Market Cycles: Market-wide fluctuations in the prevailing level of insurance and reinsurance premiums. A soft market, i.e., a period of increased competition, depressed premiums, and excess capacity, is followed by a hard market - a period of rising premiums and decreased capacity.
Minimum Premium: The least amount of premium to be charged for providing a particular insurance coverage. The minimum premium may apply in any number of ways such as per location, per type of coverage, or per policy.
Obligatory Treaty: A reinsurance treaty between an insurer and a reinsurer (usually involving pro rata reinsurance), in which the insurer agrees to automatically cede all business that falls within the terms of the treaty. The reinsurer, in turn, is obligated to accept such business. "Automatic treaty" is another term for obligatory treaty.
Participating Reinsurance: A form of reinsurance under which the reinsurer and primary insurer share losses in the same proportion as they share premiums and policy limits. Quota share reinsurance and surplus share reinsurance are the two types of participating reinsurance. Pro rata reinsurance is another term often used to describe participating reinsurance.
Payout Profile: A schedule illustrating the typical rate of dollars paid out in claim settlements over time. For example, on average, less than 30 cents of the total loss dollar for workers compensation claims is paid during the first year of coverage. Even less is paid on average for general liability claims. Depending upon the particular type of risk, an additional 5 to 10 years can elapse before the full 100 percent of the loss reserve is paid out on a particular claim. During this long pay-out period, the loss reserves (i.e., the not-yet-paid-out funds which are set aside by the insurer to cover the loss claims) can be a source of significant investment income to the insurer, and the payout profile is instrumental in estimating this source of profit for any given category of risk.
Pool: An organization of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses, and expenses shared in agreed ratios. Pools are also groups of organizations that are not large enough to self-insure individually and thus form a shared risk pool, also referred to as "risk pooling".
Pro Forma Financial Statements: A set of financial statements (usually an income statement, balance sheet, and statement of cash flows) designed to exhibit "as-if" financial results, often used to project future financial results, based on a set of assumptions. These statements are commonly used to evaluate the feasibility of proposed risk funding programs such as captives and risk retention groups.
Pro Rata Reinsurance: A term describing all forms of "proportional" reinsurance. Under pro rata reinsurance, the reinsurer shares losses in the same proportion as it shares premiums and policy amounts. Quota share and surplus share are the two major types of pro rata reinsurance.
Probability: A numerical measure of the chance or likelihood that a particular event will occur. Probabilities are generally assigned on a scale from 0 to 1. A probability near 0 indicates an outcome that is unlikely to occur, while a probability near 1 indicates an outcome that is almost certain to occur.
Producer-owned reinsurance captive (PORC): This is a type of captive reinsurance company that underwrites risks of an affiliated operating business by means of having those risks first directly underwritten by a fronting insurance company which then cedes those risks on through to the captive as reinsurer. The insurance is "producer-owned" in the sense that the producer of the initial insurance contract owns the captive. In some instances, this type of reinsurance company is owned by an insurance agent and broker, in which case, it is not technically-speaking a captive insurer since it is not owned by the owners of the affiliated operating company.
Professional Reinsurer: A company whose business is confined solely to reinsurance and peripheral services offered by a reinsurer to its customers. This is in contrast to primary insurers who exchange reinsurance or operate reinsurance departments as adjuncts to their basic business of primary insurance.
Profit Commission: A provision found in some reinsurance agreements that provides for profit sharing. Parties agree to a formula for calculating profit, an allowance for the reinsurer's expenses, and the cedant's share of profit after expenses.
Purchasing Group: Authorized by the Liability Risk Retention Act of 1986, a group formed to obtain liability coverage for its members, all of whom must have similar or related exposures. The Act requires a purchasing group to be domiciled in a specific state. In contrast to risk retention groups, purchasing groups are not risk-bearing entities.
Pure Risk: The risk involved in situations that present the opportunity for loss but no opportunity for gain. Pure risks are generally insurable, whereas speculative risks (which also present the opportunity for gain) generally are not. See speculative risk.
