This study book was initiated as a project of theon German Insurance (GDV). The authors, who have written the chapters a voluntary basis, Association are experts from the German insurance industry. The GDV makes this study book available to partner associations, supervisory authorities as well as other institutions in countries where there is an interest. The purpose of the study book is to enable the staff of insurance companies to acquire a basic knowledge of insurance interrelationships. Complex facts are also presented for new entrants into the industry. This book addresses staff who are internally employed as well as those with customer contact. The facts are based on European law and describe the implementation into German insurance law in an exemplary fashion. The study book, which is available in a German and English version, is divided into the two parts: Volume II II Basic Principles Volume II Classes of insurance We hope that all readers obtain many insights as they read and with them much success in transferring these to the workplace. We are grateful to all the authors for their voluntary contribution to this work.
Munich and Berlin in August 2010
Contents 1 1.1 1.2
Basic Basi c pr prin inci cipl ples es of th the e in insu sura ranc nce e in indu dust stry ry ...................................................... 5 Risk Ris k mana manageme gement nt .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ... 6 Financia Fina nciall coverag coverage e of the the risk risk .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... 12
Organi Orga niza zati tion on of th the e ins insur uran ance ce in indu dust stry ry........................................................... ........................................................... Legal forms of insur insurance ance comp companie anies s .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... Co-op Co -opera eratio tion n and concen concentra tratio tion n in the insura insuranc nce e industr industry y ... ...... ...... ...... ...... ...... ...... ...... ...... ..... Separatio Sepa ration n of insura insurance nce class classes...... es.......... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. Structur Stru cture e of the organi organizatio zation n .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... Organiza Orga nization tion of workflow.... workflow........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ... Methods Meth ods of dist distribu ribution tion in the insu insuranc rance e indu industry stry .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... ..
Legall bas Lega basis is of th the e ins insur uran ance ce con ontr trac actt .............................................................. 52 Overview of the new German German Insurance Insurance Contract Law.......... Law................... .................. ................ ....... 53 Introduc Intr oduction...... tion.......... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ....... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... 54
3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10
Legal sour Legal sources ces .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. Insuranc Insu rance e cond conditio itions ns .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. Persons Pers ons involved involved .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... Conclusi Conc lusion on of the insu insuranc rance e cont contract ract .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ... Comme Co mmenc nceme ement, nt, dura duratio tion n and and termi terminat natio ion n of the the insura insuranc nce e contra contract. ct.... ...... ..... .... Duty to pay pay the premi premium um .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ... Obligatio Obli gations ns .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. The insurer’ insurer’s s duties .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... Possibil Poss ibilities ities for for the policyh policyholde older’ r’s s complain complaints ts and assert asserting ing his will... will....... ........ ......
55 57 58 62 71 81 85 89 92
4 4.1 4.2 4.3
Insura Insu ranc nce e pr prac acti tic ce an and d st stat atis isti tics cs...................................................................... ...................................................................... Insuranc Insu rance e risk risk.... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. Basic Basi c prin principl ciples es of the prem premium ium calc calculat ulation ion .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... Emergenc Emer gence e and and distri distributio bution n of surp surpluse luses..... s......... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....
94 95 97 99
4.4 4.5 4.6
Insurance Insuranc e acco accounti unting ng .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... 104 Insuranc Insu rance e mathematic mathematics s and actuarial actuarial scien science ce .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... 112 Fundamen Fund amentals tals of clai claims ms hand handling ling .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... 116
Cos ostt ac acco cou unt ntin ing g and and re res sul ults ts ac acc cou ount nts s ............................................................. 131 Tasks and terms ........ .................. ................... .................. .................. .................. .................. .................. .................. .................. ................. ........ 132 Contribu Cont ribution tion marg margin in acco accountin unting g .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... ... 142
Controlling .......................................................................................................... 148 Nature Natu re of cont controll rolling ing .... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... .. 149
Basic principles of the insurance industry by Dr.. Georg Erdmann Dr
Dr. Georg Erdmann
Herr Otto Müller is the proprietor of a carpenter’s shop. He is thinking about what risks threaten his business, his private home and himself. Basically, every entrepreneur and every private person must think about these problems. It must be the aim to minimize such risks and if necessary to pay a premium to transfer them. The planning, execution and control of security measures of all kinds is called risk management. The choice of these words indicates that these risks must be controlled. It is necessary to recognize and then control them. For private households risk management is simply part of housekeeping. In the case of companies the responsibility rests either with the management or in special departments. It is important that the whole business and all the staff should be security conscious. The starting point of all risk management considerations are the risks and their consequences if they occur. It is necessary to analyze each risk separately and consider if it can be controlled.
1.1. 1. 1.1 1
Secu Se curit rity y, ris risk, k, in inse secu curi rity ty
Perils threaten security. In normal speech “peril” means the possibility that something economically unfavourable will occur. Instead of the word “peril” the term “risk” is often used in the same sense. They are semantically basically the same. In the science, however, three terms are used
Security (“We know what will happen in the future.”),
Risk (“We can measure the occurrence of future situations with probabilities.”),
Insecurity (“We do not know what will happen in the future.”) or (“We cannot measure the occurrence of future situations with probabilities.”).
There are many different perils. They can lead to damage to belongings, strike people down by illness and death, or lead to considerable claims for damages in the event of carelessness. Perils threaten: People
damage, destruction, loss, e. g. by by
Unexpected financial expenses for
sickness accident death disability
fire burglary machinery breakdown tapwater
indemnification legal expenses continuation of wages after a fire
Basic principles of the insurance industry
For private persons and households, on the one hand, and companies, on the other, there are different risks. Companies are also exposed to the danger of property and pecuniary losses. More especially they are threatened by the so-called entrepreneurial risk, which includes the possibility that losses arise from the economic environment, from fluctuations in economic activity, from changes in the market and variations in customer behaviour. entrepreneurial risk uninsured
They are different depending on how they arise Moral hazards
are based directly on human behaviour – arson – care careless lessness ness when weld welding ing – dan danger gerous ous dri drivin ving g
are generally not influenced by human behaviour – li ligh ghtn tnin ing g – nat natura urall disa disaste sters rs
The occurrence of a threatening event leads to a loss. Loss means, therefore, the ascertainment or realization of the threatened peril. Material damage
is immediate financial loss for the injured party – bec becaus ause e of loss loss of asset assets s – beca because use of expens expenses es incur incurred red
affects the wealth directly because of – pai pain n after after an acc accide ident nt – los loss s of a clos close e relati relative ve
Dr. Georg Erdmann
Material damage or financial losses can occur with a person or an object or with the wealth as such. Accordingly, a distinction is made between bodily injury, property damage and financial loss. Bodily injury
Pure financial loss
Injury or death of a person
Loss, damage or destruction of an object
Reduction in the wealth itself (bad advice by a lawyer or notary, which leads to financial loss)
Property damage can affect the wealth of the aggrieved party in two ways: Unplanned expenses
Loss of sources of income
– replacem replacement ent of hous househol ehold d goods goods – mot motor or vehi vehicl cle e repair repair – doct doctor or an and d hospita hospitall expense expenses s
– death death of the the breadw breadwinn inner er – di disa sabi bili lity ty – un unem empl ploy oyme ment nt
1.1. 1. 1.3 3
Anal An alys ysis is an and d con contr trol ol of ri risk sks s
Loss prevention is an important task because of the many threatening risks and the losses associated with their occurrence. A precondition for all security measures is the timely recognition of risks (perils). The function of familiar street signs as danger signals serves this purpose, purpose, for example. They warn of the need to be prepared for the looming peril. Risk avoidance is part of the security policy of the state to protect its citizens. There are many legal rules to this effect: traffic laws, fire protection, commercial and health police regulations. But also every private person and every company is concerned to take measures against threatening perils. As risk management such measures are of particular importance in businesses, because technology, industrialization and scientific progress create new sources of danger all the time. The analysis and handling of risk is generally called risk management. This approach consists of several stages. The process of risk management consists of three different steps: 1) Risk analysis analysis and evaluation evaluation 2) Handling of risk 3) Risk control
Basic principles of the insurance industry
Re 1) Risk analysis and evaluation In the beginning there is always a risk analysis. The carpenter has to examine which perils threaten his business, his household as well as himself and his family members. This risk analysis process is composed of three different areas. Risk analysis process Risk recognition
Quantification of risks
Root cause analysis
It is only possible to get a grip on risks and deal with them if they and their causes have been recognized. Consequently, the carpenter has to examine systematically which events threaten his business. The following events are conceivabl conceivable: e: – A fire destroys the building building and the the complete plant and and equipment including including stostores of wood. – Valua aluable ble furnitu furniture re is stol stolen en – A storm strips strips off the roof roof and rain makes makes the wooden wooden products products unusable. unusable. – A valuable machine machine needed for the production production is suddenly no no longer available. available. – An important customer customer becomes becomes bankrupt bankrupt so that bills bills are not not paid. Not only the detection of possible perils is part of risk analysis but also the valuation of the whole business. This is called the quantification of risks. There are two ways of achieving this. The carpenter will first of all inquire about the frequency of occurrence of particular events. Have there been many fires in this business? How frequently have important machines broken down? Has the workshop been plagued by thieves? Furthermore, it is also very important to know what damage the individual risks can cause if they occur. From this point of view they can be divided into three different danger classes: – Catastrophic perils such such as, for example, example, the complete complete destruction destruction of the business business by fire – Perils that threaten threaten the existence of the business, business, such as, as, for example, the the breakdown of a machine or the failure of an important customer – Perils that do not not threaten the continuation continuation of the business, business, such such as, for example, example, the breakage of glass as a result of a storm The measures to establish the level of the resulting damage are the reinstatement costs as well as the loss of profits for the business. Besides the recognition and quantification of the risks, within the framework of an analysis it is necessary to establish their causes. Risks can have their origins in the business itself, because, for example, there is a lack of organization, the staff lacks risk awareness or the fire protection installation installation is inadequate. But risks can also have their origins outside the business, as for example, natural forces or the insolvency of important customers.
Dr. Georg Erdmann
Re 2) Dealing with risk The most important task of risk management is to deal with the risks after they have been analyzed. To this end appropriate wide-ranging measures must be decided on, carried out and controlled. Dealing with risks is thus divided into three areas. Dealing with risk Alternative courses of action
After the proprietor of the carpenter’s shop has achieved a clear overview of the situation by means of a risk analysis, with a risk management approach he can choose between different courses of action. The master carpenter decides on the following possibilities: – Ri Risk sk ret reten enti tion on – Ris Risk k avoidanc avoidance e or contai containmen nmentt – Fina Financia nciall transfe transferr of the the risk risk Entrepreneurs and private persons can retain the threatening risks themselves without taking any measures regarding their avoidance, containment or financial transfer. They assume that they will not be subject to the perils or that their occurrence will not destroy their financial existence. Such a decision is very rare, because everyone knows that businesses and all personal belongings can be completely destroyed by fire or natural catastrophes. Security and protection measures are possible alternatives by which the occurrence of particular perils should be avoided or the degree of loss reduced. Since human existence and the economy necessarily involve perils, there is no general risk exclusion. Rather, risk avoidance can only be considered for limited areas. Preventive measures to avoid risk can only apply to the time before the loss occurs as well as its subsequent containment. The laying off of risk by means of relevant agreements with the contractual partner, splitting and spreading risk are also part of risk avoidance. Risk avoidance
Risk containment by means of preventive measures
Risks cannot be generally excluded
For limited areas it is possible to – tr tran ansf sfer er ris risk k by excluding liability contractually – Sp Spli litt a ris risk k by by sub-contracting – Sp Spre read ad ris risk k by distributing the assets over several types of investment
Against the occurrence of the risk (realization of the peril) – Al Alar arm m sy syst stem em – Acc Accide ident nt preve preventi ntion on equipment – In Insp spec ecti tion on of of technical plant – ea earl rly y detec detecti tion on measures
To contain the loss (minimization) – Co Comp mpan any y fi fire re brigade – Em Emer erge genc ncy y power generator – De Dete tect ctio ion n and and rescue sytems for traffic accidents – Fi Fire re wa wall lls s
Basic principles of the insurance industry
Since risks cannot be entirely avoided and can only be reduced to a certain degree, financial safeguarding safeguarding by means of a series of early measures within the framework of risk management is very important. The decisions with respect to these matters very often consist of a combination of measures. Thus a business will, for example, take the necessary safety measures against fire, burglary and accident, but also carry part itself in order to save premium if necessary and to this end set up the reserves needed, so that when a loss occurs it can be paid. Re 3) Risk control Subsequent to the stages of risk recognition and dealing with risk within the framework of risk control it is necessary to establish whether the desired targets could be attained with risk management, in order to receive suggestions suggestions for improvement for further risk management procedures. Summary 1 Peril = Possibility of the occurrence of the loss 2
Nature of the threat
Reason for occurrence
1 Loss = realization realization of a threatened peril peril 2
3 Results – unp unplan lanned ned exp expens enses es – lo loss ss of in inco come me 1 Need for security measures 2 Carrier: state, private private persons, enterprises enterprises 3 Risk management route: Dangers – Re Reco cogn gnit itio ion n – Avo void idan ance ce – Re Redu duct ctio ion n – Finan Financial cial trans transfer fer (preca (precautio ution) n) 4 Combination of different different measures depending depending on the particular situation
Dr. Georg Erdmann
Fin ina anc ncia iall co cove vera rag ge of the ri risk sk
Despite all safety measures the realization of perils and thus the occurrence of losses cannot be avoided. For this reason private households and economic enterprises are forced to take precautions to mitigate the economic effects by means of complete or partial compensation. There are different types of protection which can be employed by private households and economic enterprises. They differ according to their carriers and preconditions. Possibilities for financial precaution – stat state e ben benef efit it – ind indivi ividu dual al self self help help – in insu sura ranc nce e
State be benefits
State benefits can be claimed under certain circumstances in most countries. The cases are very limited, however, because in a mixed economy the emphasis is on each individual taking responsibility for making his or her own provision. Only in exceptional circumstances should tax funds be employed for such purposes. Yet in the event of catastrophes there is often a national programme to help the victims. Incidentally, for social political purposes the state makes use of insurance, especially social insurance. For individuals, private households and economic enterprises the following state benefits are also of significance: Subsidies
Measures to support the enterprise in the form of lost allowances, credits, pledges and guarantees
Claims of a particular group (especially civil servants, soldiers, war victims) because of the fiduciary duty of their employers
State support for those in a situation of need, which prevents them leading a decent life and which they cannot change by their own means and efforts
The provision of these state benefits generally differs from country to country. So for example, the social state in Germany is much more developed than in Great Britain. The provision of state benefits is provided as a rule on the basis of certain objective criteria to those who fulfil them.
Basic principles of the insurance industry
1. 1.2. 2.2 2
Indi In divi vidu dual al se self lf he help lp
The simplest means of individual protection for private persons and households is saving. By consuming less, money is collected which is available for future financial needs. However, savings can never replace insurance protection against the occurrence of uncertain events. Savings accumulate gradually and are not freely available, whilst at any time there could be a need for money to pay for losses. Also enterprises are not in a position by building up reserves to have adequate sums available to pay for the economic effects of losses. Such a procedure is economically unsuitable, because such risks are incalculable in the individual case. Furthermore, resources which might not be needed would be tied up inefficiently. Nevertheless, savings savings and reserves are also a necessary form of protection in addition to taking out insurance. Not all private and business risks can, namely, be covered by insurance. The entrepreneurial risk is in any case only to a limited extent insurable. There is no insurance cover, for example, for the replacement and renewal of objects subject to wear and tear, such as machines, clothing or motor vehicles. Savings must also be available if a policyholder quite consciously does not completely insure against all possible losses. Whoever agrees to a deductible in motor or health insurance achieves a lower premium by doing so, but in the event of an insured loss he must pay the amount that is not covered himself.
1.2. 1. 2.3 3
Insu In sura ranc nce e of of ris risk ks
A very suitable and thus very widespread way of financial protection against against contingent need, which becomes reality if the threatened peril happens, is insurance. It provides benefits in accordance with the insurance classes if particular events such as fire, burglary, storm, hail, sicknesss, unemployment or death occur. The extent of the insurance protection depends on the particular legal requirements or by contractual agreement in the individual case. The means to pay for the insurance benefits are provided by the insured by means of premiums or contributions. All expenses have, therefore, to be covered by the appropriate contributions. contributions. This financial procedure is called the insurance principle. Insurance differs from saving or the building up of reserves in that its benefits are not limited to the saved resources of the individual insured. Rather, risks are spread over a large number of insureds. Insurance is different from savings protection in that it is not limited to a narrow circle of people who have a right to protection, and it offers not only to basic protection, but also complete indemnity. Insurance differs from social welfare in that the claimant’s need for help is not a precondition and it offers complete compensation for the economic results of losses. Insurance offers complete insurance protection right from the beginning without having to save the money that would be needed to pay for a claim. By paying his premium the insured achieves a legal right to the complete insurance benefit that has been agreed.
Dr. Georg Erdmann
Insurance can take two forms: – Individual insurance insurance is an economic economic branch branch and is based on the the principle of benebenefit and benefit in return. (Principle of equivalence) – Social insurance insurance is a part of the state’s state’s social policy policy and has the purpose purpose of social equilibrium by means of the contributions. (Principle of solidarity) Financial protection Forms
Saving Protection Social welfare Insurance
No No Yes No
Saving money Tax revenue re venue Tax revenue re venue Contributions of the insured
1.2 .2.4 .4
Ter erm m of of ins insur ura anc nce e
Insurance is characterized by the following features: 1. Covering a need for for money 2. Uncertaint Uncertainty, y, but the need can be estimated 3. Spreading economic risk over many entities Re 1. Covering a need for money It is the task of insurance to place at disposal the means to cover a possible need for money. This need is triggered by the occurrence of a threatened peril and the necessity to compensate for the economic results. The need that arises must be a financial need. That is, it must be quantifiable in monetary terms. This is always the case when there are economic losses such as the destruction of assets by fire. Consequently, objects are not insurable for whose valuation there are no objective criteria, such as a family photograph or the letters of a deceased relative. The level of need which should be covered by insurance can be calculated in different ways. In this way a distinction is made between concrete and abstract need. Concrete need
This depends basically on the size of the loss that occurs (stolen items, car repair costs, burnt down building).
It is decided by the policyholder himself, in that he fixes the sum insured for life insurance or daily benefits in the accident or health insurance.
Basic principles of the insurance industry
Re 2. Uncertainty, but the need can be estimated The monetary need must be uncertain. The occurrence and extent of the insured event must not, therefore, be known. It must occur fortuitously. Admittedly, everyone is exposed to perils: it is nevertheless uncertain when and to what extent they actually occur. An event is fortuitous, – if it is not known whether it will occur occur at all: e.g. e.g. a hailstorm or an accident, accident, – if it is known known that it will certainly certainly occur occur, but the timing is uncertain, uncertain, such as the death of a person in life insurance. An insurance company can offer cover for perils only if the need for financial compensation can be estimated. Consequently, certain statistical documents are needed for the premium calculation. Re 3. Spread of risks Insurance is based on the assumption that the perils threaten all persons, households and economic enterprises, but that only a few of them will be actually affected. For this reason we speak of spreading risks in the community of policyhold policyholders. ers. The insurer takes responsibility for the individual risks in return for a premium, whereby the total premium income must be sufficient to pay for the losses that occur and cover the expenses. Furthermore, risks can be spread over time, for example, by setting up reserves for the need to pay claims in the case of annually fluctuating claims experience, such as in the hail or storm insurance.
Many persons threatened by perils (policyholders)
Paying out the insurance benefits to the policyhol policyholder der or injured third parties
There must be a balance between the premiums of the policyholder, on the one hand, and the claims benefits and expenses [of the insurer], on the other. This need for a balance is called the principle of insurance equivalence.
Claims benefits Expenses
Dr. Georg Erdmann
To achieve a spread of risks insurance companies use the statistical experience rate which is commensurate to the loss occurrence according to the values resulting from the probability calculation. calculation. Using further insurance techniques techniques other methods are used to spread risk, such as safety loadings in the premium calculation, coinsurance or reinsurance. The provision of insurance protection is an entrepreneurial service. From a legal point of view insurance is a promise of a benefit for the contingency that an insured peril occurs. Because this kind of service appears particularly complicated and intangible on account of the mathematical preconditions and the need for a precise legal delimitation of the extent of cover, it is particularly important that insurance companies and their staff perform their tasks in a consumer friendly way. The circle of persons insured by an insurance company should not be called a risk-bearing community as often used to be the case in the past. They are customers of the insurance company, who must be treated as individually as possible. Summary Ways Wa ys of of provi providin ding g finan financia ciall prot protect ection ion Saving: Limited amount of money to pay for losses Social welfare: Basic provision for emergencies
Insura Ins urance nce feat feature ures s Cover of the need for money
– co conc ncre rete te ne need ed
– ab abst stra ract ct ne need ed
Provision: Number of candidates limited by law
Uncertainly about the assessmen assessmentt of the need – Fo Fort rtu uity – Sta Statis tistic tical al documen documents ts
Insurance: Economic effects of losses made up from premiums
Spreading of risk over many entities Coverage of the insurance benefits and expenses by means of premiums
1.3 1. 3
Clas Cl assif sific icat atio ion n of of ind indiv ivid idua uall and and th the e soc socia iall ins insur uran ance ce
1.3.1 1.3 .1
Demarc Dem arcati ation on of of indiv individu idual al and and the the soci social al insu insuran rance ce
In most countries insurance is divided into the two large fields of individual and social insurance. There are considerable differences between the two areas. Considering the range, social insurance in Germany provides only basic provision. Furthermore, its purpose is restricted to the insurance of risks connected with the workplace. For this reason statutory accident insurance covers only accidents at and on the way to work, not accidents which occur in leisure time, while engaged in sport or at home.
Basic principles of the insurance industry
Individual insurance provides insurance protection in all the areas not covered by social insurance. In addition, it is possible in some cases to avoid contributing to social insurance insurance by taking out a private insurance policy policy – for example, for students covered by statutory health insurance. Furthermore, individual insurance complements the benefits provided by social insurance insurance and supplements them by: – Additional benefits benefits to those of statutory health insurance insurance – Life insurance to augment the statutory pension pension – Private accident accident insurance insurance – Private long-term care insurance. insurance. The interaction of individual and social insurance is especially clear with respect to provision for old age. According to the so-called three pillar concept, their foundation is statutory pension insurance, company pension schemes and private life insurance. Life insurance in particular serves the purpose of extending and increasing the basic cover provided by statutory pension insurance. Summary Feature
Creation of the insurance relationship
According to law Compulsory insurance for occupations with a duty to insure
Agreement by taking out an insurance policy
Sickness, workplace accident, disability, provision for widows and orphans, unemployment, long-term care (risks of the person)
All insurable perils (natural and legal persons)
Social insurance carriers as institutions or public
Private and public statutory insurance companies
corporations autonomy (participationwith of the insureds) Premium rating
Depending on the income of the insured (principle of solidarity)
According to risk and benefit (principle of equivalence)
Legally uniformly determined
1. 1.3. 3.2 2
Dr. Georg Erdmann
Indi In divi vidu dual al in insu sura ranc nce e
Individual insurance is understood as being the insurance sold by private insurance companies. And so instead of the word “individual insurance” the expression “private insurance” is often used. In the field of individual insurance contracts are taken out ancalculated individualby basis toon theeconomic needs of the individual The premiumson are the according companies principles andcase. are appropriate for the risk as well as the benefit offered. Private persons, households and companies seek protection within the framework of individual insurance against against the economic effects of the most varied types of loss. This insurance cover is offered by many classes of insurance which are based on legal and insurance techniques. 1.3.2. 1.3 .2.1 1 Cla Classe sses s of ins insura urance nce The word “Versicherungssparte” (class of insurance) can be explained by comparing insurance protection to a tree, in which the individual branches indicate the insurance classes. Instead of “Sparte” the word “Branch” is also used, although this expression should be reserved for the term “Wirtschafts “Wirtschaftssparte” sparte” (economic class). It is difficult to get an overview of all the individual classes of insurance. Their number is large. Nevertheless, they are not all equally important. Some branches produce only a small premium income and are only sold by a few companies. Breakdown of the gross premiums according to class of insurance 2007 Class of insurance
Gross premium in € 1,000m
Life insurance Private health insurance Motor insurance General liability insurance Personal Accident Buildings insurance
83.4 31.5 20.1 6.8 6.4 4.7
Legal expenses insurance Contents insurance Transport insurance
3.2 2.6 1.7
Source: German Insurance Association (Publisher): Year Book 2009 – The German insurance industry Page 51
Within a class of insurance, broadly similar risks are bundled together that are insured against the same perils. This aggregation makes it possible to calculate a fair risk premium due to statistical documentation and to create unified policy terms and conditions for each class of insurance, in which the extent of the insurance cover as well as the rights and duties of the contractual partners are regulated.
