TERM PAPER

UNIVERSITY OF NAIROBI RISK MANAGEMENT AND INSURANCE ASSIGNMENT TERM PAPER TITLE: CONTROVERSIES RESULTING FROM INSURANCE INDUSTRIES PRESENTED BY: MERIAN NELSON MAREN D33/39502/2013 TETU TIMOTHY NKAITOLE D33/39022/2013 TABLE OF CONTENTS Content Page Title………………………………………………….. 1 Table of Contents……………………………………. 2 Abstract……………………………………………… 3 Introduction…………………………………………... 3 Body………………………………………………….. 4 Insurance insulates too much……………………... 4 Complexity of insurance policy contract…………. 4 Limited consumer benefits………………………... 5 Redlining………………………………………….. 6 Insurance patents………………………………….. 7 Insurance industry and rent seeking………………. 7 Religious concerns………………………………… 7 Conclusion…………………………………………….. 8 References……………………………………………... 8 Abstract This term paper entails on a research done on the controversies resulting from insurance industry. These contradictions results since insurance uses probability to determine insurance premiums based on various risk factors. The Major concerned factors on this research were; Complexity of insurance policy contract , insurance insulates too much, Limited consumer benefits, Redlining, Insurance patents and insurance industry and rent-seeking. INTRODUCTION Insurance protects individuals from risk of uncertain outcomes.  It’s a contract that transfers the risk of financial loss from an individual or business to an insurer. The insurer collects smaller amounts of money from its clients and pools that money together to pay for losses. There are different types of insurance for different types of protection. When someone purchases insurance, they purchase what’s called an insurance policy. The insurance industry dates back hundreds of years, with Lloyd’s of London serving as one of the oldest insurance organizations. Many of the terms used in modern insurance, such as underwriter and premium, had their origin at the coffee house of Edward Lloyd. There are many positive aspects to the products and services provided by the insurance industry.     Fires, floods, earthquakes, tornadoes, hurricanes, car accidents, burglaries--the list is nearly endless when you consider the many risks you face in your daily life.  Luckily, you don’t need to face them alone. Insurance is available to help you pay for damage to your property or to pay others on your behalf when you injure someone or damage their property. Citation;  Susie’s Super Sweet 16: When Susie turned 16 her parents pulled out all the stops. The vampire themed sweet 16 party was well attended and the faux blood beverages flowed. At the end of the event, everyone was asked to join her parents outside for the great-gift unveiling. In true made for TV fashion, a green two-door sedan was parked in the driveway with a large red bow. But, before letting her take the driver’s seat, Susie’s parents made sure to add her “new” pre-owned car to their insurance policy. That way, if something where to happen, Susie and her family would be protected and the insurer would help.   Insurance uses probability to determine insurance premiums based on various risk factors.  The more risk an exposure has the more insurance companies need to collect to pay anticipated claims.  To get a better understanding play the Risk and Probability interactive game. BODY There are quite a number of controversies in any kind of an insurance industry. These can be discussed as follows; Insurance insulates too much An insurance company may inadvertently find that its insureds may not be as risk-averse as they might otherwise be (since, by definition, the insured has transferred the risk to the insurer), a concept known as moral hazard. To reduce their own financial exposure, insurance companies have contractual clauses that mitigate their obligation to provide coverage if the insured engages in behavior that grossly magnifies their risk of loss or liability. For example, life insurance companies may require higher premiums or deny coverage altogether to people who work in hazardous occupations or engage in dangerous sports. Liability insurance providers do not provide coverage for liability arising from intentional torts committed by or at the direction of the insured. Even if a provider desired to provide such coverage, it is against the public policy of most countries to allow such insurance to exist, and thus it is usually illegal. Complexity of insurance policy contracts was a major insurance loss, but there were disputes over the World Trade Center's insurance policy Insurance policies can be complex and some policyholders may not understand all the fees and coverages included in a policy. As a result, people may buy policies on unfavorable terms. In response to these issues, many countries have enacted detailed statutory and regulatory regimes governing every aspect of the insurance business, including minimum standards for policies and the ways in which they may be advertised and sold. For example, most insurance policies in the English language today have been carefully drafted in plain English; the industry learned the hard way that many courts will