Rating Bureau: An organization that collects statistical data on losses and exposures of businesses and promulgates rates for use by insurers in calculating premiums. The two most important rating bureaus are the National Council on Compensation Insurance and the Insurance Services Office, Inc. However, a number of states also use their own rating bureaus.
Reinsurance: Insurance in which one insurer, the reinsurer, accepts all or part of the exposures insured in a policy issued by another insurer, the ceding insurer. In essence, it is insurance for insurance companies.
Reinsurance Intermediaries: Brokers who act as intermediaries between reinsurers and ceding companies. For the reinsurer, intermediaries operate as an outside sales force. They also act as advisers to ceding companies in assessing and locating markets that meet their reinsurance needs.
Rent-A-Captive: An arrangement in which a captive insurer "rents" its facilities to an outside organization, thereby providing the benefits that captives offer without the financial commitments that captives require. In return for a fee (usually a percentage of the premium paid by the renter), certain captives agree to provide underwriting, rating, claims management, accounting, reinsurance, and financial expertise to unrelated organizations.
Reserve: An amount of money earmarked for a specific purpose. Insurers establish unearned premium reserves and loss reserves indicated on their balance sheets. Unearned premium reserves show the aggregate amount of premiums that would be returned to policyholders if all policies were canceled on the date the balance sheet was prepared. Loss reserves are estimates of outstanding losses, loss adjustment expenses, and other related items. Self-insured organizations also maintain loss reserves.
Retention: Assumption of risk of loss, generally through the use of noninsurance, self-insurance, or deductibles. This retention can be intentional or, when exposures are not identified, unintentional. In reinsurance, it is the net amount of risk the ceding company keeps for its own account or that of specified others.
Retention Plan: A dividend plan normally used in writing workers compensation insurance in which the net cost to the policyholder is equal to a "retention factor" (insurance company profit and expenses) plus actual incurred losses subject to a maximum premium equal to standard premium less premium discount.
Risk-based Capital (RBC) Requirements: A method developed by the National Association of Insurance Commissioners (NAIC) to determine the minimum amount of capital required of an insurer to support its operations and write coverage. The insurer's risk profile (i.e., the amount and classes of business it writes) is used to determine its risk-based capital requirement. Four categories of risk are analyzed in arriving at an insurer's minimum capital requirement: asset, credit, underwriting, and off-balance sheet.
Risk Financing: Achievement of the least-cost coverage of an organization's loss exposures, while assuring post-loss financial resource availability. The risk financing process consists of five steps: identifying and analyzing exposures, analyzing alternative risk financing techniques, selecting the best risk financing technique(s), implementing the technique(s), and monitoring the selected technique(s). Risk financing programs can involve insurance rating plans, such as retrospective rating, self-insurance programs, or captive insurers.
Risk Purchasing Group: A group formed in compliance with the Liability Risk Retention Act of 1986 for the purpose of negotiating for and purchasing insurance from a commercial insurer. Unlike a risk retention group which actually bears the group's risk, a risk purchasing group merely serves as a vehicle for obtaining coverage, typically at favorable rates and coverage terms.
Risk Quantification: Measurement of risk to make risk financing decisions. Loss frequency and loss severity are the dimensions of measurement. The value of loss and the variation in value from one period to the next will quantify the impact of the risk.
Risk Retention Group: A group self-insurance plan or group captive operating under the auspices of the Liability Risk Retention Act of 1986. A risk retention group can cover the liability exposures, other than workers compensation, of its owners.
Risk Sharing: Also known as "risk distribution," risk sharing means that the premiums and losses of each member of a group of policyholders are allocated within the group, based on a predetermined formula. Risk is considered to be shared if there is no policyholder-specific correlation between premiums paid into a captive, for example, and losses paid from the captive's reserve pool.
Self-Insurance: A formal system whereby a firm pays out of operating earnings or a special fund any losses that occur that could ordinarily be covered under an insurance program. The moneys that would normally be used for premium payments may be added to this special fund for payment of losses incurred.
Self-Insured Retention: The amount of each loss for which the insured agrees to be responsible before a commercial insurer begins to participate in a loss. This is in contrast to a deductible in that the commercial insurer is responsible for losses even within the deductible limit. Although the deductible insurer looks to the insured for reimbursement of such losses, the insurer's responsibilities are unaffected by the insured's failure to reimburse.