Basic principles of the insurance industry
Insurance of buildings and goods and chattels against the peril of fire = fire insurance Insurance of persons against expenses in the event of sickness = health insurance Insurance of persons against liability for indemnification = liability insurance Insurance of contents against fire, burglary, robbery, vandalism, tap water, storm and hail perils = contents insurance Insurance branches are further sub-divided into types of insurance according to the insured risks. In these cases they are subdivisions of an insurance branch. Several insurance types create a branch of insurance. Insurance branch
Motor liability insurance Motor hull insurance Motor accident insurance
Personal liability insurance Public liability insurance Professional indemnity Professional Liability for financial loss
Simple fire insurance Agricultural fire insurance Industrial fire insurance
There are insurance companies which sell several branches together: for example, the classes property and liability, accident and motor insurance. They are known as multiline or composite insurers. Among them one has to distinguish between monoline or special insurers, which have restricted themselves to the sale of one class of insurance. This specialization can be for strategic reasons (e.g. transport insurance) or be due to a supervisory requirement requirement (e.g. life and health insurance). 188.8.131.52 1.3.2. 2 How individu individual al classes classes of insuran insurance ce can be classi classified fied The individual classes of insurance can be subdivided according to different criteria. They can be classified according to the type of insurance benefit, the insured object and the need covered. Subdivision according to insurance benefit Indemnity insurance
Fixed benefit insurance
Insurance benefit: Compensation for loss. The insurer has to replace the actual loss, insofar as it is covered by the sum insured. Case of actual demand covered.
Insurance benefit: Payment of the agreed sum insured. There are no objective measures for the insurance value. Case of abstract demand covered.
Dr. Georg Erdmann
Example of indemnity insurance: The policyholder insures an object worth € 50,000 for € 100,000. In the case of a total loss the insurer indemnifies only the actual loss of € 50,000. If the policyholder insures an object worth € 100,000 for only € 80,000, the indemnity is limited to the sum insured, because he has only paid the premium for the lower sum. Example for fixed benefit insurance: The policyholder chooses a sum insured of € 100,000 for the sum insured. There are no restrictions if there is a claim. Classification according to the insured object Insurances of the person
The risk consists of an actual person. Financial loss is indemnified.
Individually indicated objects (buildings or goods and chattels) are insured in the insurance policy. Single or several
The insurance relates to the wealth as a whole, not to single objects. Reduction of wealth is insured (e.g. (e. g. because of
perils can be insured.
expenses to a court case or thedue liability claims of third parties).
– Proper Property ty ins insura urance nce – Sto Storm rm ins insura uranc nce e – Hou House sehol hold d insura insuranc nce e
– Liabil Liability ity ins insura urance nce – Le Lega gall expe expens nses es insurance – Cre Credit dit ins insura uranc nce e
– Life Life insu insura ranc nce e – Hea Health lth ins insura urance nce – Acc Accide ident nt ins insura urance nce
184.108.40.206 1.3.2. 3 Summa Summary ry of the the insurance insurance classe classes s of private private insuranc insurance e Dividing insurance protection into insurance classes may cause gaps in cover for the policyholder, which can be avoided by combined insurances. At the same time they serve the purpose of simplifying the work, because only the acceptance of a proposal and the issue of a policy are necessary. We must distinguish between combined insurance and insurance package policies. Combined insurance
Insurance package policies
Coverage of a majority of perils on the basis of one set of policy conditions in an insurance contract. A new class of insurance is created by this combination. There is one premium rate. The policy can only be cancelled as a whole.
Consolidation of several insurance contracts on the basis of separate general policy conditions for each of them. For each class of insurance there is a specific premium. The individual insurance policy can be cancelled independently of the other covers.
Examples: Comprehensive household insurance Comprehensive building insurance
Examples: Family insurance as a bundle of household, personal liability and accident insurance
Basic principles of the insurance industry
System of insurance classes Indemnity insurance Actual need for cover Indemnity Bodily injury Medical expenses
Property damage – Fire
Fixed benefit insurance Abstract need for cover Sum insured agreed Financial loss – Li Liab abil ilit ity y
Amount – Lif Life e insu insuran rance ce su sum m
Recurring benefits – Da Dail ily y bene benefi fits ts
Summary of insurance classes Single proposal and one insurance policy Combined (linked) insurance
Insurance package policies
One insurance contract One insurance class
Several insurance contracts Several insurance classes
1. 1.3. 3.3 3
Soci So cial al in insu sura ranc nce e sys syste tem m
Besides private insurance in many countries, there is also a statutory social insurance system, which is either financed out of contributions or tax. In what follows such a social insurance system will be explained using as an example the Federal Republic of Germany. In contrast to private insurance, social insurance is a part of social security in the Federal Republic of Germany. In this way the state pursues it socio-political aims. Consequently, alongside the insurance principle social insurance includes elements that have nothing to do with insurance, such as, for example, statutory grants. As a matter of principle social insurance has its roots in the contract of employment. The insurance relationship occurs as a rule because of the law or because of certain labour law or occupatio occupational nal features. The individual branches of social insurance are regulated in a relatively complicated way by a large number of legal provisions. They can be distinguished by five important features, however: – co comp mpul ulsi sion on – lab labour our pro protec tectio tion n – prin principl ciple e of of soli solidarit darity y – non non-ca -cash sh ben benefi efitt – propagated by by the social insurance carrier Compulsion For those in employment social insurance is usually compulsory. The start of the insurance relationship and the extent of insurance protection are legally prescribed (compulsory (compulsor y character). This regulation serves the purpose of protecting the insured and the social balancing process. There is, for example, voluntary insurance for persons who are not compulsorily insured within the statutory health insurance, because they have exceeded the income limit.
Dr. Georg Erdmann
Labour protection Social insurance is restricted to covering certain risks of the person in connection with work, such as health, accident at work, disability, unemployment and long term care. Contributions The insurance benefits are paid for in the first instance by the contributions of those insured and their employers, in part also by the employer alone. The insurance principle is broken by means of state allowances. The contributions are not levied in accordance with the principle of equivalence, but according to the principle of solidarity in line with the income of the insured, so that a redistribution takes place. Social pension insurance is based on the solidarity of the generations (generation contract). The generation in work pays contributions in the expectation that the following generation will take over the same duty to guarantee the pensions. Benefits The purpose of social insurance benefits is in the first instance the recovery/resto recovery/restoraration and the commitment of the labour force. In the forefront is the principle of payment in kind in the form of health insurance or the provision of therapy in the accident and pension insurance. In contrast, private insurance provides its benefits mainly in the form of money payments. Social insurance carriers Social insurance is conducted by special social insurance carriers on a legal basis. It is subject to the principle of self administration, which is carried out in the committees appointed for that purpose, which are comprised of those insured and the employers. Legal action can be taken in the social courts against decisions of the social insurance carriers.
Impo Im port rta anc nce e of pr priv iva ate in insu surran ance ce
Insurance fulfils important economic tasks. Microeconomically it safeguards the existence of private households and companies. Macroeconomically it provides them with the unhampered continuation of the economic process. process.
1.4. 1. 4.1 1
Micr Mi croe oeco cono nomi mic c impor importa tanc nce e
Private households and companies take out insurance policies, policies, because they expect that insurance protection will bring them advantages and thus economic utility. The insurance protection constitutes an economic good that has a value as a market benefit. It is a necessary safeguard, which transfers to the insurer the risk of negative effects on current sources of income and investments.
Basic principles of the insurance industry
Insurance offers the possibility of independent provision, for which savings and reserves would be inadequate. Furthermore, insurance protection is generally cheaper than always having to have resources available to cope with particular events. With respect to the microeconomic importance of insurance, considerations of customer orientation must govern the form and development that the contractual relationship takes. Risk transfer By taking out insurance, private households and companies transfer particular, precisely defined risks to the insurer. In the first instance, the importance thus lies in the reduction or removal of dangerous situations and the generation of security. For companies the risks thus become calculable and the premium is factored into the calculation of their products. The delimitation of the perils by this means enables companies to concentrate on those risks that are not covered, such as the distribution risk. Equalization of risk If an insured peril occurs, the economic consequences of a loss of wealth are materially compensated for. Private households and companies are put in the same position as if the insured claim had not occurred. Example: Property insurance makes the money available to rebuild a burnt down building as well as to repurchase damaged or missing objects. Liability insurance frees the policyholder from his duty to provide compensation. Financing Private households and companies must offer collateral when they take up a credit. Objects used to provide security for financing, such as buildings or vehicles, can only thiscapital purpose if they are adequately insured. Ita is thus insurance thatalso enablesserve foreign to be taken up. In this connection life insurance policy constitutes an important collateral for a personal loan. A prerequisite for the financing of companies is that creditworthiness only exists if the usual volume of insurance protection is available. In this way creditors and shareholders can be offered increased security.
1.4. 1. 4.2 2
Macr Ma croe oeco cono nomi mic c impor importa tanc nce e
In the macroeconomic system insurance has an important position alongside productive industry and trade. Insurance is a service, the effects of whose benefits are not restricted to private households and enterprises, but are also of importance for the whole economy.
Dr. Georg Erdmann
Economic process Insurance ensures that a loss is usually confined to the area of the policyholder and does not affect other persons or businesses. The primary loss is thus localized and the consequential damage for other economic entities is avoided. To this extent insurance prevents an interruption of the economic process. An uninsured loss in an industrial enterprise enterprise would have a deleterious effect on creditors, suppliers suppliers and customers. Continued employment is not only guaranteed in the company directly affected, but also within its sphere of activity.
Fire in an industrial enterprise
Due to the concentration of the loss on the insured business insurance insurance reduces the susceptibility susceptib ility of the whole economy to negative effects and enables the uninterrup uninterrup-ted continuation of management in an economic sense. Discharge of the state Insurance absolves absolves the state and thus the public from the need for tax relief if a loss occurs. For this reason public authorities have an interest in a functioning insurance industry. They would otherwise have to take frequent action to prevent interruption of the economic process and to relieve the labour market. Thus the state assists the insurance industry industry by means of tax relief for insurance premiums and the introduction of compulsory insurance insurance for certain risks. The aim of these measures is to protect the general public from unforeseen burdens. Reservoir for capital The insurance industry creates a reservoir for capital that is filled by the policyholders’ premiums. Since the premiums are paid in advance and in the case of life insurance saving and insuring are bound up with each other, insurance companies have considerable sums to invest. They flow especially into promissory note bonds, commercial papers, credits on real estate and property. With these funds particularly housing construction, industry and the state is financed. In this way insurance companies contribute to the promotion of the economy and to the increase of the national income.
Basic principles of the insurance industry
Capital investments of insurance companies Promotion of
Economic result: – Pro Promot motion ion of inves investme tments nts – Cr Creat eation ion of of employ employmen mentt – Dema Demand nd for for goods goods and and service services s – Inc Increase rease of the nati national onal incom income e
Promotion of technical development The insurance industry encourages technical development and the adoption of new methods of production. It takes over the associated risks and in this way supports the willingness of the economy to invest. Certain technical facilities such as energy plants as well as modern road and air traffic could not be realized without suitable insurance protection. Social function Finally, the protection of injured third parties by liability insurance is of great social Finally, importance. There is a close connection between this and the promotion of technical progress. In many cases traffic victims and other injured parties could not assert their claims for compensation against the injuring party if the latter were not insured. Consequently, liability insurance serves to protect the tortfeasor by freeing him from the claims of third parties, as well as the injured party, who otherwise would often not be indemnified. Motor liability is an important example of this, which every owner of a motor vehicle is legally bound to take out. Summary Microeconomic importance of insurance
Macroeconomic importance of insurance
– – – –
– Continua Continuation tion of of the economic economic proce process ss – Freei Freeing ng the state state from provid providing ing benefits benefits – Fina Financin ncing g of the public public purs purse e and the the economy – Prom Promotio otion n of techni technical cal progr progress ess – Prot Protecti ection on of injure injured d third third parties parties
Assumpti Assum ption on of of risk risks s Paymen Pay mentt of of clai claims ms Facilita Faci litation tion of finan financing cing Enabling Enab ling the conce concentra ntration tion on risks that are not covered
Dr. Georg Erdmann
1.5. 1. 5.1 1
Purp Pu rpos ose e of co cost st acc accou ount ntin ing g
The purpose of cost accounting is to record systematically, control and consolidate into information the company money and the flow of Cost money of an insurance companyinternal company that is engendered by the value chain. accounting thus achieves and external tasks. External cost accounting tasks – Reporting to creditors creditors and shareholders about business business success, success, liquidity liquidity and creditworthiness – Reporting to the public and the state about the safeguarding safeguarding of jobs and the economic policy – Basi Basis s of assessm assessment ent for for tax purpose purposes s Internal cost accounting tasks – Docu Document mentation ation of of the course course of the busine business ss – Cont Controll rolling ing the the cost effect effectiven iveness ess – Control Control of the financ financial ial equili equilibriu brium m – Basi Basis s for operati operational onal decis decisions ions
1.5. 1. 5.2 2
Orga Or gani niza zati tion on of co cost st ac acco coun unti ting ng
Depending on the different task priorities there has developed a number of organizational possibilities – Fina Financia nciall accountin accounting g and the balance balance sheet sheet – Cos Costt and acti activity vity acco accounti unting ng – Bu Budg dget etin ing g – Operational statistics and comparative calculatio calculations ns
Costs Opera Operating ting
Basic principles of the insurance industry
The four branches of cost accounting differ fundamentally from each other with regard to contents, but they are associated with each other, they complement each other and they are in part constructed on each other. Bookkeeping Bookkeeping creates the prerequisites for the compilation of individual bills and together with these the accounting system of the insurance company. It is the planned, systematically ordered, complete record of the business transactions transactions in an insurance company over a specific period of time. By means of this complete, orderly and planned registration and chronicle of all business transactions the company can at any time establish, e.g.: – how the assets assets and/or and/or the the debts have have changed changed – wheth whether er the company company has has made a profit profit or a loss loss Further important tasks of the bookkeepin bookkeeping g are: – Basis of information information for the branches of the the cost accounting accounting system system (statistics, (statistics, cost-benefit accounting and budgeting) and thus for the company decisions – Basis of taxation taxation by means means of the basis basis of calculation calculation profit profit and assets – Methods of information information for third party stakeholders stakeholders (e.g. policyholders, policyholders, shareholshareholders, creditors, supervisory authorities) by means of financial accounting – Proof in the case of legal disputes disputes with representatives, representatives, the tax authority authority,, courts, banks Bookkeeping is based on a great number of different rules (among other things, laws and regulations) and among other things recommendations and customary usages. The most important principles are the basics of orderly bookkeeping, which are partly the source and partly the result of the legal regulations. Cost accounting and results accounts One of the most important functions of the cost accounting and results accounts is the supervision of the economic efficiency of the business value chain. In this connection among other things the costs the production of the protection are allocated according to incurred type, theinplace of production andinsurance the cost centre. This information is among other things the basis for pricing and thus also for the calculation of the insurance premium. The cost accounting and results accounts is a purely internal business concern. Budgeting, controlling and auditing As preview accounting, budgeting budgeting has a future orientation. It is based on the data of the other three branches of the business accountancy system. Within a complete plan partial plans are compiled (finance, turnover, advertizing plan, etc.). The budget is a control and management instrument for the company’s management, because targets are given in the process of making business decisions which can be compared to the actual results. (Target performance comparison). Closely connected with the budget is controlling. In contrast to the branches already mentioned in connection with business accountancy, in the case of controlling, as
Dr. Georg Erdmann
with auditing, it is a component part of the company’s system of supervision. This means that although controlling is dependent on information from business accountancy, it itself should nevertheless be interpreted as a service function for the management. The company management, but also sections of the company, should be supplied with information which enables them to manage the company and its divisions in a future-oriented way. In addition, there is the important task of co-ordinating subtasks in the complex company system. Auditing should further be distinguished from controlling insofar as it constitutes the management of all business activities, processes and structures that is independent of the systems and processes. Among other things, compliance and economic efficiency must be controlled. Statistics – In order to be able to charge premiums that match match the risk and to regulate all claims that must be indemnified, insurance companies need in motor insurance, for example, information about claims frequency and the average level of claims for the various types of vehicle. – In order to protect protect market share insurance companies companies need among other things things information about the product wishes of households and companies, the premium development of the individual classes of insurance, the disposable income of the respective groups of households and the rate of inflation for the most varied range of goods and services. – To achieve adequate personnel personnel planning insurance insurance companies companies need, for example, information about the average age and income, in all cases broken down among other things according to staff with company internal duties and those with customer contact, gender, possibilities of employment with office work and staff qualifications.
1.5.3 1.5 .3
Tech echnic nical al term terms s of the cos costt accou accounti nting ng syste system m
Certain technical terms have developed in connection with the individual sections sections of business accounting, in order to express various economic circumstances – payment and benefit processes. Broadly, these are the following contrasting pairs: – rec receip eiptt / disburs disburseme ement nt – in inco come me / ou outg tgo o – pro profit fit / exp expend enditu iture re – be bene nefi fitt / cos costs ts In daily usage not much care is taken to differentiate precisely between these contrasting pairs. An exact separation of the individual pairs of terms is advisable, however, because a precise distinction of terms makes it easier to talk about business economics. Every entry for means of payment or liquid funds is called income. (Examples could be premium income, as well as paid up owner’s equity or borrowed capital, interest earnings or tax rebates). Every movement out of means of payment or liquid funds
Basic principles of the insurance industry
is known as a disbursement. (Examples could be claims payments, payments for working capital, dividends, tax payments). Income, in contrast, means – irrespective of the actual cash flow – the equivalent in monetary terms for goods and services sold. An outgo, interms contrast, means – irrespective of the cash (goods flow – the in monetary for the addition to the factors of actual production andequivalent services). It makes no difference in this respect as to whether the factors of production are paid or consumed in the accounting period. The profit for a period is the value of net income for all consumed goods and services. The expenditure for a period is the value of net income for all consumed goods and services. By benefit is meant the gross added value obtained in an accounting period insofar as it can be traced back only to one of the activities relevant to the business target. By costs are meant the quantified use of factors of production which are needed for the production and sale of the business’s products and for the maintenance of its business capability in order to achieve these aims.
Organization of the insurance industry by Dr.. Gerhar Dr Gerhard d Mayr Mayr
Organization of the insurance industry
2. 2.1 1
Lega gall fo form rms s of of ins insu ura ranc nce e com comp pan anie ies s
Legally every carriesby out insurance is an (IC). The legalcompany form is that regulated the nationalbusiness legislator. In insurance Germany company the legal forms that are currently approved are: – Stock company company (including (including the European Company – SE) – Mutua Mutuall insu insuranc rance e compa company ny – Insu Insuranc rance e company company under under public public law In other countries individuals, too, can quite easily be insurers, as is the case with the names of Lloyd’s in Great Britain. Insurance companies need the approval of the supervisory authority before they start business. (In Germany this is controlled by the Insurance Supervisory Law – VAG). In Germany the business plan must be handed in with the submission for approval. It must clarify the purpose and the organization of the enterprise, the area covered by the intended business operations, as well as the conditions by which the future obligations of the company should be permanently met. Among other things, the constitution of the company, the classes of insurance to be sold, company policies, contracts for the outsourci outsourcing ng of functions, proof of required capital (guarantee funds) and a business case for the first three business years must be submitted.
2.1. 2. 1.2 2
Join Jo intt-st stoc ock k co comp mpan any y
The joint-stock company (Plc) is a company with its own legal personality, whose authorized capital is split into shares. Its carriers are the shareholders as owners and suppliers of the owners’ equity. The company’s creditors are responsible for the liabilities of the company only to the extent of the company’s assets. In Germany the German Stock Companies Act stipulates the legal norms. Foundation 1. The foundation by one or several persons persons who take over the shares by means of outstanding capital contributio contributions ns 2. Minimum face value value of the authorized authorized capital of € 50,000. In the case of insurance companies the regulation of capital resources, which can require higher amounts, must be considered. 3. Shares are either par value shares (at least (same share of the authorized capital).
1) or a share without a par value
4. Articles of association association certified by a notary (constitution) (constitution) After the supervisory authority has granted the license, this is registered in the commercial register. With the registration the joint stock company receives its legal capacity.
Dr.. Gerhard Mayr Dr
Important rights of shareholders – Voting rights in the Annual General Meeting according to the face value of the shares or in the case of shares without par value according to their number, – Profit sharing rights (dividends), – Subscription right on the issue of new (young) shares, so that the shareholder – can secure the current proportion proportion of voting rights rights by taking up the subscription subscription right – receives compensation compensation for the sale of the subscription subscription right, that a “watering down” of the share price occurs by the average price after the increase in capital, because in general the issue price of new shares is lower than the stock exchange price of the old shares before the increase in capital. Institutions of the PLC a) Annual General Meeting (AGM)
Shareholders’ Shareholder s’ meeting, use of the voting right Important functions: – Appointment of of the shareholders’ shareholders’ representatives representatives on the supervisory supervisory board – Resolution regarding the use of the balance balance sheet sheet profit – Release of of the members members of the the board and the supervisory board – Chan Changes ges to the the articles articles of associ association ation – Meas Measures ures to incre increase ase and reduce reduce capita capitall b) Supervisory board (SB)
Controlling Controllin g body of the supervisory board, appointed every four years Composition: – up to 2,000 employees: employees: two two thirds shareholders’ shareholders’ representatives representatives,, one third ememployees’ representatives (the number must be divisible by three; the number is determined by the level of authorized capital) – more than 2,000 2,000 employees: employees: half shareholders’ shareholders’ representatives, representatives, half employees’ employees’ representatives (equal rights) Important tasks: – Cont Control rol of the mana manageme gement nt – Appo Appointm intment ent and dismis dismissal sal of the board board – Checking the annual financial financial s statement, tatement, of the management report report and the board’s recommendation about the disposal of the balance sheet profit – Repo Report rt for annu annual al general general meeti meeting ng – Calling of an extraordinary annual general meeting
Organization of the insurance industry
c) Board of managemen management t
Management of the company on own authority Important tasks: – Report to the supervisory supervisory board board about the course course of business business and the situation of the company – Compilation of the annual financial statement statement and the draft for the auditor auditor of the annual accounts – Calling of the annual general general meeting and recommendation recommendation about about the disposal disposal of the balance sheet profit – Insurance stock stock company: company: Announcement Announcement to the supervisory supervisory authority authority in the the event of insolvency or if liabilities exceed assets
2.1.3 2.1 .3
Europe Eur opean an Com Compan pany y (So (Socie cietas tas Eur Europa opaea ea – SE) SE)
The European company is a legal form for a stock company in the European Union. Since 2004 this has enabled the EU to found companies according according to broadly unified legal principles (Regulation 2157/2001 concerning the Statute of the European Company (SE) of 8.10.2001). Subject to the EU-provision an SE founded in accordance with the law of the SE’s state of domicile will be treated as a stock company in each member state. Nature of the European Company: – Own lega legall person personali ality ty – Limi Limited ted liab liabilit ility y compa company ny – The capita capitall is split split into shares shares – Domicile in an EU EU state, transfer of domicile domicile into another another EU state possible possible at any time. – Shareholders exercise their their rights of of ownership in the annual general meeting – The managem management ent can be carri carried ed out in two two ways: (1) Board manages the business and is controlled by the supervisory authority (dual system – as is usual in Central Europe) (2) An administrative organization (Board of Directors) that consists of three boards including an executive director (mono system – usual in Anglo-Saxon countries) – Shares are transferable transferable in accordance with the respective respective national national regulations. regulations. Listing is not absolutely necessary.
