Krishna’s insurer deny coverage for the fire on the basis of a material concealment?
Explain.

1. Scott borrowed $500,000 from the Gateway Bank to purchase a fishing boat. He keeps the
boat at a dock owned by the Marina Company. He uses the boat to earn income by fishing.
Scott also has a contract with the Blue Fin Fishing Company to transport shrimp from one
port to another.
a. Do any of the following parties have an insurable interest in Scott or his property? If an
insurable interest exists, explain the extent of the interest,
(1) Gateway Bank
(2) Marina Company
(3) Blue Fin Fishing Company
b. If Scott did not own the boat but operated it on behalf of the Blue Fin Fishing Company,
would he have an insurable interest in the boat? Explain.
2. A drunken driver ran a red light and smashed into Kirsten's car. The cost to repair the car is
5000. She has collision insurance on her car with 250 deductible.
a. Can Kirsten collect from both the negligent driver’s insurance and her own insurer?
Explain your answer.
b. Explain how subrogation supports the principle of indemnity.

Carmine purchased an automobile service station from Ben. The purchase price included the
building, equipment, and other assets. The business was financed by a loan from National
Bank, which held a mortgage on the building. Carmine also converted a one-car repair bay
into a short-order restaurant. When Carmine applied for property insurance on the business,
he did not tell the insurance company about the restaurant because his premiums would have
been substantially increased. Six months after the business opened, a car caught fire and
damaged the roof over a bay in the service station area.
a. Do any of the following parties have an insurable interest in the business at the time of the
fire?
Ben
Carmine
National Bank
b. Ben told Carmine he could save money by taking over Ben’s insurance instead of buying a
new policy. Would it be appropriate for Carmine to take over Ben’s insurance without
notifying Ben’s insurer? Explain.
c. Investigation of the fire revealed that the car owner knew the gas tank had a leak, but this
information was not disclosed to Carmine when the car was brought in for service. Explain
how subrogation might apply in this case.
d. Did Carmine show utmost good faith when he applied for property insurance on the
business? Explain.
e. Could Carmine’s insurer deny coverage for the fire on the basis of a material concealment?
Explain.

3. Nicole is applying for a health insurance policy. She has a chronic liver ailment and other
health problems. She honestly disclosed the true facts concerning her medical history to the
insurance agent. However, the agent did not include all the facts in the application. Instead,
the agent stated that he was going to cover the material facts in a separate letter to the
insurance company’s underwriting department, but the agent did not furnish the material facts
to the insurer, and the contract was issued as standard. A claim occurred shortly thereafter.
After investigating the claim, the insurer denied payment. Nicole contends that the company
should pay the claim because she answered honestly all questions that the agent asked.
a. On what basis can the insurance company deny payment of the claim?
b. What legal doctrines can Nicole use to support her argument that claim should be paid?

Technical elements applications

1. Insurance premium = Insurance quota * Insured Amount (IA)

2. Franchise = part of loss covered by insured
If loss <= franchise insurer does not cover Insurance compensation (IC) =0

If loss > franchise

a)simple franchise, insurer covers the entire loss

b) deductible franchise, insurer covers only the part of the loss exceeding the franchise level.

exemple

loss = 1300 lei

franchise =1200 lei

IC =?

a) Deductible franchise IC = 1300-1200=100 lei (the rest of 1200 lei is

covered by insured)
b) Simple franchise IC = 1300 lei (the insured covers nothing aș loss >
franchise)

1. The following information is known about an insurance policy:

Insurance quota = 0.01%

Market value (MV) of the building= 900 mil RON

Insured amount (IA) = 600 mil RON

Partial loss= 300 mil RON

I. Compute the insurance premium.

II. Compute the insurance compensation, if the policy includes a :
a) deductible franchise= 20 mil
b) simple franchise= 40 mil

I. Insurance premium = 0.01% *600 mil = 0.06 mil (meaning 60000 RON)
II. As MV<> IA,

IC = Loss * IA/MV

a) Deductible franchise 20 mil, loss 300 mil

IC = (300-20)*600/900 = 186.67 lei

b) simple franchise 40 mil, loss 300 mil

As franchise < loss, insurer covers the entire compensation , weighted by the ratio between IA and
MV

IC = 300*600/900 = 200 lei

Applications to solve:

1.The following information is known regarding a property insurance contract: market value =
900 mil RON; partial loss = 300 mil RON; premium quota = 0.02%. Determine: a) the insurance
premium and the insurance compensation knowing that the contract includes a simple franchise of
50 mil RON and an insured amount of 600 mil RON; b) the insurance compensation knowing that
the contract includes a deductible franchise of 100 mil RON and an insured amount of 900 mil
RON.

2.The following information is known regarding a property insurance contract: market value = 900
mil RON; partial loss = 400 mil RON; premium quota = 0.04%. Determine: a) the insurance premium
and compensation knowing that the contract includes a simple franchise of 80 mil RON and an
insured amount of 600 mil RON; c) the insurance compensation knowing that the contract includes a
deductible franchise of 90 mil RON and an insured amount of 600 mil RON.

Reinsurance

An excess of loss reinsurance contract is signed by an insurer (A) with three reinsurers
(R1,R2,R3)according to which A retains 350,000 m.u.; R1 covers up to 450,000m.u.; R2 covers up to
700,000m.u.; R3 covers up to 1,000,000 m.u. Determine: a) The maximum capacity of each reinsurer;
b) Who covers and in what amount the following losses: i. 200,000 m.u.; ii. 850,000 m.u.; iii.
1,100,000 m.u.

Taking into consideration a quota share reinsurance contract which stipulates that the insurer (A)
covers 25% of any loss and that the maximum capacity of the reinsurance contract is 800000 m.u.,
determine: a) Maximum capacity of the reinsurer (R); b) Who covers and in what amount the
following losses: i.100,000 m.u.; ii.400,000 m.u.; iii. 1,000,000 m.u..

A mixed proportional reinsurance is signed by insurance company A with the reinsurance company R.
According to this contract, the insurer retains 300,000 m.u. and 20% of anything exceeding this
amount. Taking into consideration that the maximum capacity of the reinsurance contract is 900,000
m.u., determine: a) The maximum capacity of the reinsurer; b) Who covers and in what amount the
following losses: i. 100,000 m.u.; ii. 500,000 m.u. iii. 925,000 m.u

An excess of loss reinsurance contract is signed by an insurer (A) with three reinsurers (R1,R2,R3)
according to which A retains 200,000 m.u.; R1 covers up to 400,000m.u.; R2 covers up to 650,000
m.u.; R3 covers up to 800,000 m.u. Determine: a) The maximum capacity of each reinsurer; b) Who
covers and in what amount the following losses: i. 150,000 m.u.; ii. 550,000 m.u.; iii. 850,000 m.u