not enforce policies against insureds when the judges themselves cannot understand what the policies are saying. Typically, courts construe ambiguities in insurance policies against the insurance company and in favor of coverage under the policy. Many institutional insurance purchasers buy insurance through an insurance broker. While on the surface it appears the broker represents the buyer (not the insurance company), and typically counsels the buyer on appropriate coverage and policy limitations, in the vast majority of cases a broker's compensation comes in the form of a commission as a percentage of the insurance premium, creating a conflict of interest in that the broker's financial interest is tilted towards encouraging an insured to purchase more insurance than might be necessary at a higher price. A broker generally holds contracts with many insurers, thereby allowing the broker to "shop" the market for the best rates and coverage possible. Insurance may also be purchased through an agent. A tied agent, working exclusively with one insurer, represents the insurance company from whom the policyholder buys (while a free agent sales policies of various insurance companies). Just as there is a potential conflict of interest with a broker, an agent has a different type of conflict. Because agents work directly for the insurance company, if there is a claim the agent may advise the client to the benefit of the insurance company. Agents generally cannot offer as broad a range of selection compared to an insurance broker. An independent insurance consultant advises insureds on a fee-for-service retainer, similar to an attorney, and thus offers completely independent advice, free of the financial conflict of interest of brokers and/or agents. However, such a consultant must still work through brokers and/or agents in order to secure coverage for their clients. Limited consumer benefits In United States, economists and consumer advocates generally consider insurance to be worthwhile for low-probability, catastrophic losses, but not for high-probability, small losses. Because of this, consumers are advised to select high deductibles and to not insure losses which would not cause a disruption in their life. However, consumers have shown a tendency to prefer low deductibles and to prefer to insure relatively high-probability, small losses over low-probability, perhaps due to not understanding or ignoring the low-probability risk. This is associated with reduced purchasing of insurance against low-probability losses, and may result in increased inefficiencies from moral hazard. Redlining, Redlining is the practice of denying insurance coverage in specific geographic areas, supposedly because of a high likelihood of loss, while the alleged motivation is unlawful discrimination. Racial profiling or redlining has a long history in the property insurance industry in the United States. From a review of industry underwriting and marketing materials, court documents, and research by government agencies, industry and community groups, and academics, it is clear that race has long affected and continues to affect the policies and practices of the insurance industry. In July 2007, The Federal Trade Commission (FTC) released a report presenting the results of a study concerning credit-based insurance scores in automobile insurance. The study found that these scores are effective predictors of risk. It also showed that African-Americans and Hispanics are substantially overrepresented in the lowest credit scores, and substantially underrepresented in the highest, while Caucasians and Asians are more evenly spread across the scores. The credit scores were also found to predict risk within each of the ethnic groups, leading the FTC to conclude that the scoring models are not solely proxies for redlining. The FTC indicated little data was available to evaluate benefit of insurance scores to consumers. The report was disputed by representatives of the Consumer Federation of America, the National Fair Housing Alliance, the National Consumer Law Center, and the Center for Economic Justice, for relying on data provided by the insurance industry. All states have provisions in their rate regulation laws or in their fair trade practice acts that prohibit unfair discrimination, often called redlining, in setting rates and making insurance available. In determining premiums and premium rate structures, insurers consider quantifiable factors, including location, credit scores, gender, occupation, marital status, and education level. However, the use of such factors is often considered to be unfair or unlawfully discriminatory, and the reaction against this practice has in some instances led to political disputes about the ways in which insurers determine premiums and regulatory intervention to limit the factors used. An insurance underwriter's job is to evaluate a given risk as to the likelihood that a loss will occur. Any factor that causes a greater likelihood of loss should theoretically be charged a higher rate. This basic principle of