Severity: The amount of damage that is (or that may be) inflicted by a loss or catastrophe. Severity is sometimes quantified as a severity rate, which is a ratio relating the amount of loss to values exposed to loss during a specified period of time.
Speculative Risk: Uncertainty about an event under consideration that could produce either a profit or a loss, such as a business venture or gambling transaction. A pure risk is generally insurable, while a speculative risk is usually not.
Spread of Risk: Consideration of the number of independent exposures to loss in a given time period. As the number of units exposed independently to loss increases, the spread of risk expands and the likelihood that all units will suffer loss diminishes. Predictive ability increases as the spread of risk increases. This is often called the "law of large numbers."
Stop Loss Reinsurance: A form of reinsurance also known as "aggregate excess of loss reinsurance" under which a reinsurer is liable for all losses, regardless of size, that occur after a specified loss ratio or total dollar amount of losses has been reached.
Structured Settlement: A settlement under which the plaintiff agrees to accept a stream of payments in lieu of a lump sum. Structured settlements can be tailored to the individual's inflation-adjusted living costs, anticipated future medical expenses, education costs for children, and other lifetime needs. Annuities are usually used as funding mechanisms.
Surplus Reinsurance: Reinsurance amounts that exceed a ceding company's retention. In surplus reinsurance, the reinsurer contributes to the payment of losses in proportion to its share of the total limit of coverage.
Third-Party Administrator (TPA): A firm that handles various types of administrative responsibilities on a fee-for-services basis for organizations involved in cash flow programs. These responsibilities typically include claims administration, loss control, risk management information systems, and risk management consulting.
Treaty Reinsurance: A form of reinsurance in which the ceding company makes an agreement to cede certain classes of business to a reinsurer. The reinsurer in turn agrees to accept all business qualifying under the agreement, known as the "treaty." Under a reinsurance treaty, the ceding company is assured that all of its risks falling within the terms of the treaty will be reinsured in accordance with treaty terms.
Unbundling: The practice of separating risk handling and risk funding services either from a multiline insurer or from themselves. Captives that require a "front" may also be required to purchase all or some of the services from the same insurer. This is a "bundled" program. Unbundling indicates the ability to purchase services from any vendor, not just those associated with the fronting insurer.
Valuation Date: The cutoff date for adjustments made to paid claims and reserve estimates in a loss report. For example, a workers compensation loss report for the 1996 policy year that has a 1998 valuation date includes all claim payments and changes in loss reserves made prior to the 1998 valuation date.
Weighted Average Loss Forecasting: A method of forecasting losses that assigns greater weight, typically to more recent years, when developing a forecast of future losses. Recent years receive a greater weight because they tend to more closely approximate current conditions (e.g., benefit levels, nature of company operations, medical expenses).
Working Layer: A dollar range in which an insured or, in the case of an insurance portfolio, a group of insureds, is expected to experience a fairly high level of loss frequency. For many organizations, this loss frequency is adequate to provide some degree of statistical credibility to actuarial forecasts of the total expected losses during a specific period of time, e.g., 1 year. This is the layer typically subject to deductibles, self-insured retentions, retrospective rating, and similar programs.
Wrap-Around Risk Financing Program: A risk financing program in which two or more different risk financing approaches are combined into one overall program. Typically, a wrap-around is used for workers compensation insurance so that the most cost-effective program in each state can be used to an insured's advantage. For instance, in state A, an insured may have an exposure large enough to qualify as a self-insurer, whereas the requirements in state B may be such that another type of risk financing program is preferable.
Medical Stop Loss: Insurance coverage that protects against unforeseen or catastrophic losses. Medical stop loss insurance is typically purchased by employers looking to reduce health benefit costs, maintain control over cash reserves, and offer comprehensive health coverage for employees. Under medical stop loss policies, employers who have opted to self-insure their employee benefit plans do not assume 100% of the liability for losses that may arise from those plans. Liability is transferred to the insurance company for eligible losses that exceed certain limits called deductibles.