2.1. 2. 1.4 4
Mutu Mu tual al ins insur uran ance ce com compa pany ny
A mutual insurance company is an association vested with legal capacity, which pursues the insurance of its members according to the principle of mutuality. It receives the legal capacity with the approval of the supervisory authority. It is – like a stock company – registered in the commercial register. The company name has to contain the addition “a.G.” The assets of the association are liable only for the association’s commitments. The members are not liable with their assets.
Dr.. Gerhard Mayr Dr
The membership is acquired by the establishment of an insurance relationship with the mutual, so that the beginning of the membership coincides with the beginning of the insurance. As consideration the policyholders have to pay provisional premiums or an apportionment later.
obligation to pay an additional premium
The provisional premium is required for the estimated future need. If the provisional premiums are insufficient, in accordance with the articles of association additional premiums are required or the insurance benefits are reduced. The obligation to pay additional premiums can, however, also be excluded by the articles of association. This is meanwhile the rule for mutual insurance companies. Then in effect there is no difference from the fixed premium of an insurance stock company. The apportionment is not payable in advance but afterwards when the need arises, such as on the death of a member if there is a funeral expenses fund. The articles of association fix a limit for the apportionment. Such an apportionment process is only found in smaller mutual insurance companies. Foundation A defined number of founders is not prescribed. Foundation is possible with two people. A reserve fund must created for the financing, the level of which depends on the regulation for capital resources. Company functions a) Highest Representation This is broadly equivalent to the annual general meeting of a stock company and is the gathering of members or the representatives of the members. b) Supervisory Board This consists of at least three persons. The articles of association can fix a higher number, which must be dividable by three (21 at most). Two thirds of the supervisory board is elected by the Highest Representatives and one third by the employees. c) Board of Management Management This consists of at least two persons. The same regulations apply as for a stock company.
Organization of the insurance industry
2. 2.1. 1.5 5
Insu In sura ranc nce e comp compan anie ies s under under pub public lic law law
State law applies to insurance companies under public law, which is also decisive for the supervision of services. The state supervision of insurance companies companies is responsible for supervisory control . They are mainly public law institutions for which the liability is guaranteed by public bodies. They were founded, for example, by states, territories, local associations and regional banks. Nowadays most insurance companies under public law sell all classes of insurance. However, the business is restricted to a particular region or state (regional principle), principle), so that they cannot compete with each other. Bodies The large insurance companies under public law have a board of management, which runs the business and represents the insurance company externally and a board of directors which mainly exercises rights of control.
2.2 2. 2
Co-o Co -ope pera rati tion on un und d co conc ncen entr trat atio ion n in th the e insurance industry
There is co-operation when economically independent companies commit themselves contractually to work together. Example: An insurance company, a bank, an investment company and a building society work together in order to offer the customers all financial services from one source.
Aims: – Completion of product product range (“Everything from one source“) – Bette Betterr utilizati utilization on of the sales sales capaci capacity ty – Prote Protectio ction n from from comp competiti etition on – Policyhold Policyholder’ er’s s capital stays with the co-operating co-operating companies companies – Acce Access ss to new custo customer mer group groups s – Impr Improveme ovement nt of the the insuran insurance ce image image – Exten Extensive sive inform information ation about about custom customers ers Problems: – Overt Overtaxin axing g the sale sales s person personnel nel – Agents’ commission commission must be factored into bank products products – Bancassuran Bancassurance ce concepts concepts do not always always offer customers customers the cheapest products products
Dr.. Gerhard Mayr Dr
– Ove Overla rlapp pping ing produ products cts – Different size and strengths strengths of the contractual contractual partners partners can to lead to dependency dependency relationships – Conflict Conflicts s of interest interest between between the contractu contractual al partners partners (e.g (e.g.. in the targets targets or accordaccording to customers – “good” bank customer – but “bad” insurance policyholder)
2.2. 2. 2.2. 2.1 1 Ca Cart rtel el The cartel is a contractual horizontal agreement of companies that remain legally separate but give up a part of their economic independence. independence. The aim is that the market should be influenced by cartel contracts. The cartel members want to limit the competition in their commercial sector in order to be able to increase their profit. Cartels contradict the economic and social political goals of our economic system and are thus – a few exceptions aside – forbidden. Example: The industrial fire insurers decide to calculate a common risk premium (calculation cartel). On breach of the cartel contract a contractual penalty is agreed. Calculation cartels are strictly forbidden. Also a non-binding recommendation for the risk premium (net premium) is not allowed by the associatio association. n. The European Union has also taken up this matter and certain gentleman’s agreements between insurance companies are excluded from the cartel prohibition. These exceptions are regulated in the Group Exception Regulation for Insurance Companies.. The regulation that currently applies was last extended to and runs out Companies in March 2010. Exemptions from prohibition are among others non-binding examples of general insurance conditions, the exchange of statistics about risk coverage and theInsetting up of the insurance (so-called pools – see 5.3.4 in this imrespect). this respect EU is ofcollectives the opinion that co-operation in these areas proves efficiency for the insurance companies, from which consumers also benefit. 2.2. 2. 2.2. 2.2 2 Co Cons nsor orti tium um The consortium is the horizontal agreement of companies in order to carry out certain tasks that are usually of limited duration. Example: Various insurance companies share a risk (coinsurance) 2.2.2. 2.2 .2.3 3 Affi Affilia liated ted com compan panies ies Affiliated companies are formed primarily because of capital and personal connections as well as by means of company contracts.
Organization of the insurance industry
a) Concern The concern is a horizontal, vertical or unconnected union of companies that remain legally independent but whose economic independence has been given up because of a unified management. In the insurance industry the separation of lines of business leads to the creation of concerns. If all classes of insurance are to be offered, then separate companies must be founded for life, health and composite insurance respectively (previously legal expenses insurers were also separate). Horizontal concern Company unions at the same production and service level: e.g. an insurance concern with general, life, health and legal expenses insurance. Vertical concern Company unions with successive production and service levels: e.g. reinsurance and direct insurance companies. Unconnected concern Unions which straddle branches: e.g. insurance – banks – motor manufacturers Subordination concern A company controls one or more companies by means of capital or voting majority. The controlling company is often a holding. It is usually a purely financing and administrative company without insurance business.
Controlling company Insurance company or Holding company
Company for life insurance
Company for health insurance
Company for general and accident insurance (composite insurer)
Group of companies which are legally separate entities, but under unified control without a parent company The companies are combined by one management without any of them being dependent on the others. b) United companies United companies (trusts) (trusts) are a union of companies which have given up their legal and economic independence.
Dr.. Gerhard Mayr Dr
2.2.2. 220.127.116.11 4 Goals and probl problems ems of conce concentrati ntration on Goals – Use of synergy effects (purchasing, (purchasing, production production,, marketing) marketing) – Increase of share value and higher dividends dividends (shareholder (shareholder value) – Low Loweri ering ng the the premiu premium m – Gre Greate aterr sec securi urity ty – Strengthening the market power or weakening the competitors competitors – Euro European pean or or worldwid worldwide e activities activities – Cus Customiz tomized ed financi financial al concep concepts ts Problems – Curt Curtailm ailment ent of of the com competit petition ion – Cu Curta rtailm ilment ent of of supply supply – Exploitation of power (e.g. (e.g. by means of collective collective agreements, legislatio legislation) n) – St Staf afff reduc reducti tion on – Cong Conglome lomerates rates that that are difficu difficult lt to manage manage – Loss of identity identity of the individual individual insurance insurance company
Sepa Se para rati tio on of in insu sura ranc nce e cl cla ass sse es
For the protection of policyholders insurance companies are not allowed to sell all classes of insurance. According to German supervisory law the division into classes of insurance applies to life and substitutive health insurance. insurance. Reasons Life insurance is characterized by the accrual of savings premiums in the mathematical reserve and in profit sharing schemes. If it were sold with non-life insurance, which is subject to great fluctuations, there would be the danger that losses from the non-life insurance would be made up from the life insurance surplus. In the case of health insurance the ageing reserve in particular, which contains all the risk premiums for old age, should be protected from non-life losses. For legal expenses insurance there is the special case that the claims handling must be transferred to another company (claims handling company). The transfer counts as functional outsourcing. In this way a conflict of interest should be avoided. If the claimant’s legal expenses insurance and the liability of the defendant were with the same company, the legal expenses insurer would have to deal with a claim against itself. By means of the transfer of the benefit to an independent claims handling company this conflict is avoided.
Organization of the insurance industry
2. 2.4 4
Str tru uct ctu ure of th the e or orga gani niza zati tion on
The structure of the organization constitutes a company’s hierarchical framework. While the structure of the organization establishes establishes the basic framework (which tasks will be tackled by which people and which material resources), workflow management regulates the work and information processes within the framework. The company is organized on the basis of the structure of the organization. To this end the company’s global task is broken down into sub-tasks and the company as a whole is divided into business areas (section). The business sections are allocated to the tasks that have to be completed. In doing so the relationships between the individual areas have to be exactly regulated. Paradigm models are broken down into functions according to the following factors: – according to products products or product product groups (e.g. property, property, liability liability,, accident, motor motor insurance) – according to economic economic functions functions (e.g. acquisition acquisition,, production, production, sales, financing financing and administratio administration) n) – according to region (e.g. (e.g. according according to business business areas or home/abroad) home/abroad) – acco accordin rding g to cust customer omer grou groups ps The structure of insurance company organization is not in practice derived from these paradigm models. In practice, blends of functional related factors (acquisition, financing, administration) administration) are found.
2.4. 2. 4.1 1
Prod Pr oduc uctt rela relate ted d stru struct ctur ure e
The insurance business is, for example, divided into the following business areas: – Ma Mana nage geme ment nt – Underwriting area (with respective respective proposal, proposal, contract contract and claims claims processing) processing) – Finan Financial cial area area (financing, (financing, investm investments ents)) – Administratio Administration n (e.g. personnel, administratio administration, n, legal legal department) department) The underwriting areas are basically constructed on a product related basis (life, health and composite area), and composite is usually further divided into classes of insurance. The processing of insurance business by classes is traditionally done according to specialization, specializa tion, for each of which there is a management that is responsible for fundamental questions, the organization of the insurance protection according according to price and coverage for the particular class, as well as the monitoring of the daily business. Below this level is contract and business processing. The processing of proposals (new business) and portfolio administration belong to contract processing. This is referred to as the processing of new and renewal business. These are often combined as business departments with corresponding claims departments, which in the insurance of the person are called benefits departments.
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Specialist department for a class of business (e. g. motor insurance) Management – Fun Fundam dament ental al questio questions ns – Co -ord rdin inat atio ion nrgaining – Co-o Collecti Coll ective ve ba bargai ning poli policy cy Business Initial processing (Proposal processing)
Claim From time to time also for several combined classes of business
Func Fu ncti tion onal ally ly orie orient nted ed cons constr truc uctio tion n
The insurance company’s mission is divided into functions, e.g. – Ma Mana nage geme ment nt – Ac Acqu quis isit itio ion n – Sales – Pr Prod oduc ucti tion on – Ad Admi mini nist stra rati tion on – Fi Fina nanc ncin ing g Management includes planning, organization and control. It combines the business production factors. It makes the decisions about company policy, especially the specification and implementation of the company goals. Acquisition includes particularly the basic materials, the personnel and further services. Sales are vitally important for an insurance company. Branch offices and the sales force are usually part of the sales or distribution. Production is usually broken down into proposal, contract and production processing. There are other sub-functions besides these, such as underwriting, reinsurance and coinsurance. Administration includes activities that are not directly connected to the production of insurance protection, such as personnel administration, the administration of working capital, IT. It is a continuation of the supply function. Financing should safeguard the performance in particular – even when there are unexpected losses.
Organization of the insurance industry
Structure of organization according to functions Type
Acquisition and Sales administration
Bas asiic mat mater eria ials ls
Inte tern rnal al suppo port rt
Init In itia iall
processing Renewal processing
according to functions or areas
2. 2.4. 4.3 3
Struc St ructu ture re bas based ed on on custo custome merr grou groups ps
The customer group orientation should achieve a better matching of the insurance coverage for the individual customer groups as well as customized in-house support. The customer is offered a range of insurances which meet his needs. The trend is away from simply offering products to solving problems. The structure of the organization and also the processes have to focus on the solution of problems. The specific risk situation of each individual customer group should be considered both by the sales force in counselling as well as by in-house staff in dealing with policies. Structure based on customer groups Private customers
Private households – simple – wealthy
Private customers, e.g. – yo youn ung g pe peop ople le – yo youn ung g fami famili lies es – sin single gle hou househ sehold olds s – wea wealth lthy y hous househo ehold lds s – ol olde derr pe peop ople le Independent professions, e.g. – do doc cto torrs – law lawyer yers s / not notari aries es – tax advi advise sers rs / audit auditors ors – artists
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Advantages of customer group organizations – Insurance selection customized to the need of of the customer customer group – Quick adjustment adjustment of the the insurance selection to the changed changed customer need – “Package solutions solutions” ” – sell sell few single single insurance insurance policies policies – Cut Cut out the the compet competiti ition on – Stro Stronger nger identifi identificati cation on with the customer customers s – Insurance calculated according to the customer groups – One voice voice to the customer for the complete complete product product range range – Shor Shortt commu communic nication ation path – Better use of of qualifications, qualifications, especially especially for younger younger members of staff Problems – Difficult to implement, implement, especially especially with the sales force force (agency contracts contracts still in in force) – High costs costs and and friction friction losses losses when when restructuring restructuring – Erro Errors rs in the contract contract and claims claims proces processing sing – Staff diffic difficult ult to replace: replace: long long training training period period – Overl Overlappi apping ng custo customer mer grou groups ps – For small insurance insurance companies companies scarcely scarcely possible possible (Contract portfolio, portfolio, number of customer groups) – Uncl Unclear ear delineat delineation ion of insuranc insurance e classes classes
2.4. 2. 4.4 4
Cent Ce ntra rali liza zati tion on and dece decent ntra raliz lizat ation ion
Centralization means the concentration of administrative work of an insurance company in the head office. Decentralization means the general transfer of this work to the branches. Reasons for decentralization – Cl Close ose to the the custo customer mer – Cl Close ose to to the sale sales s force force – Flexibility because close close to the market and quick quick decisions decisions – Cons Consider ideratio ation n of regional regional differenc differences es – The head office office is relieve relieved d of administra administrative tive tasks tasks – Loca Locall presence presence (image (image adverti advertizing zing)) Reasons for centralization – Less co-ordi co-ordinatio nation n of work and control controlling ling – Better control control of the the underwriting underwriting and claims handling handling policy policy – Fewe Fewerr problems problems if if staff are are not availab available le – Better distribution distribution of work work and and specialization specialization – Dupl Duplicat ication ion of work work avoi avoided ded
Organization of the insurance industry
– Cost reduction reduction because of elimination elimination of personnel personnel and material material costs – The branches become less important because because of complete complete processing processing by the sales force
2.4. 2. 4.5 5
Over Ov ervi view ew of ca call ll ce cent ntre res s
With a call centre the customer comes into direct contact with a competent business partner. Call centres are telephone service departments in which incoming calls are distributed over an automatic call distribution system to the staff of the centre. The automatic call distribution system provides a well-balanced utilization of staff. Incoming calls are accepted within a few seconds. At peak times the calls can be switched to other clerks (e.g. those responsible for correspondence) or to external staff. The staff in the call centre as well as being very resilient must also have a sound knowledge of the products. During the discussion the employee can call up all the relevant data about the customer onto the screen and update it during the call. In the call centre up to 80 80% % of all incoming calls can be completely processed – from the acceptance of proposals to policy changes and claims handling as well as tariff information, product information or complaints. In this connection the call centre is often called „first level processing“. If the question cannot be completely answered the call is forwarded to the specialist departments (so-called “second level”). For the processing of documents it can also make sense to divide the processing into first level (routine questions) and second level (complex technical detail). The call centre can not only be used for inbound questions, i.e. for questions from outside for the insurance company, but also for outbound questions, for telemarketing. In telemarketing the telephone system dials the numbers of selected customers. If the customer can be reached, his contract details appear on the screen. The employee in the call centre can then give the sales talk – supported by this data. The call centre call (outbound) can also be used to maintain the business portfolio. The maintenance of the business portfolio can be carried out prophylactically (e.g. if a tariff is increased) as well as for actively winning back customers Advantages of the call centre – Alw Always ays ac acces cessib sible le – Quick assistance assistance in the event of a claim or for for contractual questions – No transfer transfer (several (several times) times) to special special departme departments nts – Com Comple plete te proce processi ssing ng – Easy to deal deal with with compl complaint aints s – Use for advertizing advertizing campaigns campaigns (“outbound”) (“outbound”) – the customer customer is approached approached by telephone – “Comfort call” call” in the face of of surrender surrender or to pre-empt it. Disadvantages of the call centre – Complexity of the material makes makes it necessary necessary to have have highly qualified qualified staff – Overlaps with the service activities of intermediaries intermediaries – Under certain certain circumstances circumstances double work work with doubled costs costs
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Organiza zattio ion n of workflow
The organization of workflow in an insurance company includes the design of the individual work processes in order to complete tasks, their assignment to particular responsible persons and the rules for the combination of the individual work processes for the overall performance. Within the structural framework of the organiza organiza-tion the processes are ordered realistically in space and time. The work places and work processes created in this way are linked with each other. Workflow management is thus based on an analysis of the processes and the ensuing process synthesis. Examples of processes in the insurance company – Proposal process process (from the process in the sales force until the the policy is dispatched) – Claims regulation regulation process process (from the the first claims claims report until until the final regulation) – Process of of the in-force business (from policy alteration to sending sending the new new policy)
2.5.1 2.5 .1
Exampl Exa mples es of the cla claims ims han handlin dling g pro proces cess s
The work can also be done at the first and second level in the claims regulation process. While at the first level mass claims up to a certain level are processed, high claims or bodily injury claims are taken care of at the second level. In this connection, so-called workshop management plays an ever greater role in motor insurance. When a claim is reported, the insurer tries to send the customer or the injured party to a workshop that is contractually bound to the insurance company in order to reduce claims costs (A price discount can be agreed with the workshop in return for a large total volume of repairs).
Outsourci Outsourcing ng is the removal of services or parts of the administratio administration n and production to subsidiaries or to other companies. In the insurance industry the following can be outsourced: – Di Dist stri ribu buti tion on – Claims handling handling (e.g. for major claims claims and for for bodily injury) injury) – IT – Inve Investme stment nt admi administ nistratio ration n – Administrati Administrative ve areas (e.g. security security,, cleaning, cleaning, cantine) cantine) – Ac Acco coun unti ting ng – Pe Pers rson onne nell
Organization of the insurance industry
Advantages – Lower wages wages and salaries (other collective collective agreements) – Less protec protection tion again against st dismiss dismissal al – Low Lower er soci social al benef benefits its – Flexi Flexible ble reaction reaction to variation variations s in production production – Increased awareness of costs costs and earnings awareness – Winn Winning ing of of third third party party contrac contracts ts – Tax advantages (e.g. with regard to Value Value Added Tax; Tax; Profit Tax) Tax) – Bet Better ter inter internal nal cont control rol
2.6 2. 6
Meth Me thod ods s of of dis distr trib ibut utio ion n in th the e ins insur uran ance ce in indu dust stry ry
Insurance companies bring their insurance products to the customers. Sales or distribution of insurance protection means, therefore, in the first instance the bridging of the gap between the insurer and customer. The sales or distribution of insurance protection is not a one off activity, but the issue of an insurance policy means a long-term relationship with the customer, which must be fostered accordingly (so-called portfolio servicing). As a rule insurance contracts are concluded by means of a sales organization (e.g. an intermediary or broker). The expression for this is indirect distribution. In contrast, in the case of direct distribution direct relationships are established between the customer and the insurer. In this case the customer turns directly to the insurance company in order to obtain insurance protection. protection.
2.6.2 2.6 .2
Indire Ind irect ct dist distrib ributio ution n by by sal sales es org organi anizat zation ions s
2.6.2. 2.6 .2.1 1 Com Compan pany y sales sales organiz organizatio ations ns Company sales organizations are part of the insurance distribution. These are usually employees in the sales force. force. Features – Employment contract that that is dependent dependent on the insurance insurance company company – Not se selflf-emp employ loyed ed – No entrep entrepren reneur eurial ial risk risk – Bou Bound nd by inst instruc ructio tions ns – Salar Salary y (plus commi commissi ssion on and expense expenses) s) – Col Collec lectiv tive e agreeme agreement nt – Right Right to ho holid liday ay – Obli Obligati gation on to contribute contribute to social social insuranc insurance e
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Main tasks – Winning and training training of insurance insurance representatives – Supp Support ort of difficult difficult insura insurance nce classes classes – Carr Carrying ying out speci special al tasks tasks – In some insurance insurance companies companies normal customer customer contact contact (prospecting, (prospecting, sales cloclosure, portfolio support as well as help in claims handling) 18.104.22.168 2.6.2. 2 Means of distrib distribution ution that that are linked linked to the company company (insurance (insurance agents) agents) By this means of distribution is meant a self-employed businessman (insurance agent) who is tied to the insurance company by means of a contract of representation or an agency agreement. He is permanently entrusted with the task of arranging or concluding insurance contracts. The typical insurance agent acts on behalf of an insurance company or for a concern. He is, therefore, known as a tied agent or tied representative. From a legal perspective the name representative of a concern or of various companies is more correct, since he represents several companies with which he has contracts, because of the various classes of insurance. Features – Legal Legally ly recogni recognized zed busine businessm ssman an – Free to to arrange arrange his his own own activitie activities s – Free to determ determine ine his his own worki working ng hours hours – Bo Book ok-k -kee eepi ping ng – Co Commi mmiss ssion ion (no (no salary) salary) – Regi Register stered ed at the trade trade licensing licensing offic office e – Free from from the duty duty to pay pay social social insura insurance nce – Submission Submission of income tax and and trade tax on the basis basis of self-employed self-employed commercial commercial activity – Comp Compensa ensation tion enti entitleme tlement nt Principle tasks – Maki Making ng customer customers s aware of the need need for insuranc insurance e – Arran Arranging ging insu insuranc rance e contract contracts s – Serv Servicin icing g poli policyho cyholder lders s – Assi Assistin sting g in claim claims s handlin handling g 2.6.2. 2.6 .2.3 3 Ext Extern ernal al sales sales organi organizat zation ions s Insurance brokers The insurance broker is a self-employed businessman who arranges contracts for other people without being contractually tied to this task. The insurance broker has his own contract with the customer (so-called broker contract) and in contrast to the insurance agent does not have a fixed relationship to the insurance company. He has a duty to the customer and not the insurer. This leads to a special kind of liability
Organization of the insurance industry
towards the customer. The payment is in the form of commission, which is part of the insurance premium and is paid by the insurance company to the broker. Advantages from the point of view of the insurance company – No expenses expenses for for setting setting up up a sales sales force force – No claim claim for comp compensa ensation tion – Brok Brokers ers are know knowledg ledgeabl eable e – Brok Brokers ers often often take work off off the insuranc insurance e company company – Brok Brokers ers often often bring bring large large contract contracts s Disadvantages from the insurance company’ company’s s point of view – The insurance insurance company scarcely has has contact with the policyholder policyholder – The contrac contracts ts are often often not not long-term long-term – The broker broker represents represents the policyhol policyholder’ der’s s interests interests – Comm Commiss ission ion and and premium premium pressu pressure re – “Com “Competit petition” ion” betwee between n the brokers brokers and own agents agents Independent sales organization The independent sales organization usually has several hierarchical levels. At the lowest level the placing of insurance (“sales”) (“sales”) – often by part-time staff – is the main activity. If the sales results are good, the sales persons can be promoted to higher levels. Besides the placing of insurance there is organizational activity, i.e. the finding and training of new intermediaries. A member of staff who has been promoted participates in the turnover of the intermediaries below him (third party turnover). The higher the member of staff rises, the less sales work he does and the more the administrative work increases. Remuneration and career progress follow exclusively the performance principle.