insurance must be followed if insurance companies are to remain solvent.] Thus, "discrimination" against (i.e., negative differential treatment of) potential insureds in the risk evaluation and premium-setting process is a necessary by-product of the fundamentals of insurance underwriting. For instance, insurers charge older people significantly higher premiums than they charge younger people for term life insurance. Older people are thus treated differently from younger people (i.e., a distinction is made, discrimination occurs). The rationale for the differential treatment goes to the heart of the risk a life insurer takes: Old people are likely to die sooner than young people, so the risk of loss (the insured's death) is greater in any given period of time and therefore the risk premium must be higher to cover the greater risk. However, treating insureds differently when there is no actuarially sound reason for doing so is unlawful discrimination. Insurance patents New assurance products can now be protected from copying with a business method patent in the United States. A recent example of a new insurance product that is patented is Usage Based auto insurance. Early versions were independently invented and patented by a major US auto insurance company, Progressive Auto Insurance (U.S. Patent 5,797,134) and a Spanish independent inventor, Salvador Minguijon Perez . Many independent inventors are in favor of patenting new insurance products since it gives them protection from big companies when they bring their new insurance products to market. Independent inventors account for 70% of the new U.S. patent applications in this area. Many insurance executives are opposed to patenting insurance products because it creates a new risk for them. The Hartford insurance company, for example, recently had to pay $80 million to an independent inventor, Bancorp Services, in order to settle a patent infringement and theft of trade secret lawsuit for a type of corporate owned life insurance product invented and patented by Bancorp. There are currently about 150 new patent applications on insurance inventions filed per year in the United States. The rate at which patents have been issued has steadily risen from 15 in 2002 to 44 in 2006. Inventors can now have their insurance US patent applications reviewed by the public in the Peer to Patent program. The first insurance patent application to be posted was US2009005522 “risk assessment company”. It was posted on March 6, 2009. This patent application describes a method for increasing the ease of changing insurance companies. The insurance industry and rent-seeking. Certain insurance products and practices have been described as rent-seeking by critics. That is, some insurance products or practices are useful primarily because of legal benefits, such as reducing taxes, as opposed to providing protection against risks of adverse events. Under United States tax law, for example, most owners of variable annuities and variable life insurance can invest their premium payments in the stock market and defer or eliminate paying any taxes on their investments until withdrawals are made. Sometimes this tax deferral is the only reason people use these products. Another example is the legal infrastructure which allows life insurance to be held in an irrevocable trust which is used to pay an estate tax while the proceeds themselves are immune from the estate tax. Religious concerns Muslim scholars have varying opinions about life insurance. Life insurance policies that earn interest (or guaranteed bonus/NAV) are generally considered to be a form of riba (usury) and some consider even policies that do not earn interest to be a form of gharar (speculation). Some argue that gharar is not present due to the actuarial science behind the underwriting. Jewish rabbinical scholars also have expressed reservations regarding insurance as an avoidance of God's will but most find it acceptable in moderation. Some Christians believe insurance represents a lack of faith and there is a long history of resistance to commercial insurance in Anabaptist communities (Mennonites, Amish, Hutterites, Brethren in Christ) but many participate in community-based self-insurance programs that spread risk within their communities. CONCLUSION From the above discussion, we can argue whether insurance contract is an efficient way of solving uncertainity or not. Insurance industry has tried its level-best to engulf uncertain loss. However, there are still some contradicting concepts on the policy. The insurance industry should lay down clear procedures to minimize on the above discussed issues. REFERENCES Vaughan, E.J. (1997). Risk Management. New York: Wiley. Thomas JE. (2002).The Role and powers of the Chinese insurance regulatory commission in the administration of insurance law in china. Geneva papers on risk and insurance. Kunreuther H. (1996). Mitigating disaster losses through insurance. Journal of risk and uncertainity. Gollier C.(2003). To insure or not to insure? : The Geneva paper on Risk and insurance theory.