No direct contribution to turnover, many members of staff
5 4 3 2 1 A
Large contribution to turnover, no members of staff
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Independent sales organizations try to sell their products with as many members of staff as possible, who are organized in a pyramid structure. At the lowest level A the sales persons have to sell as many insurance policies as possible in order to move on to Level 1 and to earn from the turnover of the members of staff of Level A. At Level A only the own turnover is evaluated. From Level 1 onwards not only the own but also the turnover of others is quantified as part of the total turnover, and with this the possibility of moving higher up the hierarchy. Opportunities – High Highly ly motivat motivated ed sales sales perso personnel nnel – Good possibilitie possibilities s to earn well if good at selling – Good opportuniti opportunities es for promotion and earnings earnings – Targeted customer customer approach (e.g. by analyzing the the wealth and insurance insurance relationships) – Financial service offers offers that are are customized customized for customer customer groups groups – Comprehens Comprehensive ive counselling counselling (everything from one source) Risks – Sometimes poor counselling counselling because of of inadequate inadequate knowledge knowledge – Agg Aggres ressi sive ve se selli lling ng – Stro Strong ng (also psychol psychologic ogical) al) sales sales pressure pressure – Hig High h cancell cancellati ation on rates rates – Hig High h staff staff fluct fluctuat uation ion – Low earnings earnings at the lowest lowest hierarc hierarchica hicall level – Low follow up service for policyholders, policyholders, because because there is is no fixed portfolio portfolio – Often expensive expensive financial and insurance insurance products – Often intensified intensified sale of products with with higher commissi commission on (that are not not needed) Other external sales organizations – Co-o Co-opera peration tion with bank banks s – Annex distribution distribution (sales over third parties, parties, whose core business business has nothing nothing to do with insurance distribution) e.g.: – Mai Mail-o l-orde rderr compani companies es – Moto Motorr traders traders and and manufa manufactur cturers ers – Aut Automo omobil bile e clu clubs bs – Cre Credit dit ca card rd sell sellers ers – Tour ope operat rators ors – Foo Food d stor store e chai chains ns They offer specific insurance policies, which in certain circumstances are connected with their product. Thus insurance protection is offered to the supporting product only in limited areas which often overlap with already existing insurances (e.g. credit cards, travel insurance policies). If these providers succeed, however, in developing an independent distribution channel, channel, there can be real competition to the traditional sales channels (e.g. ADAC, which offers all forms of motor insurance).
Organization of the insurance industry
2.6. 6.3 3 2.
Dire Di rect ct ma mark rket etin ing g
In the case of direct marketing selling is done directly by the head office without involving sales organizations. The contact between the customer and the insurance company takes place exclusively by letter, telephone or other electronic media. In the case of direct marketing it is the customer who takes the initiative. He must know which insurance policies and which sums insured he needs and which insurance can best meet this need. Advantages – No commission, commission, and consequentl consequently y lower costs costs and cheaper cheaper premium – No agent visit visit (custome (customerr can decide decide himself) himself) – No unnecessary unnecessary insurance policies policies or policies policies with too too high a sum insured insured – Low Lower er cancel cancellat lation ion rate rate – New custo customer mer groups groups are reache reached d – Sho Shorte rterr work work proces processes ses – Professional counsellin counselling g by the head office if desired desired (e.g. telephone, letter letter,, Internet) Disadvantages – No arousin arousing g of needs needs by the the sales sales force force – No persona personall counsell counselling ing / conta contact ct – Low insurance insurance penetration, because the need need for insurance insurance protection protection is suppressuppressed – Poor support support / missing missing adjustment of the insurance insurance contracts contracts – Miss Missing ing assista assistance nce in claims claims handlin handling g – Busi Business ness is diffic difficult ult to dire direct ct – Onl Only y simpl simple e produc products ts – Relatively expensive direct advertizing advertizing (low success success rate) – To some extent extent aggressive underwriting (e.g. in motor motor insurance) insurance) – To some extent extent high high complain complaintt rate
2.6. 2. 6.4 4
Insu In sura ranc nce e co cons nsul ulta tant nts s
Insurance consultants advise and support the self-employed, companies, private clients and public authorities about all forms of individual insurance and are, therefore, committed to a form of counselling that is oriented to the personal need that has been ascertained. They produce risk analyses for their clients, advise about insurance cover, which is customized to the needs of the particular client, and they negotiate about this with possible insurers. They represent their clients before the insurers if there are claims. They continuously check that the insurance covers in force are updated. In so doing they play an advisory and professional role, the placing or the sale of insurances being forbidden for them. On request the client receives the names and
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addresses of relevant insurers. One of the main tasks is to achieve the cheapest and most suitable insurance cover for the client. Insurance counsellors counsellors must be neutral and independent: i.e. they must not work on behalf of an insurance company, but generally receive receive their fee from their client according according to an agreed hourly or daily rate. The direct instruction and also the direct payment by the client avoids some of the possible adverse affects of one party representing the client’s interests. The profession of insurance counsellor is one of the legal advisory professions and can only be performed if the responsible Chamber of Industry and Commerce has granted authority. The professional title “insurance adviser” is legally protected.
2.6.5 2.6 .5
Legal Leg al aspe aspects cts of insu insuran rance ce sale sales s and and marke marketin ting g
The European Union Directive on Insurance Selling (Directive 2002/92/EG of the European Parliament and Council of December 9th 2002 concerning insurance selling) was published on January 15th 2003 in the official gazette of the EU. The directive was needed, on the one hand, to facilitate freedom of services in the field of insurance sales and, on the other, to comply with consumer protection requirements. The following important points are regulated in the Directive: – Recording of the intermediary intermediary in a register register that is accessibl accessible e to the public public – The duties duties of the intermediary intermediary to provide information – Counselli Counselling ng and documentatio documentation n duties (Counselli (Counselling ng report) report) – Crea Creation tion of an arbi arbitrati tration on post post – Safeg Safeguard uarding ing of of custome customerr monies monies In the course of implementing the EU-Directive on Insurance Selling new rules were introduced with effect from May 22nd 2007 in Germany Germany,, among other things in the trade regulations as well as in insurance contract law. These clearly define the types of intermediary. Thus henceforth insurance intermediaries are either insurance agents or insurance brokers. Since May 22nd 2007 permission has had to be obtained in order for an intermediary to sell insurance, and the Chamber of Industry and Commerce is responsible for granting this. This is contingent on certain requirements. Thus the intermediary has to be personally reliable, i.e. he cannot have been legally convicted in the last 5 years prior to submission of the application. Furthermore, his financial affairs must be in order, which is usually the case if no insolvency proceedings have begun or they have been rejected owing to a lack of substance and he has not made an affidavit before the district court – a court which executes civil judgments. He must continue to show that he possesses a professional indemnity policy with a certain minimum cover. Finally, proof of professional competence is needed. This professional professional expertise can be proved by a professional examination examination of the Chamber of Industry and Commerce that has been passed. A large number of other legally controlled qualifications are also recognized as being adequate proof of competence.
Organization of the insurance industry
Furthermore, an intermediary register has been set up, in which every intermediary has to be entered. The entry application must be made for the intermediary at the Chamber of Industry and Commerce that is responsible. The insurance agent represents the interests of the insurer. For insurance agents there is fundamentally the duty to provide counselling as needed. They must, however, only refer to the insurers and their products with which they have a contract. The customers must be told who these insurers are. During their first meeting the intermediary has to give the customer the so-called “first information” in writing, from which can be seen: – the name and busine business ss address address of the interme intermediary diary – the intermedia intermediary’ ry’s s registratio registration n number – the intermedi intermediary’ ary’s s status (broker (broker or agent) agent) – the mediatio mediation n offices offices in case case of disputes disputes During the counselling the wishes and needs (better: the objectively existing need) of the customer is established. The advice to the customer should match the complexity of the insurance product, product, the person and the customer situation. As defined in law the level of the insurance premium premium should also be a measure of the counselling requirements. Reasons must given for the advice the customer receives, so that the customer can also understand later why he chose a particular insurance product. The basic facts of the counselling must be recorded in the counselling documentation, which the customer must receive at the latest before the contract in written form has been concluded. The customer can dispense with counselling and documentation of the counselling, but he must do this in a separate written statement which contains a warning that such a waiver could be disadvantageous for him in pursuing and achieving claims for damages against the intermediary. The new legal regulation stipulates that the agent and broker are personally liable for wrong advice and for inadequate compliance with the requirements described above. The tied agent as well as the agent that represents several companies can let themselves be contracted out by an insurer. In this casewould the insurer takes over liability against which professional indemnity insurance otherwise have tothe be taken out.
Sources Farny, Dieter: Versicherungsbetriebslehre. 4th edition. Karlsruhe: VVW, 2006 Schulenburg, J.-Matthias Graf von der: Versicherungsökonomik – Ein Leitfaden für Studium und Praxis. Karlsruhe: VVW, 2005
Legal basis of the insurance contract by Esther Grafwallner
Legal basis of the insurance contract
Overview of the new German Insurance Contract Law By Professor Helmut Schirmer
On January 1st 2008 a new Insurance Contract Law (VVG) came into force in Germany that replaced the old one of 1908. The preparation for this new codification had begun in the middle of 2000. The guidelines of the EU directive for intermediaries have been included. The aim of the new law is to strengthen strengt hen the rights of the policyholder, pol icyholder, to increase the transparency of insurance products for the policyholder and to incorporate court verdicts into the earlier insurance contract law and to develop it further. The duty to counsel the policyholder as developed by jurisprudence is henceforth subject to law, the commensurate duties of intermediaries are based on the intermediary directive. Violation of the policyholder’s duties to conform (obligations) has received a new system. The consequences of a breach – total or partial loss of insurance coverage – fundamentally make causality a precondition. The only exception is fraudulent intent by the policyholder. A distinction has to be made between the degrees of responsibility. If the policyholder is merely slightly negligent, the insurance coverage remains unaffected. In the case of gross negligence, there is contribution. Contribution means that the insurance cover can be limited depending on the degree of the policyholder’s responsibility. Only in the case of policyholder intention, however, may the insurer not need to pay the benefit. This system is supported by the insurer’s numerous informational duties, by means of which the policyholder should know of the negative consequences of not complying with the obligations. (Duty to warn). Many of the insurer’s duties to inform have the aim of drawing the policyholder’s attention to the content of the future insurance cover even before making a contractual declaration. A general right of revocation extends the policyholder’s freedom of decision. For large risks as defined by EU directives, however, freedom of contract remains broadly as before. Agreements that do not conform to the new insurance contract law (VVG) remain fundamentally valid.
The contracts taken out between insurance companies and their customers are called insurance contracts. Their contractual partners are called insurers and policyholders. insurer
An important feature of an insurance contract contract is that the insurer safeguards against an unforeseeable event. In other words, in return for a fee it takes over the risk that a peril might occur. For carrying this risk and the promise of a benefit that is bound up with it, the policyholder owes the insurer financial consideration, the premium. insurer
carrying of risk
payment of premium
The insurer and the policyholder have the freedom to agree whether an insurance contract should be concluded and what its contents should be. This freedom of contract is limited in various ways:
3.1. 3. 1.1 1
Comp Co mpul ulso sory ry in insu sura ranc nces es
Basically, everyone can decide for himself whether he wants to insure certain risks of his life. However, it can be in the public interest that this freedom is restricted by the regulation of a compulsory policy of insurance. A motor vehicle, for example, is considered considere d a potential source of danger, but the driver may not be able to pay easily in case of a claim for damages. Consequently, the legislator has decided in this case to introduce compulsory liability insurance. There are other such compulsory insurances in many other areas, such as, for doctors or lawyers, for example.
3.1. 3. 1.2 2
Oblig Ob ligat atio ion n to en ente terr into into a co cont ntra ract ct
Insurers as well as policyholders are generally free to decide whether and with whom they want to take out an insurance policy. In some areas of insurance this freedom is abolished by the obligation to enter into a contract. This means that the insurer is compelled to accept a proposer’s proposer’s application (e.g. in motor insurance, § 5 II Compulsory Insurance Law for Motor Vehicle Drivers (PfIVG)).
Legal basis of the insurance contract
3.1. 1.3 3 3.
Laws La ws an and d re regu gula lati tion ons s
In order to protect the policyholder as the weaker party from discrimination, freedom of contract is limited in various laws and regulations, which at the same time constitute the legal sources of the insurance contract.
3.2.1 3.2 .1
Insura Ins urance nce Contra Contract ct Law (Vers (Versiche icherun rungsv gsvert ertrag ragsge sgeset setz z VVG)
The most important basis is the VVG, first passed on May 30 th 1908 and which on January 1st 2008 was thoroughly reformed. Important contents of the reform are the introduction of many advisory, explanatory and informational duties of the insurer as well as extensive consumer protection, which has been very largely harmonized. The VVG is a special law for insurance contracts and therefore overrides or supplements the general regulations about the form of contracts as they are particularly found in the Code of Civil Law (BGB). Only if there is no regulation under the VVG regarding a specific matter, are the more general regulations of the BGB used. The basic principle of freedom of contract applies to the insurance contract. contract. For this reason the contractual parties can depart from individual standards standards of the VVG, unless the legislator wants to safeguard particular rules or minimum contents for one party or even both parties. Thus a distinction should be made between Non mandatory norms
Half mandatory norms
It is possible to depart from these norms, either to the advantage or the disadvantage of the policyholder.
It is only possible to depart from these norms to the advantage of the policyholder.
It is not permitted to depart from these norms.
In the VVG they are not specifically specifical ly identified.
In the VVG they are specifically identified, as a rule at the end of a section and combined with the information that they cannot be departed from to the disadvantage of the policyholder.
They are also specifically identified in the VVG.
3.2.2 .2 3.2
VVG Regu Regulat lation ion regar regardin ding g the duty duty to to provid provide e inform informati ation on (VVG-Informationspflichtenverordnung VVG-InfoV)
The Insurance Contract Act (VVG) is supplemented by some ancillary laws and regulations. In practice the most relevant of these is the VVG-InfoV. It has its basis of authorization authorizatio n in § 7 Abs. 2 VVG and regulates in detail the content of the insurer’s insurer’s duty to provide information before the conclusion of the insurance contract and for its duration.
Insurance Insura nce Superv Supervisory isory Law (V (Versich ersicherungs erungsaufsic aufsichtsges htsgesetz etz VAG)
The VAG regulates in the first instance the relationship between insurance companies and the Insurance Supervisory Authority (so-called Federal Financial Supervisory Authority – BaFin, for short) and is thus public law, whereas the Insurance Contract Act (VVG) regulates the private legal relationships between insurance companies and policyholders. The VAG sets certain minimal requirements for insurance companies and ensures their compliance by giving BaFin possibilities ofaintervening in the event of violations. violations . The background to thisvarious is that the public has great interest in the financial stability and legality of insurance companies, in order to make sure that they survive and remain effective.
3.2.4 3.2 .4
Code Cod e of Civ Civil il Law Law (Bürg (Bürgerl erlich iches es Gese Gesetzb tzbuch uch BGB BGB))
The BGB applies to all contracts regulated by private law and thus basically also to the insurance contract. Being general law, the BGB is not used, however, if special regulations of the Insurance Contract Act (VVG) apply. Especially relevant for the insurance contract are the regulations about forming contractual obligations by means of the general terms and conditions (§§ 305 ff BGB). The General Insurance Conditions (Allgemeine Versicherungsbedingungen AVB) are a special form of the general terms and condition conditions. s. The VVG regulates how they are to be incorporated into the insurance contract, so that the regulations of the BGB are not relevant in this respect. The possible contents are also regulated as far as possible in the VVG. There are regulations in the VVG which can be departed from (non mandatory norms), but the insurer is, nevertheless, not completely free in terms of its AVB. So, for example, very important principles of the VVG have to be respected. In this case a single regulation regulation of the AVB AVB can be invalid because of § 307 BGB (“Control of contents”), even though the VVG permits a deviation.
Legal basis of the insurance contract
Example: X-AG has a clause in its AVB which contains the following: “If the policyholder causes the loss intentionally or recklessly, the insurer is not obliged to pay the benefit.” In accordance with § 81 VVG the insurer can reduce reduce its benefit in proportion to the policyholder’s degree of blame if the policyholder brought about the insured claim intentionally or recklessly recklessly.. According to § 87 VVG it is possible to deviate from § 81 VVG either to the advantage or the disadvantage of the policyholder, and in the past the insurer was released from paying the benefit if the policyholder had acted recklessly (the so-called “all or nothing principle”). The newly introduced “more or less principle” of the VVG reform, however, does not release the insurer from paying the benefit for gross negligent (reckless) behaviour, but only permits a reduction of benefit. This is such a basic principle of the VVG that it cannot be completely undermined. The X-AG clause is, therefore, therefore, invalid according according to § 307 BGB.
3.2. 3. 2.5 5
Genera Gene rall Anti Anti-d -dis iscr crim imina inatio tion n Law Law (Allgemeines Gleichbehandlungsgesetz AGG)
The intention of the AGG is to prevent or eliminate discrimination for reasons of race or ethnic origin, religion or philosophy, a handicap, age or sexual identity (§1 AGG). This law also applies according to §19 Para. 1 No. 2 AGG to insurance contracts and limits insurance companies’ freedom of contract, because they are not allowed to reject lightly a contract because of one of the above mentioned reasons. § 20 AGG regulates the cases in which under certain circumstances circumstances different different treatments are possible because of one of the above named features, without being discriminatory.. Thus, for example, a different treatment is possible because of gender criminatory if there are reasonable grounds for this (e.g. the greater risk of men to suffer a heart attack can be included in the premium calculation). Expenses in connection with pregnancy and motherhood may not – again as an exception in this respect – lead to different premiums or benefits.
The General Insurance Conditions (AVB) are preformulated contractual conditions for many contracts, contracts, which must must comply with with the regulations regulations contained in in §§ 305 ff BGB. Since the conclusion of insurance contracts is high volume business for many classes of insurance (e.g. in motor insurance), the use of the AVB is the common practice. For special risks, however, it is quite possible either to depart from individual conditions of the AVB by means of special agreements or even to make completely separate agreements. Whether and to what conditions an insurer departs from its AVB is a question of its risk assessment policy, the so-called underwriting.
Until the introduction of the Third EG-Directive into German law in July 1994 the supervisory authority had to approve the AVB for each class of insurance before they could be used. This led to very similar AVB in each class. Today insurance companies can develop their own AVB which can differ for different target groups or products even within one company. The minimum content of the AVB is explicitly itemized in §10 Insurance Supervisory Law (VAG). The unique feature of insurance contracts is that the AVB not only regulate the basic conditions of a contract, as for instance payment conditions, but also define the content of the contract itself, the promised benefit. For this reason the minimum content includes especially the regulations
for which events the insurer is obliged to provide a benefit and
in which case this benefit is excluded, nullified or restricted due to particular reasons.
Other subject matters relate to the wording of the basic conditions, such as the maturity date of the benefit, payment conditions and courts of jurisdiction. In the case of compulsory insurances, such as motor third party liability, further minimal contents can be prescribed in the relevant special laws.
The insurance contract is concluded between the insurer and the policyholder. These two parties are the contractual partners. Apart from the contractual partners, other persons can also participate in the insurance contract. That will not make them contractual partners, however.
Insured pe person
The insured person is the one for whose benefit the insurance contract has been taken out. Insofar as the policyholder and the insured person are not the same person, it is an insurance for the account of a third party. This is specifically regulated in § 43 ff Insurance Contract Contract Act (VVG). Example Examp le 1: A Plc, which has been paid to store the goods of third parties, takes out an insurance policy against fire and natural perils for these goods. If there is a claim, the customers are entitled to the settlement. Example 2: The tour operator takes out travel cancellation insurance insurance for the benefit of his travel customers. Example 3: Mr Müllerinsured has private health insurance. Hiscontractual children are included in the tariff and therefore with him, but they are not partners.
Legal basis of the insurance contract
In non-life insurance the insured person is the one whose risk is covered by the insurance policy.
Obligation to pay the premium Policyholder
r o v e c c k s r i s
This has to be distinguished, however, from a number of persons on the side of the policyholder. It is naturally also possible for several persons to be contractual partners. Example: The married couple Huber takes out a household insurance policy for their joint dwelling. Both sign the insurance policy and are joint debtors for the premium. The insured person is not liable for the payment of the premium if he is not identical with the policyholder, but he acquires the rights under the insurance contract. However, the insured person cannot demand the insurance policy from the insurer but only from the policyholder policyholder (§ 44 VVG). He needs it, on the other other hand, if he wants to exercise his rights arising from the insurance policy or assert them juridically. The insurer, on the other hand, is only obliged to provide the benefit to the policyholder if the insured person has agreed. Special case: Life Insurance In life insurance, too, the policyholder takes out a policy in principle in his own name. If the policy is on the life of another, the latter is called the insured person. In this case, however, insofar as the sum insured exceeds the burial costs, the written approval of the insured person is absolutely necessary, see §150 Para. 2 VVG. For children there are further special regulations. regulations. The reason for this is obvious: the insured person should be protected from the possibility that his or her death becomes financially interesting interesting for another person. Therefore in § 162 VVG there is a special regulation for the situation that the policyholder deliberately causes the death of the insured person.
Benefici cia ary
The beneficiary is the person to whom the policyholder has given the right to request the payment of the sum insured when there is a claim. The law of life insurance, disability income benefit and accident insurance recognizes recognizes authorizations of claim payment. The policyholder can confer the right to the insurance benefits, without the agreement of the insurer in the case of doubt. If the insurer, therefore, only wants to permit a particular right of benefit (e.g. to the heirs), it must stipulate this explicitly, explicitly, and at the same time stipulate that this right may only be changed with its approval. Furthermore regarding the right to insurance benefits, a distinction is made between revocable and irrevocable rights. The difference difference is the point of time when the right to benefit is acquired against the insurer. Acquisition Acquisiti on of the right to benefit
Revocable right to the insurance benefits
Irrevocable right to the insurance benefits
At the time of the claim
On conferring the right to benefit
The revocable right to benefit is the rule. The beneficiary only acquires the right to the insurance benefit at the time of the claim. Up to this time the policyholder can revoke or change the right to the insurance benefits at any time. The policyholder keeps all the rights and duties arising from the contract and can thus, despite granting the right to the benefits, mortgage the claims under the insurance or assign the rights from the contract. In the case of an irrevocable right to the benefits the right to the insurance benefit is acquired immediately. immediately. As soon as the relevant declaration has been made to the insurer, the right to claim the insurance benefits can only be annulled with the agreement of the beneficiary. The policyholder remains, however, also in the event of an irrevocable right of benefit the contractual partner of the insurer and must fulfil all the duties arising from the insurance contract.
3.4. 3. 4.3 3
Prem Pr emium ium pa paye yerr / Cont Contri ribu butio tion n paye payerr
The policyholder is the contractual partner of the insurer and is the premium debtor. If a third person takes the place of the policyholder in paying the premium, he is the premium payer. He does not become the premium debtor by doing this, however. The insurer need only accept the premium from another person than the policyholder if it was agreed between the insurer and the policyholder or it is a legally sanctioned special case.
Legal basis of the insurance contract
In accordance with § 34 Insurance Contract Contract Act (VVG) the insurer must accept payment of premium
from the insured person in case of insurance on account of a third party,
from the beneficiary, insofar as he has already gained a right of benefit as well as
from a bailee. This regulation applies irrespective of whether the policyholder has a right under civil law against the premium payer that the latter should pay the premium. The reason for this regulation is that the third party beneficiary has an interest in the insurance cover and should not bear the consequences of the late premium payment.
3.4.4 3.4 .4
Repres Rep resent entati atives ves of the con contra tractu ctual al part partner ners s
Insurance contracts like all other contracts can be concluded without action and declarations of intent by the parties if one or both parties is represented by a proxy proxy.. As a matter of principle the insurer as well as the policyhol policyholder der can confer power of representation to any person they like. Example: Mr Scholz instructs his brother to take out a liability policy for him and gives him the proxy needed for him to do this. In this case the rights and duties as well as the imputation of knowledge ensue solely from §§ §§164 164 ff Code of Civil Civil Law (BGB). (BGB). However, if one of the parties lets himself be represented by someone who acts as an intermediary or takes out insurance contracts commercially, this is the insurance broker for the policyholder, and for the insurance company it is the tied or multiple agent.
insurance intermediary (§ 59 VVG)
tied agent (represents only the one insurer)
multiple agent (represents several insurers)
For all these intermediaries there are special regulations; namely those that establish, on the one hand, a certain degree of qualification and financial liability (implemented by the integration of the intermediary guidelines guidelines into various German laws in 2007) and, on the other, other regulation govern that the relationshi relationship p between the contractual partners and the intermediary. These regulations, which are found in §§ 59 ff Insurance Contract Contract Act (VVG), are are described in more more detail in what follows. follows. 3.4. 3. 4.4. 4.1 1 In Insu sura ranc nce e brokers brokers The insurance broker is obliged to base his advice to the policyholder on “an adequate number of insurance insurance contracts that are on offer in the market” (compare § 60 Para. 1 VVG). This means that he first has to ask the policyholder about his wishes and needs and then advise him about the best product on the basis of a comprehensive market overview. It is not sufficient simply to offer a relevant insurance product. A different situation arises only if the broker informs the policyhold policyholder er of the restricted choice. The insurance broker can either (only) be asked for advice by the policyhold policyholder er or be authorized to conclude a contract. In the latter case, he is authorized to effect the optimal insurance cover for the policyholder. 3.4. 3. 4.4. 4.2 2 In Insu sura ranc nce e agent agents s The insurance agent is appointed commercially by one or more insurers to arrange insurance contracts. The insurance agent is the “eyes and ears” of the insurer. His knowledge is thus imputed to the insurer. The insurer is responsible for incorrect information of the agent, unless the insurance agent and policyholder have colluded to damage the insurer. 22.214.171.124 3.4.4. 3 The insuranc insurance e intermediar intermediary’ y’s s duty to advise advise The insurance broker as well as the insurance agent have a duty towards the policyholder to inquire and advise. If this duty is violated, the customer can enforce damages against the agent himself. With regard to the information, the duty to question and advise is the same as the insurer’s, which is why you are referred to section 3.5.3. The insurance agent’s duty to advise ends with the conclusion of the insurance contract, whereas the insurer’s and the insurance broker’s continues for the duration of the policy.
Conc Co nclu lusi sio on of th the insu insura ranc nce e con contr trac actt
3.5. 3. 5.1 1
Prop Pr opos osal al an and d acc accep epta tanc nce e
The insurance contract comes into force, like every other contract, in accordance with the regulations of the Code of Civil Law by two corresponding declarations of intent (§§145 (§§ 145 ff BGB). They are called proposal and acceptance. acceptance.
Legal basis of the insurance contract
The proposal for taking out an insurance policy must be so specific that the other contractual partner can accept the proposal with a simple “yes”. That is, the exact tariff with the sum insured and the premium must be already known. In the insurance industry the proposal is usually made by the customer. The initiative is taken by an insurance intermediary, however, who advises about the need for and the extent of the insurance cover. In the case of so-called direct marketing, the applicant contacts the insurance company directly due to brochures or newspaper advertisements:: for example, by a hotline or over the internet. advertisements
insurer insurance policy
acceptance In principle insurance insurance contracts do not need a set form and can, therefore, be taken out in the form of a text: for example, by e-mail. In such cases the insurer places a form, in paper or electronically, at the policyholder’s disposal. As well as the actual contractual declaration the insurer will include in this form other important matters that are relevant for its assessment or processing. Information about the risk For its risk assessment the insurer can ask questions that relate to the nature of the risk. Other than than in the Insurance Insurance Contract Law before the reform of 1. 1. 1. 2008, the insurer cannot ask questions across the board about circumstances that could increase the risk, because as a rule the policyholder cannot assess whether something is actually relevant for the insurer. The insurer must, therefore, consider very carefully in advance which facts are important for him (e.g. age, previous medical conditions, previous losses, etc.). The policyholder is obliged to answer these questions completely and truthfully. If he does not do this, the insurer can in accordance with §§19 §§ 19 ff Insurance Contract Act (VVG) modify, modify, cancel or withdraw from the policy. policy. Contractual period of commitment As a rule the future policyholder is bound to his proposal for a defined period. Within this period of time the insurer has to undertake the risk assessment and under certain circumstances accept the proposal. If the insurer accepts the policy belatedly, this amounts legally to a new proposal, which must again be accepted by the policyholder in order that an effective contract is concluded.
Miscellaneous explanations Furthermore, the future policyholder will have to make further declarations, depending on the class of business, such as a declaration of release from professional discretion or a declaration acknowledging awareness of the General Insurance Conditions (AVB) (AVB) and all additional information in accordance accordance with § 7 VVG. Acceptance The acceptance can be effected by means of a specific declaration or be implied. The latter means that from the behaviour of the contractual parties the will to conclude the contract is recognizable. An implied acceptance of the proposal by the insurer can be the dispatch of the insurance policy or a premium note without comment. The implicit acceptance by the policyholder can be the payment of the premium. In contrast, it is definitely not sufficient simply not to respond. Handing over the insurance policy is not necessary to make the insurance contract effective. In line with § 3 VVG it serves only as evidence that the insurance contract contract has been concluded and has purely declaratory effect.
3.5. 3. 5.2 2
Dive Di verg rgen entt insur insuran ance ce poli policy cy
If the insurance policy differs from the proposal, because, for example, the insurer’s risk assessment had shown that there was a higher risk, thus warranting an exclusion or a higher premium, the implicit declaration of acceptance would not correspond to the policyholder’s proposal. In accordance with the regulations of the Code of Civil Law (BGB) this case would constitute a new proposal for a (changed) contract, which further would in turn have to be accepted by the policyholder. In this case, however, the Insurance Contract Law (VVG) has set up a special regulation in § 5. According to this the “divergency is approved” approved” if the policyholder does not dissent to the change within one month after receipt of the insurance policy with the changed contents. In this case a lack of response is recognized as a notional declaration of intent, in contradiction to the usual regulations. A precondition for this is, however, that the insurer should specifically draw the policyholder’s attention to the diverging conditions and the legal consequences of not responding. Variation 1 proposal policyholder
divergent insurance policy + no advice no response
insurance contract comes into force as originally proposed
3.5 3.5.3 .3
Insure Ins urer’ r’s s duty duty to to give give advic advice e prior prior to to contra contract ct
§ 6 of the Insurance Contract Law (VVG) imposes imposes on the insurer the duty (newly introduced into the VVG) to give advice prior to contract. The insurer is obliged to ask the policyholder about his wishes and needs and to advise him accordingly, and to justify the advice finally given. Questioning, advising and justifying must be documented. The content and extent of this counselling counselling duty is governed by the specificati specifications ons of the Directive on Insurance Intermediaries Intermediaries (Directive 2002/92/EG), which imposes the corresponding duties on the insurance intermediary. The German legislator wanted to extend these duties to the insurer as well as the insurance intermediary. However, in practice the insurer will generally have to use the insurance intermediary in order to fulfil these duties, since the insurer itself often does not have any contact with customers. The action of the insurance insurance agent, which according according to § 278 Code of Civil Law (BGB) acts as a vicarious agent of the insurer, is imputed to the insurer, in contrast to the insurance broker’s action.
The advantage of imposing the above mentioned duties on the insurer as well as the insurance agent is that in the event of a violation the policyholder policyholder can assert a claim for damages against both of them. The duties of questioning and advising do not apply if the policyholder is represented by a broker. In this case, based on the broker’s appointment agreement, the duty to make inquiries and advise is already fulfilled by the broker which represents the interests of the policyholder. Furthermore, large risks as defined in Art. 10 of the Introductory Law to the Insurance Contract Act (EGVVG) are exempted from the duty to advise, since such policyholders usually possess sufficient expertise. The most important exception to the duty to advise is distant selling business, since in this case making inquiries and counselling is either impossible or very difficult. (See in this connection Wandt, Handbook of the specialist lawyer – insurance law, Luchterhand, 3rd edition 2008, 1st chapter, marginal 270). The insurer does not have a general duty to question and counsel, but only one that arises from a specific situation. This means that from the particular situation in which the insurer and policyholder find themselves, there must be indications from which the insurer can draw further conclusions. Example: The policyholder tells the sales person of insurance company X that his son has just left home. The policyholder has taken out a household policy with X. In this case the sales person should point out that the household policy does not cover the son’s new flat and that he should ask whether cover is needed for this. As well as the situation which which must offer a reason for counselling, counselling, according to § 6 of the VVG the intensity of the counselling depends depends on the premium payable for the insurance cover. This rule should protect the insurer from making an unreasonably large investment in a counselling session, which is likely to earn him very little premium. For the sake of proof, questioning and counselling must be documented. In accordance with § 6 III VVG the policyholder can forego counselling counselling as well as documentation. In order not to undermine the counselling and documentation obligation, the effectiveness of this waiver is bound to particular preconditions. The waiver declaration must be in writing on a separate document, and the policyholder must be explicitly informed that waiving could be disadvantageous if he wants to sue the insurer later. Similar obligations with regard to questioning, counselling and documentation apply also to the insurance insurance intermediary (§§ 59 ff VVG). The insurer’s insurer’s as well as the insurance broker’s duty to counsel goes even farther, however, insofar as they can be obliged to ask follow-up questions and give advice throughout the duration of the contract, if required.
Legal basis of the insurance contract
3.5 3.5.4 .4
Insure Ins urer’ r’s s duty duty to give give info informa rmation tion pri prior or to cont contrac ractt
The pre-contractual duty to give information is regulated in § 7 Insurance Contract Act (VVG). One of the innovations of the VVG reform is that a distinction is no longer made between consumers and other policyholders: the information is to be given for all insurance policies and all policyholders. Consumer in the meaning of §13 Code of Civil Law (BGB) are all natural persons, who have made a legal transaction for their own private purpose, not for their commercial or freelance activity. An exception to this principle is made only for insurance contracts for large risks, for which under the terms of § 7 VVG there is a restricted duty to give information, insofar as the policyholder is a natural person. This information is to be provided in text form. It is thus also sufficient if it is transmitted by e-mail or fax. The insurer’s duty to give information prior to contract applies only to the insurer itself, but not to the insurance intermediary as well. If the insurer uses an insurance intermediary, it has to make sure that the intermediary contract stipulates that the intermediary has to comply with these duties in its place. If a broker is involved when the contract is concluded, the insurer has to fulfil its duty to provide information to the broker. The insurer must convey the following to the policy holder in good time before he submits his declaration of intent in order to conclude the contract
his policy conditions including the AVB and
the important information in accordance accordance with § 7 VVG in connection with §1 § 1 VVInfoV and
insofar as the policyholder is a consumer (here the VVG-InfoV makes an exception from the newly introduced principle principle described above) a product information sheet as well as
the statement on the right of revocation in accordance accordance with § 8 VVG and
insofar as of it the is alife lifeinsurance insurance policy, a disability income benefit, anparticular accident insurance kind or a health insurance policy, further information in accordance accordance with §§ 2 and 3 VVG-InfoV The background to this instruction is that before concluding the contract the policyholder must be able to inform himself comprehensively comprehensively and in good time about its contents. 126.96.36.199 3.5.4. 1 Contractual Contractual requirem requirements ents including including the the General Insurance Insurance Conditi Conditions ons (AVB) The contractual requirements dealt with in the AVB have already been described in Section 3.3.
3.5.4. 188.8.131.52 2 Important Important informatio information n in compliance compliance with with § 7 VVG in conjunctio conjunction n with §1 Insurance Contract Act (VVG-InfoV)) The VVG-InfoV stipulates in detail the content and extent of the “important information” that has to be provided. This information includes in particular important information about the insurer, its payment commitments (premium and additional costs), duration and termination of the contract. The important information does not, however, include specific details of the insurance cover. 3.5.4. 3.5 .4.3 3 Pro Produc ductt inform informati ation on shee sheett Since the reform of the Insurance Contract Act (VVG), the insurer has to provide the policyholder with a product information sheet, insofar as he is a consumer. The product information sheet is the first information the policyholder has to receive. The legislators’ intention is that the policyholder should receive a file which puts together all the important information for him in a logical order. The product information sheet, that must be named as such, provides an overview of the most important insurance details. In this connection, the insurer must point out that the information is not complete. Assuming the policyholder will often not read the General Insurance Conditions, Conditions, the legislator wants to ensure that that he still receives a good overview of the contents. In addition, the product information sheet must be written in a simple and easily comprehensible way. The product information sheet contains information about the insurance contract, such as the description of the insured risk and the benefit and risk exclusions that are important in practice, as well as the particularly relevant obligations. 3.5.4. 3.5 .4.4 4 Sta Statem tement ent on the the right right of revocat revocation ion Under the new regulation of § 8 Insurance Contract Act (VVG) all insurance contracts contracts can in principle be revoked, irrespective of which distribution channel was used to acquire them. In this way the numerous regulations of the old VVG have been substituted by thebeing right of revocation used only to apply to contracts acquired by distant selling extended to allthat insurance contracts. The revocation period is 14 days, for life insurance policies 30 days, and begins when the policyholder has received all the above mentioned information. information. Only policies acquired by distance distance selling, which in compliance compliance with §§ 8 Para. 4 Insurance Contract Act (VVG) in conjunction with 312e Code of Civil Law (BGB) have another beginning to the revocation period, are regulated differently. In these cases the revocation period only begins if furthermore the special obligations arising from § 31 312 2 e BGB have have been met. In some explicitly defined cases there is no right of revocation. This is the case for insurance contracts
with a duration of less than one month
with provisional cover (Caution: the right of revocation nevertheless exists in this case if the policy was acquired by distance selling)
Legal basis of the insurance contract
for a pension scheme based on a regulation from an employment contract (Caution: the right of cancellation nevertheless exists in this case if the policy was acquired by distance selling)
for large risks.
The insurer is obliged to inform the policyholder of the existence or non existence of its right of revocation, and if it exists, the legal consequences of exercising it. § 9 VVG stipulates the legal consequences consequences of a revocation revocation in accordance accordance with § 8 VVG. The insurer must return that part of the premium which had been paid for the period after the declaration of revocation reached it. Furthermore, a precondition is that the insurer had informed the policyhold policyholder er in due form of the revocation and its legal consequences and that the policyholder had given his consent that the insurance cover should already commence before the expiry of the revocation period. For life insurance the special regulation of §152 § 152 VVG applies. applies. 184.108.40.206 3.5.4. 5 Inform Information ation in in accordanc accordance e with §§ 2 and 3 VVG-InfoV VVG-InfoV For life insurance, disability income benefit, accident insurance with return of premium and health insurance the insurer has to give additional information, such as the distribution of expenses and the paid up values. The background to this is that the above types of insurance are particularly difficult for the policyholder to understand and that they are long-term contracts. 3.5.4. 3.5 .4.6 6 Time imely ly supply supply of infor informat mation ion The information indicated above must be made available to the policyholder in good time before he concludes his policy declaration. This formulation is derived from the condition for distant selling contracts contracts in accordance with § 31 312 2 c Code of Civil Law (BGB), since the legislator wants to make sure, regardless of the sales channel (distant or personal), that the policyholder already has the information when he makes his policy declaration. It is unclear what “timely” before the submission of the policy declaration means. The term is not defined in the law and a minimum period of time is not given. The choice of words makes it clear, however, that it is certainly not sufficient to give the policyholder the information practically at the same time as he submits his policy declaration. He must have the chance to take note of this. This has implications for the various ways in which an insurance contract can be concluded. Policy model Consequently, the so-called policy model has been dropped, according to which until the VVG reform the insurer could send the information after the contract had been concluded with the dispatch of the insurance policy. Proposal model In future the insurer will be restricted to the so-called proposal model, according to which the policyholder, as described above, must have received the complete information before the submission of the proposal declaration. declaration.
Invitation model Furthermore, the invitation model is in discussion. It is assumed that the policyholder’s “proposal” is not yet a binding declaration of intent pursuant to §145 BGB, but only a request to the insurer to make an offer. He does that by sending the policy documentation the explicitly policyholder. The policyholder’s acceptance of the contractual offer is made to either or implicitly by the payment of the premium. Whether and to what extent the policyholder’s policy declaration can be understood as a simple request to submit an offer depends on each individual case. Concluding the contract by telephone If the insurance contract is concluded by telephone at the request of the policyholder or by the use of another means of communication which does not permit the transfer of information in text form, the transfer of the information can exceptionally exceptionally be made immediately after the conclus conclusion ion of the contract. Waiver of duty to provide information In accordance accordance with § 7 Para. 1 S. 3 VVG the policyholder policyholder can forego the right to receive information. Since this possibility would practically undermine the new consumer protection as a basic principle of the VVG, exactly how such a waiver declaration could be made is very controversial. It is clear, however, that an insurer may not systematically persuade all its customers to this renouncement in order to avoid the duty to provide information. In such a case the Federal Financial Supervisory Authority (BaFin) could intervene. Breach of the duty to provide information The duty to provide information is breached if the information, contents and phrasing clearly required in law are not complied with or used. This does not apply if the information is provided inaccurately. Breach of the obligation to supply information can have various consequences: consequences:
The revocation period pursuant pursuant to § 8 VVG does not commence, the policyholder policyholder can thus revoke the insurance contract for an indefinite period of time and demand a return of premium. For the insurance company this is a matter of great economic uncertainty.
If the insurer does not fulfil its obligations to supply information systematically, the Federal Financial Supervisory Supervisory Authority (BaFin) can in accordance with § 81 Para. 2 Insurance Supervisory Act (VAG) insist on the fulfilment of the duties.
Competitors or consumer associations can take action against the company in accordance accordanc e with the regulations of the Unfair Competition Act (UWG).
Legal basis of the insurance contract
Example Exampl e 1: Insurer X on principle does not hand out product information sheets to its customers. In this way it is in breach of duty to provide information and is exposed to the aforesaid consequences. Example 2: Insurer X does hand out a product information information sheet to its customers, but it does not mention the most important exclusion. There is no breach of duty to provide information that could lead to the legal consequences intended in the case of failure to provide information. This dispute can only lead to liability to pay damages for a failure to comply with pre-contractual obligations.
3.6 3. 6
Commen Comm ence ceme ment nt,, dur durat atio ion n and and te term rmin inat atio ion n of the insurance contract
3.6. 3. 6.1 1
Comm Co mmen ence ceme ment nt of the the insura insuranc nce e contr contrac actt
There are three types of insurance commencement: commencement: the formal, the material and the technical insurance commencement.
3.6.2 3.6 .2
Formal For mal insura insurance nce comme commence ncemen mentt (Conclu (Conclusio sion n of the contr contract act))
The formal insurance commencement is the time at which the contract is concluded: that is, the signing of the agreement in the legal sense. 220.127.116.11 3.6.2. 1 Materi Material al insurance insurance commencem commencement ent (Beginning (Beginning of of the insurance insurance cover) cover) The material insurance commencement is the contractually agreed time from which the insurance cover is in force: that is, when the insurer’s liability (assumption of risk) begins. This point of time does not necessarily need to coincide with the formal commencementt of the insurance. commencemen The material insurance commencement is regulated in §10 Insurance Contract Act (VVG), which states that an insurance contract whose duration is determined in days, weeks or months begins at the beginning of the day on which the contract was concluded. Example: Mr Müller takes out a household household insurance policy policy with X-Insurance X-Insurance on 10. 3. 2009 at 11:00 a.m. There is no special agreement as to the commencement of the insurance. The contract is signed with the above date. The material insurance cover begins according to §10 § 10 VVG VVG already on 10. 10. 3. 2009 at 0:00 a.m. a.m.
Because of §10 VVG the so-called “midday rule” was abandoned, according to which the insurance commencement was in principle fixed at 12 noon. Since even during the period when the midday rule was in force many classes of insurance chose to make the cover begin at 0 hours in order that there was no time gap in the cover, the new general stipulation was made to fit in with these special regulations. It is possible to diverge from § 10 VVG, since since it is only a rule of interpretation: indiviindividual agreements regarding the start of the insurance cover are possible. Payment clause In addition, until the VVG reform the so-called payment clause applied. A precondition for the commencement of the insurance cover was as a matter of principle the payment of the first premium by the policyholder. After the VVG reform the payment clause in this form is no longer permitted, because because since 1.1. 2008 already with the late payment of the first premium fault has to be considered. A payment clause that complies with the new law should thus include the default element, and could read as follows: “The insurance cover begins at the earliest with the payment of the first premium, unless the policyholder is not responsible for its not being paid.” If the policyholder is responsible for the non-payment of the first premium, the insurer is by law already free from its duty to pay insofar as it has drawn the policyholder’s attention to this effect in a specific message in text form or by means of a noticeable warning in the policy document. The policyholder is often granted insurance cover before the payment of the first premium and thus has immediate cover. In this case the (legally standard) payment clause is contractually waived. It is then substituted by the so-called “extended payment clause”, according to which the policyholder has insurance protection if the premium is paid within an agreed period of time or immediately on receipt of the invoice. Waiting period Furthermore, particularly particularly in private health insurance waiting periods can be agreed. In this case the insurance cover begins after they have finished. There is a difference between a general waiting period and special waiting periods for certain illnesses and benefits. The extent to which such waiting periods can be agreed is regulated in § 197 VVG. According According to this the general waiting period must last for a maximum of 3 months, special waiting periods especially for giving birth, psychotherapy, dental treatment, dental prostheses and orthodontics maximally 8 months. 18.104.22.168 3.6.2. 2 Techni echnical cal Insura Insurance nce comme commencemen ncementt The technical commencement of the insurance cover is the beginning of the period for which a premium is required: that is, the period of time for which a premium is calculated. The technical commencement of the insurance cover coincides regularly with the material insurance commencement. commencement.
Legal basis of the insurance contract
The period for which a premium is required is broken down into insurance periods. Each insurance period lasts one year insofar as the premium is not based on shorter periods of time (§ 12 Insurance Insurance Contract Act (VVG)). Backdating There is backdating if the technical but not also the material insurance commencement is set before the start of the formal insurance commencement. The period for which a premium is due begins before the legal contractual conclusion, but the insurance cover only begins with the start of the material insurance. Backdating plays a role in life insurance if the proposer chooses a younger age of entry in order get a lower premium rate or enjoy tax advantages for a previous period of time, or in motor liability insurance in order to achieve a better grading in the claims-free classes in the future. Example:
technical insurance commencement
conclusion of the insurance and material insurance commencement
Forward insurance and retroactive insurance “Forward insurance” is the norm and means that the material insurance commencement coincides with the formal insurance commencement or occurs later: that is, in the future. Example Exampl e 1: Ms Meier leaves her parents’ parents’ home on 1. 1. 2. 2009 for her own flat. She wants wants to take out a household policy and have insurance cover as soon as possible. She meets her insurance intermediary on the same day, therefore, and takes out the appropriate policy in in which the insurance insurance commencement commencement is also dated 1. 2. 2009. Example 2: Family Gruber books a holiday trip to Mallorca which will take place in October. The family takes out baggage insurance for the journey. The material insurance commencement is at the same time as the start of the journey. There is “retroactive insurance” when the technical as well as the material commencement of the insurance is set before the formal insurance commencement. The insurance cover should thus already begin before the conclusion of the contract. According to § 2 II VVG the insurer only has a right right to the premium payment if it did not know that the occurrence of the insured loss was excluded before it made the contractual declaration. Vice versa, the insurer is released from its liability to make
payment if the policyholder already knows that a claim had occurred when he submits the contractual declaration. If one of the two eventualities is the case, retroactive insurance is excluded.
technical and material insurance co commencement
conclusion of the insurance policy
3.6. 3. 6.2. 2.3 3 Pr Prov ovis isio iona nall co cover ver A contract for provisional cover is concluded if the policyholder needs insurance cover immediately, but the insurer would actually still need time to assess the policyholder’s risk thoroughly and determine the exact policy conditions.
Example: Ms Schmidt buys a secondhand car and in order to obtain registration she needs proof of compulsory liability insurance. Because she wants to obtain the licence on the very day of the purchase she applies for provisional cover at Insurer X, since the latter cannot make a final offer at such short notice. The contract of provisional cover is an independent insurance policy for which the regulations of the Insurance Contract Act (VVG) apply. Since this contract is usually made under great time pressure, §§ 49 to 52 VVG stipulate some exceptions which which facilitate its conclusion. Consequently, in accordance Consequently, accordance with § 49 I VVG it can be specially agreed that the information from the insurer stipulated stipulated in § 7 VVG need only be given if the policyholder requires it, at the latest with handover of the policy document. Because of the strict requirements of the distance selling directive, this concession does not apply to distance selling policies. Furthermore, the policyholder does not have a right of revocation as defined defined in § 8 VVG (which he has in the case of a distance distance selling policy). As a matter of principle, the material insurance cover of contracts with provisional cover begins with the formal conclusion of the contract or the stipulated commencement. In contrast to the main policy, the payment clause must be explicitly agreed in accordance accordance with § 51 VVG. VVG. Depending on the wishes of the parties provisional cover should apply only to the point of time at which the insurer has finished its risk assessment. There is no duty to take out the main contract, compare compare § 50 VVG. Thus in this case case it is not a so-called preliminary agreement. The contract for provisional coverage thus terminates at the latest when the main contract or a further contract for provisional cover was concluded: conclude d: namely, namely, irrespective of which insurer (§ 52 VVG).
Legal basis of the insurance contract
Example: On 1. 2. 2009 Ms Schulz takes takes out a policy for provisional provisional compulsory compulsory liability liability cover with X-Insurance X-Insurance for her car. car. On 1. 3. 2009 she takes out the main compulsory compulsory liabiliability policy with Y-Insurance. The policy for provisional cover with X-Insurance ends automatically on 28. 2. 2009 at 24:00 hours. hours. Furthermore, the provisional cover ends – provided there are instructions to this effect – if the policyholder fails to pay the initial premium.
3.6. 3. 6.3 3
Dura Du ratio tion n of of the the ins insur uran ance ce po polic licy y
The duration of the insurance contract depends in the first instance on the agreement of the contractual partners. The insurance contract can be concluded for a defined period or it can end automatically upon occurrence of a particular event. Example 1: Example A motor insurance policy is taken out for a year. Commencement of the insurance: 1. 1. 2009, 0:00 hours, Termination of the the insurance: 31 31.. 12. 2009, 24:00 hours. hours. In this case the policyholder must take action in order to take out a new insurance policy policy or in order to renew the existing policy. Example 2: Mr Kunze has bought a piece of land and while his house is being built he needs a principal’s liability insurance. This ends automatically on completion of the building. An insurance policy can, furthermore, be taken out for an indefinite period. There are two ways of doing this in practice: either the termination of the insurance policy is deliberately not stated and defined as open, or the agreement states that the insurance duration is one year and is renewed automatically unless one of the parties to the policy has cancelled it. In both cases one of the parties to the contract must take action in order to terminate the policy. In accordance with §11 I VVG each renewal of the policy must be for maximally one year.
3.6.4 3.6 .4
Term ermina inatio tion n of the ins insura urance nce con contra tract ct
Insurance policies can be terminated in different ways or they can end automatically. The most important are duration, occurrence of a particular event, mutually agreed nullification, withdrawal or cancellati cancellation. on. 3.6. 3. 6.4. 4.1 1 Exp xpir iry y An insurance contract can be taken out for a certain period and end automatically at the date stipulated. To avoid undermining the policyholder’s right of revocation, which could be the case if contracts with extremely long durations were taken out, the legislator in §11 Para. 4 Insurance Contract Law (VVG) has laid down that for contracts that last for longer than 3 years the policyholder should have a right of revocation from the end of the third year. It should be noted that only the policyholder has this right of revocation, not the insurer.
Example: Mr Huber takes out a personal liability policy. In order to get particularly good conditions, he takes out the contract for five years. Version a: The contract ends automatically without without the parties needing to take action after the agreed 5 years. Version b: Mr Huber wants to change the insurer after 4 years and gives notice of cancellation as of the end of the 4th insurance year, because he has a special cancellation privilege in accordance with §1 § 11 Para. 4 VVG. Also in the case of a temporary contract there can be ways of cancelling it during the agreed duration. But a precondition in this case are special events that would justify an extraordinary cancellation. Cancellation Cancellation by agreement with the contractual partner is also always possible. 3.6.4. 3.6 .4.2 2 Occ Occurr urrenc ence e of particul particular ar events events If it is agreed that the contract should be terminated on the occurrence of a particular event, the insurance contract ends when this event occurs without the parties to the contract needing to take further action. This is always appropriate if the occurrence of the event cannot (yet) be fixed for a particular date. Examples of such events are transports or exhibitions. As with an insurance contract for a limited period of time, the contract can only be cancelled during its defined duration for special reasons or by mutual consent. 3.6.4. 3.6 .4.3 3 Wit Withdr hdrawa awall of the the cont contrac ractt The cases in which one of the contractual partners can give notice of withdrawal are regulated in the Insurance Contract Act (VVG). Notice of withdrawal is a unilateral declaration of intent which requires acknowledgement of receipt in the sense sense of §§ 116 ff Code of Civil Law (BGB). In contrast contrast to the general law of obligations, withdrawal from an insurance contract does not lead to the contract being rescinded, because as a continuing obligation it was already partly fulfilled (usually by the insurer carrying the risk for a particular period of time). Thus the consequences of the withdrawal are regulated in the VVG in each case, where the basic principle for the right of withdrawal is also found. Withdrawal because of breach of the duty of disclosure prior to contract, §§19 ff VVG VVG In accordance with §19 § 19 VVG the insurer can question the policyholder policyholder about the present risk features before the contract is concluded. This serves the purpose of giving the insurer the chance to make a proper calculation and to consider whether or not it wants to insure a particular risk.
Legal basis of the insurance contract
Other than before the reform of the VVG the policyholder needs only disclose significant risk elements
which the insurer has inquired about in written form and
which exist before he submits his contractual declaration
The insurer must consider carefully which circumstances are important for him and which questions he would like to ask. Furthermore, he can only ask questions which are of significance for his risk assessment and not further questions which would enable him to offer other insurance policies, for example. Example Exampl e 1: Mr Müller wants to take out private health insurance and submits a proposal to X-Insurance. Following this he receives a questionnaire in which he is asked specifically about previous diseases, operations and dental treatment. The insurer needs this information in order to calculate a premium. Example 2: Ms Meier wants to take out household insurance. The insurer asks Ms Meier about her income, because at the same time he sees a chance of offering her an annuity. This new regulation has the advantage for the policyholder that as long as he answers all the insurer’s questions truthfully he no longer bears the risk of jeopardizing the insurance cover. If the insurer does not ask a question whose answer is relevant for the risk assessment, this is to the disadvantage of the insurer. In contrast before the VVG reform, the policyhold policyholder er had to decide which facts were relevant for the risk assessment. Furthermore, the policyholder need only point out circumstan circumstances ces which he is aware of until he submits his policy declaration. As a rule this is the proposal for taking out the policy. If the insurer now needs more time for its risk assessment, and should additional dangerous circumstances be known to the policyholder between his policy declaration and the acceptance of the insurer, he is only obliged to report these if the insurer explicitly asks him after his policy declaration. Before the VVG reform the policyholder was obliged to report any circumstances that could negatively influence the risk that occurred after the contract declaration, without the insurer needing to inquire specifically. If the policyholder breaches his duty duty of disclosure, §19 § 19 ll VVG gives the insurer the right to withdraw from the insurance contract, unless the breach was due to simple negligence. In this case case the insurer only has the right of cancellation, cancellation, compare §19 § 19 lll VVG. Insofar as the right to withdraw exists because of a grossly negligent or intentional violation of the duty to disclose, it is nevertheless excluded if the insurer would have concluded the contract to other conditions.
Example: Ms Gruber wants to take out private health insurance, but forgets to declare a chronically asthmatic condition, although the insurer had asked about such conditions. Although Ms Gruber has not complied with her duty to disclose, the insurer is not permitted to withdraw from the contract, because it usually insures asthma sufferers – with an extra premium of 5 %, however. however. Ms Gruber thus has insurance cover, cover, but she must pay the higher premium (with retrospective effect). If Ms Gruber had not declared the disease deliberately, the insurer would not be obliged to make the contractual adjustment, 19 IV VVG. If because of this the premium is raised by more than 10 percent or if the insurer excludes the risk that was not reported, the policyholder can withdraw from the insurance contract by cancelling it, compare compare § 19 Para. VI VVG. Furthermore, the insurer can only exercise its right to withdrawal if it has informed the policyholder accordingly by means of a separate note in written form and if it had no knowledge that the information was incorrect. The insurer should, therefore, enclose a further sheet with the proposal form, in which the consequences of supplying false information are spelt out. If the insurer announces announces the withdrawal, withdrawal, in accordance accordance with § 39 Para. 1 Sentence 2 VVG it can demand the pro rata premium which it is entitled to until the withdrawal announcement announceme nt is effective. Until the reform of the VVG the principle of the indivisibility of the premium prevailed. The insurer was entitled to the entire premium due until the expiry of the insurance period. This principle of the indivisibility of the premium was suspended, however, in the new VVG, so that pro rata premium payments are possible. This is nevertheless fair, because the insurer is liable to pay for a claim before the submission of the withdrawal announcement if neither the occurrence nor the extent of the insurance claim is due to the breach of the duty of disclosure. Withdrawal due to non payment of the first or single premium In the event of late or non payment of the first or single premium, the law also gives the insurer the right to withdraw from the contract. The preconditions preconditions for this will be dealt with in the next chapter, “Premium payment duty”. The consequence consequence of a withdrawal in accordance with § 37 VVG is that benefits already received (e.g. premium or an insurance benefit because of a claim) must be returned. This is a result of the general withdrawal regulations of the Code of Civil Law (BGB). However, However, in § 39 Para.1 Para. 1 Sentence 3 VVG there is a special regulation that the insurer can demand a reasonable expense charge. 22.214.171.124 3.6.4. 4 Cance Cancellatio llation n of of the the insuran insurance ce contrac contractt The cancellation – as also the notice of cancellation – is a unilateral declaration of intent which requires acknowledgement of receipt. Other than the withdrawal, which is aimed at ending a contract retroactively, the purpose of cancellation is to end the insurance contract for the future.
Legal basis of the insurance contract
Whether the cancellation needs a particular form can either be established in law or in the insurer’s General Insurance Conditions (AVB). It is important to distinguish between contractual notice of termination and extraordinary notice of cancellatio cancellation. n. Contractual notice of termination Contractual notice of termination can be given with effect from a specific time of cancellation, but in doing so the period of notice must be observed. It is not necessary to state the reason for cancellatio cancellation. n. The contractual notice of termination is mainly regulated in § 11 Insurance Contract Law (VVG). As already described above, the following can be given contractual notice of cancellatio cancellation: n:
Insurance contracts with a renewal clause
Insurance contracts contracts with a duration of more than three years, at the earliest to the end of the third year
Open-ended insurance contracts
In the case of the last named, the right of cancellation can be waived for a maximum of two years. The period of notice must be from one to three months and be the same for both parties to the contract. In this respect §1 § 11 may not be varied to the disadvantage of the policyholder. The legislator has standardized exceptions to these regulations for different types of insurance, insofar as particular interests require this. The insurer cannot give contractual notice of cancellation cancellation,, for example, for sickness benefit, daily benefit or long-term care insurance that replace the statutory benefits. The background to this ruling is the need to protect the policyholder, who because of medical underwriting is put into a certain tariff and after falling sick would only obtain insurance cover again to considerably worse conditions. The intention of substitutional health insurance is, namely, to provide lifelong insurance cover that is able to replace statutory schemes. The policyholder, on the other hand, is granted the right to give contractual notice of cancellation. There are further exceptions in life and disability income benefit insurance. In motor third party liability contractual notice of cancellation is also stipulated explicitly. Extraordinary notice of cancellation Extraordinary notice of cancellation is possible for temporary as well as for openended insurance contracts and can be effected during the year. There must always be a reason for this (cause of notice of cancellation). The principles on which an extraordinary notice of cancellation may be issued in favour of the policyholder and / or the insurers can be found in various places of the VVG.
Important examples of this are:
The insurer’s right of cancellation because of a simple negligent breach of the precontractual duty of disclosure
The insurer’s right of cancellation because of an increase in the risk while the
policy is in force The insurer’s right of cancellation because of a breach of obligation before a loss occurs
The insurer’s right of cancellation because of persistent failure of the policyholder to pay the renewal premium
The policyholder’s right of cancellation because of an increase in the premium
The right of cancellation of both parties because of a claim in non-life insurance
Extraordinary notice of cancellation does not necessarily mean cancellation with immediate effect. Rather, the law often fixes periods within which and at which point of time extraordinary notice of cancellation may be given. This serves to protect the policyholder, who should have time to look for new insurance cover. The law provides forbreach cancellation immediate effect only in a very few cases, if a particularly particularl y serious by onewith party justifies this. As well as the usual reasons for an extraordinary notice of cancellati cancellation on as regulated in the VVG, there are two other justifications for an extraordinary notice of cancellation. This is, on the one hand, possible with a contractual agreement, especially in the General Insurance Conditions (AVB). However, the AVB often simply repeat the rights which are already available by law. If an insurer tries to justify extraordinary notice of cancellation cancella tion in its AVB on grounds that the law is not familiar with, wit h, it will be necessary to check very carefully whether this is consistent with the relevant basic principles of the VVG. A further right to extraordinary notice of cancellation can result from § 31 314 4 Code of Civil Law (BGB) continuing obligation for anbe important if one party “after (cancellation considerationofofathe mutual interests cannot expectedreason) to continue the contractual relationship.” relationship.” This very broadly expressed right of cancellation can naturally only apply if there was not already an ultimate rule for each violation in the VVG. Excursus: Death of the policyholder The death of the policyholder does not in principle end the insurance relationship, but this is transferred to his heirs, since the insured risk basically remains (Example: motor liability insurance). Extraordinary notice of cancellation is thus not justified. If the risk depends only on the person, however (for example, health or accident insurance) there is no longer insurable interest, so that the insurance contract can be terminated in accordance accordance with § 80 VVG. For life and accident insurance insurance the death does not only mean the cessation of the risk but also the claim event, which triggers the claim to the insurance benefit.
Legal basis of the insurance contract
Duty to pay the premium
With the insurance contract the policyholder undertakes to pay the premium that has been agreed. The premium is the policyholder’s payment for the risk that the insurance carries. It is, therefore, the price for the insurance cover. The premium is called “contribution” by mutual insurance companies companies (compare § 24 Insurance Contract Law (VVG)). Nevertheless, the legal regulations, which only refer to the premium, apply also to the contributio contributions. ns. The contractual partners are free in principle to agree the premium level. Where the insurer has mass business, however, there will naturally be no individual negotiations about the premium. Rather, the insurer refers instead to its precalculated tariff tables, which reflect different risk groups. Although price control by the supervisory authority was stopped in 1994, for the classes of insurance of sociopolitical relevance – life insurance, accident insurance with return of premium and the form of health insurance that replaces statutory cover – there are still standard rules from in the Insurance Supervisory Act (VAG) about the principles of calculation and later premium adjustment.
3.7. 3. 7.1 1
Typ ype es of of pr prem emiu ium m
There are different types of premium
A single premium is one which the policyholder has to pay on conclusion of the insurance contract and then no further premiums are due. Single premiums pay a role especially for policies of shorter duration (e.g. travel cancellatio cancellation n insurance). For all policies with regular premiums the premium is generally paid per year, unless shorter periods of time were fixed by the insurer (compare §12 Insurance Contract Law (VVG)). For policies with regular premiums a distinction is made between the first premium that has to be paid (first premium) and the other premiums (renewal premiums). This distinction reflects the fact that a policyholder who has not paid the first premium (promptly) must reckon with more serious consequences consequences than a policyhold policyholder er who does this in the course of a long contractual relationship.
On the other hand, in law the single premium and the first premium are treated equally. It is necessary to distinguish between a shortened insurance duration for which a particular premium is payable and a longer insurance period with agreed instalments. The latter case constitutes only ahowever, contractual agreement payments. The reduction of the insurance duration, would affect theabout right of contractual notice of cancellation Example Examp le 1: Insurer X writes in its policy conditions: The insurance policy is taken out for 6 months and is automaticall automatically y renewable by 6 months if one of the contractual partners does not submit notice of cancellation at least one month before expiration. In this case a duration of only 6 months has been agreed and for this period a premium has to be paid. If the policy is renewed, the premium for the next 6 months becomes due. Contractual notice of cancellatio cancellation n can always be given to the end of the insurance periods. periods. Example 2: Insurer Z writes in its policy conditions: The duration of the contract is one year. The premium is always due quarterly, always at the beginning of the new quarter. In this case the insurance duration is one year. The premium is payable in instalments. Contractual notice of cancellation can only be submitted to the end of the insurance year.
3.7 .7.2 .2
Prem Pr emiu ium m due da date tes s
The due date is the point of time when the creditor can request the benefit and when the debtor must deliver. First premiums, single premiums and renewal premiums have different due dates. First and single premium In accordance accordance with § 33 Para. 1 Insurance Contract Contract Law (VVG) the first and single premium are “payable immediately after the expiry of two weeks after receipt of the insurance policy”. In the old version of the VVG there was not yet this two week shift of the payment date. With this change the legislator expresses its clear intention that payment should only be made when the revocation period has run out and the insurance policy is in force. It is, therefore, questionable questionable whether § 33 Para. 1 VVG from which deviations are also possible to the detriment of the policyholder, can be changed by means of the General Insurance Conditions to such effect that the premium is immediately payable on receipt of the insurance policy. Such a clause could be invalid according to § 307 Code of Civil Law (control of content), because because it is not consistent with imporimportant basic principles of the legal regulation, which is being deviated from. This would be the case if the two week payment period fitted in with the general principles of the new VVG and its basic concepts.
Legal basis of the insurance contract
For those insurance contracts for which there is no right of revocation (e.g. policies with a duration of less than a month), the agreement of the immediate due date of the first and single premium is certainly possible, because the principles outlined above are not relevant in this case and the policyholder does not have justifiable interest in making a later payment. For all other insurance policies both opinions could be pleaded for. Many factors indicate that the legislator did not want to link the duty to pay the premium to the duration of the right of revocation because because otherwise the premium period would be further extended if the right of revocation began to run belatedly, for example, because of inadequate information. Renewal premium The due date of the renewal premium depends on the period insured, since the premium is calculated according to the duration of the insurance period. With the beginning of the new insurance periods the renewal premium is due. Special payment modalities can naturally be agreed with the policyholder (e.g. payment within 4 weeks of the commencement of the new insurance period or only after the receipt of an invoice, etc.).
3.7. 3. 7.3 3
Debt De btor or of th the e ins insura uranc nce e pre premi mium um
The only main duty of the policyholder is to pay the premium. Also for a contract for the account of a third party or if another person pays the premium, the policyholder alone remains the one who owes the premium.
3.7. 3. 7.4 4
Late La te pr prem emiu ium m pa paym ymen entt
As already mentioned, the first premium and renewal premium are due at different times. The legal implications implications if the duty to pay the premium is not met are also different. 3.7.4. 3.7 .4.1 1 Non paym payment ent / Late Late premiu premium m payment payment § 37 Insurance Contract Contract Act (VVG) regulates the consequen consequences ces of a late payment of the first or single premium. Right of withdrawal If the policyholder does not pay the first or the single premium although it is due, the insurer is justified in withdrawing from the contract as long as the payment has not been made. In other words an existing right of withdrawal expires at the latest with the payment of the first premium. The fiction of the law before the VVG reform of 1.1. 2008, according to which which it counted as withdrawal if the premium could not be legally ascertained within 3 months, no longer applies. Today the insurer must take action in order to withdraw from a contract in force.
A precondition for the right to withdraw continues to be that the policyhol policyholder der has to take responsibility responsibility for the non payment, that is, he is culpable for not paying the premium. Example: Ms Müller has taken out an insurance insurance policy and the premium premium is due on 1. 6. 2008. In the week before Ms Müller has appendicitis and must go immediately to hospital from which which she she is only releas released ed on 3. 6. 2009. On 4. 4. 6. 2009 Ms Müller Müller transf transfers ers the money. In this case there would be no fault, and the insurer would not be justified in withdrawing withdrawin g from the contract. If the insurer declares withdrawal justifiably, the parties must return their benefits insofar as they have received any. A claim for premium payment – also pro rata – no longer exists. The insurer can only demand a reasonable administration administration fee, since it had administration costs due to the issue of the policy and the policyholder did not behave fairly. The insurer naturally has the right to hold on to the policy in force and sue for the payment of the premium. Release from obligation to perform If the policyholder does not pay the first or single premium because of his own fault, the insurer is released from its obligation to pay quite apart from a declaration of withdrawal if a claim occurs before the premium has been paid. Beside the precondition of fault, to invoke release of liability the insurer is obliged to make the policyholder aware of the legal consequences by means of a specific message in text form or a noticeable indication in the policy document. Example: On 1. 1. 4. 2009 Mr Huber takes out a baggage insurance insurance policy. policy. Failing an agreement agreement to the contrary he must pay the single premium only two weeks after receipt of the insurance policy. It is agreed, however, that the insurance should be immediately in force if he pays the premium punctually punctually at the end of these two weeks. There is no further information about this matter. On 2. 4. 2009 Mr Huber has a baggage loss and reports this this to his insurance insurance company,, which on 6. 4. 2009 already deals with the claim amounting pany amounting to € 500,–. Mr Huber forgets to pay the premium. The insurer cannot claim release from the obligation to perform, because it did not issue the noticeable information that was needed. 126.96.36.199 3.7.4. 2 Non payment payment / Paymen Paymentt default default with with the renewal renewal premi premium um § 38 Insurance Contract Contract Act (VVG) regulates the results results of a payment default of the renewal premium. In the case of non payment of the renewal premium the policyholder had already paid the first premium and so obtained insurance cover. He obviously owes the
Legal basis of the insurance contract
insurer the renewal premium, but he should not easily lose the insurance protection. For this reason the insurer must request the policyholder to pay the premium (qualified reminder reminder in accordance accordance with § 38 Para. 1 VVG) with two two weeks’ notice notice before there can be legal consequences. consequences. In this payment demand the insurer has to state the consequences of non payment. Only if the policyholder is still in default with the renewal premium after this period of notice is over,
is the insurer released from the duty to pay if the insured loss event occurs after expiry of the notice period but before the premium has been paid.
can the insurer cancel the policy without observing a period of notice. The cancellation becomes ineffective, however, if the renewal premium is nevertheless paid within a month of the receipt of notice of cancellation. According to the new VVG it does not matter in this connection as to whether an insured loss has occurred in the meanwhile. For the insured loss that occurred between the end of the notice and the payment there is in any case no insurance cover.
Example: Ms Huber has comprehensive insurance for her car. She does not pay the renewal premium, which which is due on 1.1. 1. 1. 2009. Thereupon her insurer insurer Z sends her a reminder on 5. 2. 2009, in which which it states that she must pay the premium premium by 24. 2. 2009. The rereminder states that after the expiry of the term the contract is deemed to be cancelled with immediate effect. Z points out to Ms Huber in due form what the legal consequences will will be. On 28. 2. 2009 Ms Huber makes makes a claim and pays pays the premium on 3. 3. 20 2009 09.. The notice of cancellation was effective in law and can, as in the example, be connected with the qualified reminder. Although with the payment of the premium within the month the effects of the cancellation cease to apply, there is no insurance cover for the insured loss between the end of the period of notice and the payment of the premium. Since Ms Huber is still in default with the renewal premium after the period of notice has run out, Z is released from its liability to pay.
As well as the payment of the premium the insurer is naturally interested in ways in which the policyholder behaves, in order in the first place to be able to assess its risk and during the policy that the risk does not become greater and in the event of a loss so that the claim is as small as possible. To this end the insurer has the instrument of warranties at hand. An obligation is not a statutory duty, however, because the insurer cannot bring an action for it or claim damages (compare Wandt, Wandt, l.c., marginal 522, 532). Complianc Compliance e with the rules of behaviour is only in the interests of the policyholder in order to maintain his right to cover.
3.8. 8.1 1 3.
Lega Le gall and and cont contra ract ctua uall obli obliga gati tion ons s
The legislator distinguishes between legal obligations, which are already compulsory in law for the policyholder, and contractual obligations, which the insurer generally makes an element of the insurance policy by means of the General Insurance Conditions (AVB). The legal obligations are found in the Insurance Contract Act (VVG) irrespective of when they should be observed or whether they apply to the insurance of indemnity or the insurance for a specified amount. There are legal obligations before the contract is concluded (duty of disclosure in accordance accordanc e with §§ 19 ff VVG), during the term of the contract (avoidance (avoidance and disclosure of an increase increase in risk, risk, §§ 23 ff VVG) and after the occurrence occurrence of a loss (duty to notify and give information, §§ 30, 31 VVG). In indemnity indemnity insurance the obligation obligation to reduce the claim in accordance accordance with § 82 VVG is certainly one of the most importimportant legal duties. Legal obligations often have additional regulations which describe the legal consequences of breaching them. If an insurer incorporates a legal obligation unchanged into its AVB, the obligation remains, nevertheless, a legal one. If the insurer, however, modifies the facts of the case or the legal consequence, the legal obligation becomes a contractual one. The same applies for legal obligations for which the legislator has not stipulated any legal consequences if they are breached. If the insurer incorporates such an obligation into its AVB, and couples its breach with legal consequences, the obligation becomes a contractual one. Since there are special requirements for contractual obligations, it is important that obligations should be recognizable as such. It may be problematical to distinguish them from exclusions. Since whereas compliance with an obligation can be influenced by the policyholder so that it is the insurer’s concern to encourage the policyholder to behave in a desired way, in the case of a risk exclusion the insurer wants to remove part of the cover irrespective of whether or not the policyholder can influence it. In this respect according to the consistent judgments of the Federal Court of Justice (BGH) it does not depend on the phrasing of the clause or its status in the AVB, but only on the material content (compare Wandt, l.c., l.c., marginal number 539). Example: Ms Müller has insured her expensive mountain bike. In the Exclusions/Limitations there are the following clauses: 1. There is insurance insurance cover only between 6:00 and 22:00 hours. Between 22:00 and 6:00 hours there is insurance cover if the bicycle is secured with a lock. 2. There is no insurance cover as long as the bicycle is being used for the purpose for which it was intended. The first clause is a so-called implicit obligation, because the insurer wants to encourage the policyholder to secure it with a lock. The second is a real exclusion, because the insurer definitely does not want to assume risks when the bicycle is being used, although Ms Müller could naturally also not use the bicycle.
Legal basis of the insurance contract
As the example has already shown, the distinction can be very difficult in the particular case. In laws which apply to compulsory forms of insurance, there are often further requirements for obligations in order to maintain a minimal standard of insurance cover for the protected third party.
3.8. 3. 8.2 2
Brea Br each ch of ob obli liga gati tion ons s
The legal consequences of breaching a legal obligation are regulated (variably) by the particular stipulation in the law. The legal consequences of breaching a contractual obligation are, on the contrary, fixed in § 28 Insurance Contract Act (VVG). A distinction distinction is made between contractual obligations after taking out the insurance policy but before the occurrence of a loss and obligations after the loss occurrence. The regulation is half mandatory, so that it may not be modified to the detriment of the policyholder. obligations
before the occurrence of the insured loss
after the occurrenc occurrence e of the insured loss
Legal consequences for breach of obligation before the occurrence of the insured loss If the policyholder breaches an obligation before the occurrence of an insured loss, the insurer can cancel the insurance contract without observing a period of notice. This severe legal consequence shall only apply, however, if the breach is intentional or at least grossly negligent. There is no right of withdrawal, however, and it also cannot be contractually agreed. Note: the insurer only has the right to cancel if the policyholder has breached an obligation before the loss occurrence. If the breach of obligation occurs after the occurrence of the insured loss, this possibility does not exist. After the occurrence of the insured loss, however, the insurer as well as the policyholder have the right of cancellation, §§ 92, 11 111 VVG. Legal consequences for breach of obligation before or after the occurrence of the insured loss If the policyholder breaches a contractual obligation, the insurer can be released wholly or partly from the liability to make payment. In this case the legislator no longer makes a distinction between the times of the violation (before or after the occurrence of the insured event).
Before the reform reform of the VVG of of 1. 1. 2008 the so-called so-called “all or nothing” nothing” principle principle applied. According to this the insurer was either completely liable (the policyholder then received everything) or completely free of liability (the policyholder received nothing) if an obligation had been breached. Since the border between negligence and gross negligence is blurred, but the consequences are very different, the legislator has abandoned this principle and replaced it by the “more or less” principle. In accordance accordance with § 28 VVG the insurer is thus only released released from liability if the policyholder acted intentionally. If the policyholder acted with gross negligence, the insurer only has the right to reduce its benefit in accordance with the degree of responsibility. In the case of simple negligence the insurer is completely liable.
breach of a contractual obligation
A further precondition for a reduction or rejection of the duty to provide indemnification is that the breach of obligation was the cause of the loss occurrence or the loss manifestation. This only does not apply if the policyholder has acted fraudulently. Furthermore, the insurer can only claim (partial) release from the obligation to perform if it has previously pointed out to the policyholder the consequences of a breach of obligation. This applies only to informational and explanatory obligations after thefulfilled occurrence of an insured loss, however, policyholder has already or breached its obligations when thebecause insurer the learns of the insured loss and cannot thus inform the policyholder of the effects of a breach in good time. Example: Mr Müller has taken out baggage insurance. His case is stolen from his hotel room. It states in the insurance conditions that in the case of theft the policyholder has to report the loss at the next police station immediately. Mr Müller does not want to spoil his holiday and reports the loss 10 days later when he returns home. Since Mr Müller is in deliberate breach of obligation, the insurer is released of any liability. The breach also affects the possibility of establishing whether the loss occurred and if it did, its extent, because the local police only have a good chance of catching the thief and finding the booty immediately after the theft. The insurer could not inform the policyholder of the the breach of duty duty of disclosure occurred “immediate “immediately” ly” effects and theof insurer only learnt laterbecause of the loss.
Legal basis of the insurance contract
The insurer’s duties
The insurer’s main contractual duty is to carry the risk on behalf of the policyholder and to provide the agreed benefit if the risk should occur. As a rule, the insurer will have to provide a financial benefit in the event of an insured loss, although other benefits can also be agreed, such as in liability insurance insurance the rejection of unjustified claims, or certain assistance services such as the organization of patient transport in the case of travel health insurance. Just what benefits are to be provided depends in the first instance on the contractual agreement.
3.9. 3. 9.1 1
Insu In sura ranc nce e for for a spe speci cifi fied ed am amou ount nt
With insurance for a specified amount the agreed sum (the sum insured) must be paid if the insured loss occurs, quite independently of what damage the insured loss actually caused. Thus the insurance for a specific amount has no insurable value. It is fixed by the policyholder according to the principle of the abstract need for cover. The payment of the sum insured can take the form of a lump sum payment or an annuity.
3.9. 3. 9.2 2
Inde In demn mnit ity y in insu sura ranc nce e
With indemnity insurance, on the other hand, the specific loss that the policyholder has suffered must be replaced. The insurer’s liability is limited to the level of the loss that actually occurred. Insured value Because the possible loss level is directly connected to the value of the insurable interest (insurance (insurance value as in the legal definition of § 74 Insurance Contract Contract Act (VVG)), finding what it is is relevant for the risk assessment. Already at the proposal stage the insurer will inquire about the value of the insurable interest, in order to calculate its risk on the basis of this figure. The higher the insurance value, the higher can be the obligation to pay in the event of a claim. In indemnity insurance the figure counts as the insurance value that the policyholder has to pay at the time of the insured loss for the replacement of the object as new after subtraction of the difference between old and new. The regulation regulation of § 88 VVG is flexible, however, and the parties to the contract can agree other arrangements, which makes particularly good sense if the insurance value cannot be established without a great deal of effort. For example, the reinstatement value of an object can also be insured. Sum insured In indemnity insurance the sum insured is the limit of the replacement benefit. The insurer never has to provide more than the amount of the actual loss, however, even if the sum insured is higher.
Insurance at full value There is full cover insurance if the agreed sum insured is the same as the insurance value. Only in this case is there sufficient insurance cover. Over-insurance There is over-insurance over-insurance according to § 74 VVG if the sum insured is significantly higher than the insurable value. Each contractual partner can request that the overinsurance should be corrected with immediate effect by lowering the sum insured and the premium respectively so that there is full cover insurance. If the policyholder has stated a sum insured that is too high in order to enrich himself fraudulently, the insurance contract is nullified. In this case the insurer can demand the premium up to the time when it learnt of the nullification. Underinsurance There is underinsurance if the sum insured is significantly lower than the insurable value at the time when the insured loss occurs, occurs, compare §75 § 75 VVG. In this case the insurer only needs to provide its benefit in the relation of the sum insured to the insurable value. compensation
sum insured x loss insurable value
Example: Mr Braun has taken out a household contents insurance policy and he stated that the insurable value is € 50,000. The value of the household contents is actually € 100,000, however. There is now an insured loss of € 25,000. The insurer need pay only
in this case.
First loss insurance There is first loss insurance insurance if the insurer, insurer, other than in § 75 VVG, pays the claim up to the level of the sum insured, although the insurable value is higher than the sum insured and ignores underinsurance. Example: Ms Koch has taken out a household contents insurance policy and the insurable value is stated as being € 50,000. The actual value is € 100,000, however. In her insurance conditions the following is stated: The insurer will not subtract any amount for underinsurance. There is now an insured loss of € 25,000. The insurer must pay the full claim of € 25,000.
Legal basis of the insurance contract
Partial insurance There is partial insurance if not the whole insurable value but only a fraction of it, that is a certain part of it is insured on a value basis. Partial insurance makes sense if it is very unlikely that the occurrence of the insured event could affect all the insured objects. Example Exampl e 1: Company X has a furniture store. The complete value is € 1,000,000. Since X wants to save premium and it is unlikely that all the furniture could be stolen at once, it takes out partial insurance against burglary. burglary. A 10 % share is insured – that is, € 100,000. Example 2: Company A has a furniture store. The complete value is € 2,000,000. However, A reports the total value as being € 1,000,000, because he estimates this as being much lower and then takes out partial insurance with a share of 10%. Furniture worth € 80,000 is lost in a burglary. In this case the insurance company need pay only € 40,000, because there was underinsurance. Multiple insurance One and the same risk may be insured against the same peril by several insurers and the total of the sums insured may be greater than the insurable value. In accordance with § 78 VVG the insurers are liable as joint debtors for the contractual agreement, at the most, however, for the amount of the claim. Internally, the insurers’ payments are apportioned according to the indemnification which each insurer would have had to pay according to its policy. Example: Ms Schneider is covered for health insurance abroad by her private health insurer X. X pays 80 % of the costs of treatment according to the General Insurance Insurance Conditions Conditions (AVB). Thereshe is also health of the insurer Y in her is credit card with which paidforeign for thetravel journey. Theinsurance share of the costs in this case 100 %. In the USA Ms Schneider has an accident and must be treated in hospital. The costs of treatment amount to € 100,000. Ms Schneider reports the damage to Y, which must also pay the claim in full. By way of recourse it can claim € 40,000 from X, however. Retentions The insurer’s liability can, furthermore, be limited by retentions. There are various forms of retention. They can be agreed as fixed amounts, which have to be paid for each claim (e.g. a retention in comprehensive motor insurance of € 300 each insured loss), as a percentage percentage (e.g. 80 % of the cancellation costs in travel cancellacancellation insurance will be paid for) or as a franchise, whereby the claim up to certain amount is not paid for at all, but claims that exceed this amount are paid for completely (compare Wandt, l.c., marginal 743).
The insurer’s benefit is provided after the insured loss has been reported, information has been supplied on request and documents have been provided. Due date The insurer’s payment is due on the conclusion of the investigation needed to establish the insured loss and the amount to be paid by the insurer, see §124 Insurance Contract Act (VVG). This legal regulation is not mandatory. For this reason many insurers have a clause stipulating that there must be indemnification within two weeks after admission of the insurer’s liability and agreement as to the amount. If investigations have not been completed completed by the end of the month after the reporting of the claim, the policyholder can request a part payment as high as the minimum amount that the insurer probably has to pay as things stand. This regulation must be to the advantage of the policyholder. The deadline is, however, suspended if it is the policyholder’s fault that the conclusion of the investigation is hindered, such as when the policyholder fails to bring documents requested by the insurer. Limitation of actions Other as before the reform of the VVG claims from insurance policies are no longer subject to a special limitation of actions. The general statutes of limitations apply in accordance accordance with §§194 §§ 194 ff Code of Civil Law (BGB). This means means that also these claims are usually limited to three years, whereby the limitation of actions begins with the end of the year in which the policyholder knew of the claim against the insurer or must have known it. There is still a special regulation for insurance policies in §15 VVG, however, according to which the limitation of action is suspended during the period between the reporting of the claim to the insurer and the receipt of the insurer’s decision by the policyholder. A further deadline up to which the legal action must be taken is no longer provided for in the reformed VVG, since this leads to a de facto reduction of the period of the limitation.
3.10 3.1 0 Possib Possibili ilitie ties s for the the policy policyhol holder der’’s complai complaints nts and asserting his will 3.10.1 3.1 0.1 Com Compla plaint ints s to BaFin BaFin If customers are dissatisfied with the proposal procedure, actions during the policy duration or the claims handling, they complain to, for example, the Management or the Supervisory Board of the insurer. Furthermore, customers of insurance companies can complain to BaFin about insurance companies on the basis of Art. 17. Basic Constitutional Law (GG) in connection with § 81 Insurance Insurance Supervisory Act (VAG). (VAG). Legally this complaint is classified as a
Legal basis of the insurance contract
petition, since the verdict of the supervisory authority does not have any effect in civil law. It cannot help the complainant to achieve an enforceable claim. As a rule, however, an insurance company will follow the view of BaFin. The basis of BaFin’s BaFin’s authority for claims stems from § 81 VAG. VAG. According to this it is the task of the supervisory authority to see that the interests of the insured are adequately safeguarded (compare Kollhosser in Prölss’ Insurance Supervisory Law, C. H. Beck, 12 12th edition 2005, § 81 marginal marginal 57).
3.10.2 3.10. 2 Insura Insurance nce ombud ombudsman sman proce procedure dure The insurance industry has created the so-called insurance insurance ombudsman as a neutral mediation body. This procedure is based on the regulations of the code of procedure of the insurance ombudsman. The customers of an insurance company can only make a complaint to the insurance ombudsman if the insurance company has joined the Association of Insurance Ombudsman e.V. The insurance ombudsman is allowed to decide about disputes up to € 5,000. This decision is binding for the insurance company, but not for the complainant. For higher dispute values the ombudsman can only make a non-binding recommendation. Private health insurers do not take part in the insurance ombudsman procedure, because they have appointed their own private health insurance (PKV) ombudsman.
3.10.3 3.1 0.3 Dis Disput pute e proc procedu edure re As for all civil claims the policyholder can bring an action against an insurer in a civil court and win a writ of execution. As long as a claim is being examined by the ombudsman procedure, limitation limitation of action is suspended.
Insurance practice and statistics by Dr.. Georg Erdmann Dr
Insurance practice and statistics
Insurance business is based on the idea that in accordance with the principle of equivalence an insurance company receives premiums, premiums, on the one hand, and pays insurance benefits and expenses, on the other, thus making a spread of risks possible. Although the premium computation (premium calculation) is based on statistical documentation, an exact calculation of the risk premium is a priori not possible. The actual development of claims and expenses can deviate quite considerably from the results as calculated. The basic problem in offering insurance protection is thus that a premium is required and calculated before the insurer knows whether or when it must pay and how high the benefit will be. The insurer promises to pay a benefit, and this is a future and compensatory benefit that depends on chance. It requires an adequate premium for this, but can only estimate how high this should be. This estimate is based on data from the past. The insurance risk arises from this situation. The insurance risk is the danger that in a given period the total losses of the insured portfolio will exceed the sum of the share of the total premium available to cover the risk as well as the available capital. This risk is a specifically insurance risk, because it depends on the kind of business conducted (acceptance of risks in return for a premium). The insurance risk has various origins/components. Origins/components of the insurance risk:
4.1. 4. 1.1. 1. Ri Risk sk of ra rand ndom om lo loss ss Variations in expected claims are called the risk of random loss. These occur as a result of the random development of the number and size of the incurred losses, e.g.: – Accumulatio Accumulation n risk: an event causes a great number of losses at the same time time – Risk of infection: infection: an event causes a succession succession of many many insurance losses losses or claims by the first risk “infecting” further risks. – Catas Catastroph trophe e risk or or risk of of a major loss loss The expected loss is thus subject to random fluctuations. It is uncertain as to the level and number of claims. Using historical historical data it is possible to calculate stochastic regularities which indicate indicate the losses the insurer can expect. Fortuity itself cannot be calculated, since these values are subject to random fluctuation. Measures to counteract the risk of random loss are, for example: – Sa Safe fety ty load loadin ings gs – Flu Fluctu ctuati ation on reserv reserves es – Incr Increasi easing ng the the portfoli portfolio o size size – Risk reduction reduction (objectiv (objectively/ ely/spac spaciall ially) y) – Rein Reinsura surance nce and and coinsu coinsuranc rance e – Balan Balance ce over time time (long-ter (long-term m contracts contracts)) – Suffi Sufficien cientt owner owners’ s’ equi equity ty – Clai Claims ms statis statistics tics for many many years years
Dr. Georg Erdmann
Risk of error
= Error in the stochastic regularities. This error results in erroneous calculations of the expected loss and consequently leads to wrong premium requirements. An error can occur if a mistake is made in analyzing historical data, as a result of which erroneous assumptions are made. The risk of error is thus a result of the analysis and projection risk, whereby the analysis risk aggregates the available statistical data incorrectly and the projection risk interprets the statistical aggregation incorrectly. Measures to counteract the risk of error are, for example: – Loss statistics statistics that are interpretable (Consideration (Consideration of the law of large large numbers; numbers; statistics over a long period of time) – Appr Appropri opriate ate risk featu features res – Adjustment of the risk features features to changed circumstan circumstances ces – Suit Suitable able statisti statistical cal estimate estimate procedu procedures res
Risk of change
The risk of change is, in contrast to the risk of random loss, impossible or very difficult to calculate. The divergence of the actual from the expected loss experience is in this case not the result of random fluctuations against the background of a constant risk environment, but the result of a change in the risk situation itself. The changes can scarcely be quantified in advance, because many factors can exert an influence over time, the development of which is unforeseeable. Unforeseeable changes occur in the insurer’s environment, which mean that the forecasts of expected claims are no longer true. The insurance risk is not only dependent on random events, but also on changes in the insured risks themselves and on the basic conditions. Such areas of change occur in the basic conditions of – the economy economy (fluctuations (fluctuations and changes in economic economic activity) activity) – soc society iety (shi (shifts fts in in values values)) – the stat state e (chang (changes es of law) law) – ecol ecologic ogical al environmen environmentt (cli (climatic matic changes) changes) – tec techn hnica icall env enviro ironm nment ent.. Measures against the risk of change are, for example: – Saf Safety ety lo loadi ading ngs s – Flu Fluctu ctuati ation on reser reserves ves – Restriction to short-term short-term benefit promises (short-term contracts) – Adju Adjustme stment nt clauses clauses (premium (premium and and benefit) benefit) – Rein Reinsura surance nce and coins coinsuranc urance e – Mix of risks (objecti (objectively/ vely/geog geographi raphicall cally) y) – Suff Sufficie icient nt owner owners’ s’ capi capital tal
Insurance practice and statistics
4. 4.2 2
Basi Ba sic c pri princ ncip iple les s of of the the pr prem emiu ium m cal calcu cula lati tion on
4.2. 4. 2.1 1
Purp Pu rpos oses es an and d Tar Targe gets ts
The purpose of the premium calculation is to fix a price that matches the risk. The premium must conform to the principle of equivalence. A distinction is made between the individual and the collective principle of equivalence: – Individual principle principle of equivalence: equivalence: for each individual individual insured insured risk the policyholpolicyholder’s premium and the benefits of the insurance company should match. – Collective principle principle of equivalence: even if the whole whole population population is observed, observed, premiums and benefits should match.
4.2.2 4.2 .2
Risk Ris k fac factor tors s and pre premiu mium m dif differ ferent entiat iation ion
A distinction is made between objective and subjective risk features. – Objective risk risk factors: These These risk/influencing risk/influencing factors factors do not depend depend on the behavbehaviour of the policyhol policyholder der and can be determined beforehand. – Subjective risk risk factors: These These risk/influencing risk/influencing factors factors are person related related and the policyholder policyhold er can influence them. They cannot be determined beforehand. – Moral risk (moral (moral hazard): By this this is meant the psychologic psychological al phenomenon that some policyholders change their behaviour after taking out an insurance policy. Differentiating premiums – Primary premium premium differentiation: differentiation: the premium premium for the insurance insurance protection protection is fixed in advance: that is, on taking out the policy. However, in reality only the objective features are known at the outset. That is, before the insurance policy is taken out and before knowing the policyholder’s risk behaviour, it is only possible to classify a risk as belonging to a particular premium class if features are used as criteria that are already known in advance from the objective population data. – Subjective features features can only be be brought into the the process of of differentiating premipremiums if the individual claims experience of a risk is known at the end of the period. The differentiation of premiums on the basis of subjective features is called secondary premium differentiation or experience rating, since it is based on experience with the individual loss experience/behaviour of the policyholder. The subjective features are thereby gradually brought into the rating later.
Dr. Georg Erdmann
Basic formula of the premium calculation + =
Net risk premium Safety loading Risk Ri sk pre premiu mium m (Net (Net prem premium ium,, gros gross s risk risk pre premiu mium) m)
Extra Extr a for for op oper erat atin ing g exp expen ense ses s Cash flow under underwrit writing ing (Profit (Profits s taken taken out of the the investm investments ents are are factored factored into into the premium in order to lower it for competitive reasons)] reasons)] + Profit extra –/+ –/ + Dis Disco count unts/E s/Extr xtras as + Ext Extra ra for for prem premium ium pay paymen mentt more more freq frequen uentt than than annu annuall ally y = Gross pr premium + Insurance ta tax = Total premium Structure of the premium rate in insurance companies The insurance premium or the insurance contribution is the policyholder’s financial contribution to the insurance company for carrying the risk or for providing indemnification. The policyholder’s premium must not only cover the operating expenses or the administration costs (e.g. salaries, commissions, rents, depreciations) and the profit, but also the risk and claims expenses of the insurance company. The following overview shows the components of the gross or premium rate of household insurance. Basis of calculation
Net risk premium
– sa safe fety ty loa loadi ding ng
Balance of the insurance risk
= Risk premium
(Net premium) + Loading for operating operating expenses + Loading for profit profit
Acquisition and administratio administration n expenses
= Gross or premium rate Risk contribution ca. 58 % Oper Op erat atin ing g expe expens nses es ca ca.. 36 – 40 % Profit ca. 2 – 6 % The above percentages for the operating expenses only serve as an example. They depend on the expenses of the individual insurance companies – especially on the sales system (direct selling or sales by agents) and from the class of insurance sold (risk premium). The operating expenses and under certain circumstances the profit are usually added as a percentage extra onto the risk premium.
Insurance practice and statistics
For each risk group the claims frequency (claims probability) probability) and the average claim is calculated: Claims frequency
Number of claims Number of risks (policies)
Sum of claims Number of claims
The risk premium is a product of: Risk premium = Loss frequency * average size of claim Example: The claims experience for a household insurance in Tariff Zone III is such that for every 100,000 contracts there are 8,000 claims. The total sum of claims is € 10,400,000, the average sum insured is € 70,000 What is the risk premium rate? Solution: Risk premium = Loss frequency * average size of claim 8,000 10,400,000 Risk Ri sk pr prem emiu ium m = ________ * __________ = 100,000 8,000
A risk premium of € 104 per policy is needed.
4.3 4. 3
Emer Em erge genc nce e and and di dist stri ribu buti tion on of su surp rplu luse ses s
4.3. 4. 3.1 1
Reas Re ason ons s for for the eme emerg rgen ence ce of of surp surplu luse ses s
188.8.131.52 4.3.1. 1 Emerge Emergence nce of surpl surpluses uses in in all classe classes s of insuranc insurance e Cost overrun Due to rationalization measures and economical administration the actual acquisition and administration expenses can be less than the calculated costs. Example life insurance: The acquisition and administration expenses calculated into the premium – actua actuall acquisitio acquisition n and administrati administration on expenses expenses = profit on expenses
Dr. Georg Erdmann
The profit on expenses is expressed as a percentage of the premium or as a per mille rate of the sum insured. Example: With premium income of € 66,443,750 the actual expenses for acquisition and administration ministratio n were € 12,436,900 whereas € 13,500,000 had been calculated. How high was the profit on expenses expressed as a percentage? Solution: Calculated share of expenses: – Act Actual ual exp expens enses: es: = Profit on on expenses: expenses:
€ 13,500,000 € 12,436,900 €
Profit on expenses as a percentage of the premium:
€ 66,443 66,443,750 ,750
= 100 % € 1,063,100 = x%
x = 1,0 1,063, 63,100 100 x 100 x = 1, 1,0 066,443,750 x = 1.6 %
Surplus by the release of hidden reserves These result, for example, from the sale of buildings that have been written off or from the sale of bonds that have been valued according to the strict principle of the lower of cost or market value. The selling price is then higher than the book value. Technical surplus The actual claims payments are less than the calculated ones. Surplus from reinsurance business A surplus exists if the reinsurance commission for the direct insurer is greater than its proportional share of the administration expenses 184.108.40.206 4.3.1. 2 Emerge Emergence nce of surplus surplus in life life insuran insurance ce Risk surplus (mortality profit) The actual mortality is more favourable than had been calculated, because of positive selection and outdated mortality tables, for example. Evaluating the mortality profit All risk premiums (premiums for pure term insurance and the share of risk premiums from policies with a savings component) accumulate during the business
Insurance practice and statistics
year. From these the death benefits are paid for term insurance policies and the sum at risk for the death benefit of policies with a savings component (sum insured minus mathematical reserve). The annual surplus is the mortality profit. Calculated risk premiums – Death benef benefits its of of the term term insuran insurance ce – (Death benefits – mathematical mathematical reserve) in life policies policies with a savings component component = Mortality profit Mortality profit is expressed as a percentage of the premium or as a per mille rate of the sum insured. Example: An insurer has paid out € 529,890,000 in claims for policies with a savings component. This amount contains savings components amounting to a total of €
212,760,000. For the corresponding insurance policies the life insurer has received risk premiums of € 384,600,000. Calculate the mortality profit in
Interest surplus (extra interest) The profit from investments is higher than the technical interest rate calculated into the premium. The technical technical interest rate is, for example, 2.5 %, but the insurer earns an average rate of interest of 4.5 % on the investments. Calculation of the interest profit If due to a wise investment strategy a life insurance company makes profits from investments which which are higher than the calculated technical interest rate of 2.5 % p.a., the yield which exceeds the technical rate of interest is available to it as interest profit for the profit participation. Yield from investments – Techn echnical ical intere interest st rate (e.g. (e.g. 2.5 %) – Expen Expenses ses for asset asset manag management ement = Interest profit
Dr. Georg Erdmann
The interest profit is achieved by the investment of the mathematical reserve. For this reason it is expressed as a percentage of the mathematical reserve. Example: A life insurance company achieves a total interest yield of € 2,525,893 from a mathematical reserve of € 56,897,000. The technical technical interest rate is 2.5 %, the cost of the asset management € 284,485. a) How high is is the interest interest profit in €? b) How high is the interest profit as a percentage percentage of the mathematical reserve? Solution a): Interest total: – Technical interest rate = 2.5 % of 56, 56,897,000: 897,000: – Cos Costt of the the asset asset manage management: ment: = Interest profit:
€ 1,422,425 €
Solution b) Profit on expenses as a percentage of the premium:
Surrender surplus If the policyholder cancels the life insurance policy before maturity, the insurer can charge a cancellation fee if this had been agreed with the policyholder and the amount of the reduction is reasonable. The cancellation fee is calculated as a percentage of the capital at risk. The percentage depends on the age of entry and the duration of earns the policy. If the cancellation fee is higher than the actual expenses, then the insurer a surplus. The surrender value corresponds to the current value reduced by the cancellation fee. The cancellation fee is, however, only permissible if it was agreed in the conditions. The surrender value of a life insurance policy is basically calculated as follows: Savings components with compound interest – unam unamorti ortized zed acquis acquisitio ition n costs costs = zillmerized mathematical reserve reserve – cred credited ited and and earned earned surpl surpluses uses = current value, however, at least the current value for the guaranteed insurance insurance benefit with waiver of premium – surr surrende enderr fee (insof (insofar ar as agree agreed) d) = surrender value
Insurance practice and statistics
Example: For an endowment policy of € 30,000 a mathematical reserve of mulated over a period of 27 months.
According to the insur er’s s documentation 90 % of theand acquisition cos costs (40have %o of sum insured) are insurer’ not amortized. Surpluses90% Surpluses (credited earned) of €ts 120 tothe be taken into account. Calculate the surrender value of this policy if a cancellation fee amounting to 1% 1 % of the sum at risk had been agreed. Solution: Savings components:
Unamortized acquisition costs 40%o of € 30,000 = € 1 1,,200, of which 90%:
– € 1,080
Surpluses (credited and earned)
Cancellation fee 1% of € 30,000 - € 2 2,,040 = 1% of 27,960: = calculated surrender value:
4.3. 4. 3.2 2
– € 279.60
Dist Di stri ribu buti tion on of of surp surplu luse ses s
220.127.116.11 4.3.2. 1 Distr Distributio ibution n of surplus surpluses es in non-li non-life fe insurance insurance Premium refund (depending on success) If there is a surplus in the class of business (e.g. household insurance), part of it is returned to the policyholder. 18.104.22.168 4.3.2. 2 Distr Distributio ibution n of surplus surpluses es in life insura insurance nce For the shares of surplus that are allocated to the individual insurance policy there are the following distribution possibilities: Cash payment A cash payment of the surpluses to the policyholder is seldom used for tax reasons. Premium offset Especially in the case of term insurance policies the surplus is set off against the premiums. In this way the policyholder has to pay a lower premium for an unchanged sum insured. This procedure is tax neutral. Accumulation of interest The surplus shares accumulate for the policyholder and are invested with interest. On the due date the sum thus saved is paid out with the sum insured. Due to compound interest the interest on the amount saved grows slowly at first, but towards
Dr. Georg Erdmann
the end of the contract duration strongly, so that the system of profit distribution is particularly particularl y favourable for those customers who continue their contract to maturity and want the highest possible maturity benefit. Reversionary bonus system (bonus system) The annual share of the surplus is regarded as a single premium payment and is used for the calculation of an additional sum insured. By means of the annually increasing sum insured the risk protection provided by the policy is considerably improved. This form of surplus sharing leads to a higher benefit in the event of early death than with the accumulation of interest, since the single premium payment results in a higher sum insured than the sum of the share of the surplus plus interest. Example of a surplus statement for a life insurance policy. (Other bases of assessment could also be agreed, and the rates are only examples. They differ from insurer to insurer and also from year to year.): – 1.5% 1.5 % of the mathematical mathematical reserve, reserve, and it is contractually contractually agreed agreed how this this mathematical reserve is to be determined at the policy anniversary before the distribution: for example, in accordance with the actuarial basis of the premium calculation on renewal: – 20 % of of the the ris risk k prem premium ium – 2 % of th the e pre premi mium um – 0. 0.1 1 % of the the sum sum ins insure ured d Relative importance of the types of profit distribution for the market All the types of profit distribution shown are offered in the market. A number of life insurance companies companies do not let their policyholders choose between different types of profit distribution and it is agreed – especially in the case of life insurance policies with a savings component – that the bonus system should be the basic form of profit distributio distribution. n. Should insurance companies plan to offer different types of profit distribution, a number of life insurance companies often combine some of them. It can thus be agreed that part of the surplus be used for an increase in the sum insured and that the rest should be invested at a rate of interest. If there is an additional benefit to the main cover, the profit share from the additional benefit is often used to lower the premium (immediate offset), whilst the surplus from the main policy is used for the accumulation accumulati on of interest or to increase the sum insured.
Purposes of the annual financial statement – The first duty is is to provide information information about the the company or, or, with the assistance assistance of the accounting department, to report about the deployment of the available resources
Insurance practice and statistics
– The second duty is the distributio distribution n of income income or the measure measure of assets – The third function function is that that of protection. protection. Company stakeholders (staff, creditors, creditors, suppliers, customers) customers) should be protected, but also the company itself by means of the enforcement of self information. Receivers of financial accounting – Empl Employees oyees and and salaried salaried insuranc insurance e agents – Sup Superv ervis isory ory author authority ity – Owners – In Inve vest stor ors s – Int Intere ereste sted d publ public ic – Asso Associat ciations ions and unio unions ns – State – BAV – Cust Customer omers s and and polic policyhol yholders ders – Po Pote tent ntia iall staff staff – Inj Injure ured d third third parti parties es – Direc Directt and reins reinsuran urance ce compan companies ies Sections of the annual financial statement – Bal Balanc ance e sheet sheet § 246 l HGB – Profi Profitt and loss loss accou account nt § 246 l HGB – Sch Schedu edule le § 264 264 I HGB – Manag Management ement repo report rt § 264 I HGB – Cash Cashflow flow state statement ment § 297 I 2 HGB HGB – Seg Segmen mentt report report § 297 297 I 2 HGB HGB Description of the balance sheet of an insurance company Insurance companies companies have to prepare the balance sheet – in contradiction contradiction to § 266 HGB – in accordance with a form (§ 2 RechVersV). RechVersV). The organization in accordance accordance with § 266 HGB thus does not apply to insurance companies. companies. The differences differences are particularly clear clear on the assets side of the balance sheet: § 266 HGB subdivides the the asset side into fixed and liquid assets. This arrangement mainly depends on the degree of liquidity of the assets. Such a distinction is not possible in an insurance balance sheet. Reasons for the deviation from the commercial balance sheet The following reasons can be given for the deviation of an insurance balance sheet from a “normal” commercial balance sheet: – The intangible intangible nature of the insurance insurance product means that there there are no identificaidentification problems for products and also no evaluation process.
Dr. Georg Erdmann
– The time relationship relationship of the insurance policies policies causes causes delineation delineation problems problems for a one period overview such as that given in the balance sheet. This is clear, for example, with the mathematical reserve or the fluctuation reserve, which contain long-term assumptions. – The random nature oftoinsurance nature insuranc e business This leadsistoparticularly leads an extension extension of theinprinciples princi ples of creditor protection the policyholders. obvious the duty to set up further insurance specific reserves. In so doing due to its legal nature (uncertainty as to existence, point of time and the amount of the obligation) a reserve can adequately replicate the features of the insurance product that also has an uncertain duty to pay with regard to existence and amount. The general evaluation evaluation rules of §§ 252 to 256 HGB apply to the drawing up of the insurance company’s balance sheet. They are complemented by the regulations for large limited liability companies in §§ 273 to 283 HGV as well as the specifically insurance regulations regulations of §§ 341 341ff. ff. HGB, which the insurance company company has to apply. Furthermore, the insurers must continue to observe the complementary regulations of RechVersV.
Asset side of an insurance company’s company’s balance sheet A. Out Outsta standi nding ng asse assets ts of the the share share capi capital tal B. In Inta tang ngib ible le as asse sets ts C. Investments I.
Land La nd,, la land nd ri righ ghts ts an and d bu buil ildi ding ngs s
Investme Inves tments nts in affi affili liate ated d compa compani nies es and and hold holding ings s 1. Sha Shares res in in affili affiliate ated d compa companie nies s 2. Len Lendin ding g to affili affiliate ated d compan companies ies 3. Holdings 4. Lend Lending ing to compani companies es with which which there there is a holding holding relations relationship hip
III. II I.
Miscel Misc ella lane neou ous s inve invest stme ment nts s 1. Shar Shares, es, investm investment ent shares, shares, and and other fixed fixed interes interestt bonds 2. Coup Coupon on bonds bonds and other other fixed inter interest est bonds bonds 3. Mortg Mortgages ages,, land land charg charges es and and rent rent charg charges es 4. Mis Miscel cellan laneou eous s len lendin ding g 5. Outs Outstandi tanding ng credit credit contributio contributions ns with credit credit instituti institutions ons 6. Ot Othe herr in inve vest stme ment nts s
Deposit Depo sit rece receivab ivables les from rein reinsure sured d bus busines iness s
D. Investme Investments nts for the the account account of and risk risk of holder holders s of life insura insurance nce polici policies es (§14 RechVersV) In unit-linked life insurance the insurance company does not carry the investment risk,the but the policyholder, since he the kind of investment. In this case information about amount ofdetermines capital invested for the unit-linked life insurance is in terms of the current value.
Insurance practice and statistics
Requireme Requir ements nts ari arisi sing ng fro from m the the ins insura urance nce bus busin iness ess wi with th 1. po poli licy cyho hold lder ers s 2. in insur suranc ance e int interm ermedi ediari aries es 3. me memb mber ers s and and car carri rier ers s
Accoun Acc ountin ting g require requiremen ments ts arisi arising ng from from reinsu reinsuran rance ce busin business ess
III. II I.
Misc Mi scel ella lane neou ous s requi require reme ment nts s
Misc Mi scel ella lane neou ous s ass asset ets s I.
Cash Ca sh wit with h bank banks, s, ch cheq eque ues s and and cas cash h in ha hand nd
Tre reas asur ury y sto stoc ck
Other as assets
G. Acc Accrue rued d and def deferr erred ed ite items ms H. Def Defic icit it not not cove covered red by owne owners‘ rs‘ equ equity ity J.
Sett Se ttle leme men nt am amou ount nt
Liabilities side of an insurance company’s company’s balance sheet A. Ow Own ner ers s’ equ equiity I.
Sha hare re cap apit ital al or simi millar ite tems ms
Addi Ad diti tion onal al pa paid id-i -in n cap capit ital al
Prof Pr ofiit re res ser erve ves s
Bala Ba lanc nce e she sheet et pro profi fitt
B. Par Partic ticip ipati ation on rig rights hts cap capita itall C. Su Subo bord rdin inat ated ed li liab abil ilit ity y D. Ext Extrao raordi rdinar nary y items items with with rese reserve rve fund funds s (§ 273 S. S. 1 i.V. i.V. m. § 247 III III S. S. 1 HGB) HGB) E.
Prov Pr ovis isio ions ns fo forr own own ac acco coun untt In accordance with with § 341e I HGB reserves reserves must be set up in excess of what is allowed by § 249 HGB, in order to guarantee permanently permanently the commitments from the insurance policies (especially the insurance industry’s principle of prudence). Because of the temporal difference between the premium payment and the uncertain claims payment they serve the purpose of allocating the profits and expenditure to the year in which the premiums had been earned and in which the claims had occurred. For a life insurer insurance comp they amount 90balance %, in the case of athey property accident insu rer ca. company 60 %, any of the total assetsto onca. the shee sheet, t, i.e. are on/ the liabilities side the largest and most important item.
Dr. Georg Erdmann
Unearn Unea rned ed pr prem emiu ium m res reser erve ves s (§ (§ 34 341e 1e II No No.. 1) 1) They must be set up “for the part of the premiums, which represents the profit over a certain time after the balance sheet date.” Unearned premium reserves actually constitute constitute a passive accrued and deferred item. They constitute the part of the booked gross premiums which are to be accounted to the following year as profit for a time after the balance sheet date.
Mathem Math emat atic ical al re rese serv rve e (§ 34 341f 1f HGB HGB)) The mathematical reserve in life insurance insurance business constitutes constitutes about 80 % of the total assets on the balance sheet. It serves the purpose of covering the liabilities as they occur from the life insurance business and from the business that is conducted like life insurance. Why does the insurer have commitments towards the policyholder for which it has to set up a mathematical reserve? 1. The risk risk componen componentt of the premium premium is consta constant nt over the whole whole durduration. It follows from this that in the first policy years the risk premium is too high and in the last years it is too low. Consequently, in the first years provision (as a sort of reserve) is set up, which in the last years is released, so that the risk premium is correctly apportioned. 2. The insurer insurer receives a savings component from the policyhold policyholder er,, which which has to be paid back with interest. Here, too, the insurer is liable to the policyholder, with the result that provision must be made, since the level and timing of the repayment is uncertain. According to § 25 I S.2 RechVersV RechVersV the insurance company can choose to take account of one off acquisition costs in the mathematical reserve (Zillmerung). Already in the first business year the insurer is allowed to charge the policyholder for the paid acquisition costs. If the acquisition costs are higher than the first year premium, there is a negative balance for the liability of the insurer towards the policyholder: that is, the policyholder would actually be liable to the insurance company. The mathematical reserve is called an ageing reserve in health insurance.
Provision Provis ion for out outsta stand nding ing cl claim aims s (§ 34 341b 1b HGB) HGB) This reserve is generally referred to as a loss reserve. It contains especially – Rese Reserve rve for for the indem indemnifi nificatio cation n of claim claims s that have occur occurred red and and are known to the insurer but which have not yet been regulated. – Late loss loss reser reserve ve for clai claims ms that that have have occurred occurred but which which the insure insurerr does not yet know about. The technical term for this is also IBNR claims (incurred but not reported).
Reserve for premi Reserve premium um refunds refunds depend dependent ent on succ success ess or not not dependen dependentt on success (§ 341e II No. 2 HGB)
Equaliza Equal izatio tion n reser reserve ve and and simi similar lar res reserv erves es (§ (§ 34 341h 1h HGB) HGB) – It has an equali equalizatio zation n functio function: n: that that is, it serves serves the the purpose purpose of of smoothsmoothing out fluctuations in the annual claims expenditure that the insurance company has to carry itself. –
Rela Related ted to thisclasses is the the security sec function func tionInasthis a measur me asure e against against fluctuatio ations ns in particular ofurity insurance. way there is afluctu safeguard against future major losses.
Insurance practice and statistics
How does the equalization reserve fulfil its security and smothing function? 1. Case: Case: Low claims claims year: year: that is, fewer fewer claims claims than average. average. In In this case case the equalization reserve is increased. That is, there is an allocation, by which the expenditure increases and less profit is declared. 2. Case: Case: High claims claims year: year: that is, is, more claims claims than than average. average. In this case case the equalization reserve is released affecting net income, by which the loss is reduced. By allocation or release the claims expenditure is smoothed out over the years. At the same time, the equalization reserve that has already accumulated serves as a safety cushion. VI. Misc Miscella ellaneou neous s tech technica nicall insu insuranc rance e reser reserves ves In this mixed item five single technical insurance reserves are summarized, of which only the 1st and 2nd have special importance: 1. Res Reserv erve e for anti antici cipat pated ed laps lapses es 2. Reserve Reserve for for threatened threatened losse losses s out of the the insuran insurance ce busines business s (§ 34 341e 1e II No. 3 HGB, vgl. also § 249 I 1 HGB) For a better understanding: a delineation from other technical insurance reserves:
Unearned prem Unearned premium ium reser reserves ves are are collec collected ted premiu premiums ms which which do not not concontribute to the profit of the business year, whereas the reserve for contingent losses results from the mismatch of benefit and consideration.
In the the case case of the the loss loss reserve reserve the the focus focus is on claims claims that have have alread already y occurred or have been caused, whilst with the reserve for contingent losses future claims that occur after the cut-off date are taken into account.
The equali equalizatio zation n reserve reserve smooth smooths s out fluctu fluctuation ations s in claims claims expend expenditure iture which is under control, whereas in the case of the reserve for contingent losses a loss is seriously suspected: that is, the premiums are actually insufficient.
Techn echnical ical reserv reserves es in life life insurance insurance,, insofar insofar as the investm investment ent risk risk is carried carried by the policyholders policyholders (§ 32 RechVersV). RechVersV). Technical reserves must be set up for commitments from life insurance policies whose value or profit is determined by the investments for which the policyhol policyhol-der carries the risk or by which the benefit is index linked.
G. Ot Oth her re res serv rves es H. Depos Deposits its recei received ved from from reins reinsured ured insu insuranc rance e busines business s I.
Other liabilities I.
Other Oth er liabi liabilit lities ies from from insu insuran rance ce polic policies ies und underw erwrit ritten ten by the the compan company y itself itself 1. Po Poli licy cyho hold lder ers s 2. Ins Insura urance nce int interm ermedi ediate ates s 3. Affil Affiliated iated comp companie anies s and pensi pension on fund fund carrier carriers s
Dr. Georg Erdmann
Accou Ac counti nting ng liab liabili ilitie ties s from from rein reinsur suranc ance e busi busines ness s
Liabil Lia biliti ities es toward towards s credit credit insti institut tution ions s
K. Passi Passive ve acc accrua ruals ls and def deferr errals als L. Set ettl tlem emen entt amo amoun untt Construction of the Profit and Loss Account The Profit and Loss Account is divided into an insurance related and a non insurance related account. It is constructed as follows: Insurance related business (including or excluding investment profitability) +/– = +/– = +/– +/ –
Change of the Change the fluctuat fluctuation ion reser reserve ve (not (not for life life insure insurers) rs) Real Re al te tech chni nica call in insu sura ranc nce e re resu sult lt Insurance related business (excluding or including investment profitability profitability)) Resu Re sult lt of the the nor norma mall bus busin ines ess s act activ ivit ity y Extrao Ext raordi rdinar nary y pro profit fit/l /loss oss
+/– Tax +/– Trans ransfer fer of loss losses/T es/Trans ransfer fer of profi profits ts = Surp Su rplu lus s fo forr the the ye year ar/D /Def efic icit it fo forr th the e ye year ar Insurance profits and expenditure according to Form 2 1. Earn Earned ed pr prem emiu iums ms Written premiums – Re Rein insu sura ranc nce e pr prem emiu iums ms pa paid id +/– Chan Change ge in the the gross gross premium premium transf transfer er +/– Change in the share of the reinsurance reinsurance in the gross gross premium premium transfer = Ea Earn rned ed pr prem emiu iums ms fo forr own own ac acco coun untt 2. Tech echnic nical al inte interes restt earni earning ngs s 3. Misc Miscella ellaneou neous s tech technica nicall insu insuranc rance e profi profitt 4. Expe Expend ndit itur ure e for for cl clai aims ms a) Cl Clai aims ms set settl tlem emen ents ts b) Chan Change ge of the the reserve reserve for claims claims not not yet settled settled 5. Change Change of the other other tech technica nicall insura insurance nce net net reserves reserves a) Net mat mathem hemati atical cal res reserv erve e b) Misc Miscella ellaneou neous s technical technical insura insurance nce net reserves reserves 6. Expenditu Expenditure re for premium premium refund refunds s that depend depend and do do not depend depend on profitprofitability 7. Expend Expenditu iture re for the the insura insuranc nce e busine business ss 1. Claims regulation: internal and external, external, direct direct and indirect claims handling expenditure 2. Acquisiti Acquisition on of insurance policies policies:: commission, commission, brokerage, expenditure for issuing policies 3. Administrati Administration on of insurance policies policies:: premium premium collection, collection, claims prevention and containment
Insurance practice and statistics
8. Misc Miscella ellaneou neous s techn technical ical insu insuranc rance e expend expenditure iture 9. Ch Chang ange e in the the equa equaliz lizati ation on rese reserve rve 10.. Un 10 Unde derw rwri riti ting ng re resu sult lt Non insurance related profits and expenditure 1. In Inve vest stme ment nt yi yiel eld d These are only for property and accident insurers and reinsurers in the non insurance related account. For life insurers they are a part of the insurance related account. a) Pro Profit fits s fro from m ho holdi lding ngs s b) Yi Yields elds from othe otherr inves investmen tments ts c) Pro Profit fits s from from appr appreci eciati ations ons d) Prof Profits its from from the the outflo outflow w of inves investmen tments ts e) Prof Profits its from from profit profit pools and and transfer transfer of profits profits contra contracts cts f) Prof Profits its from from the releas release e of extraordi extraordinary nary items items with with reserve reserve funds funds 2. Exp Expend enditu iture re on in inves vestme tments nts a) b) c) d) e)
Expenditure for the administrati administration on of investments Deprec Dep reciat iation ion of inves investme tments nts Losses Loss es from the outfl outflow ow of inves investment tments s Expenses Expe nses from trans transfer fer of losse losses s Adjustmen Adju stments ts in the extraor extraordina dinary ry items items with reserve reserve funds funds
3. Tec echni hnica call int intere erest st yie yield ld 4. Mi Misc scel ella lane neou ous s pro profi fits ts 5. Mis Miscel cellan laneou eous s exp expend enditu iture re 6. Res Result ult of of the norm normal al busin business ess act activi ivity ty 7. Ex Extr trao aord rdin inar ary y pr prof ofit its s 8. Ex Extr trao aord rdin inar ary y ex expe pend ndit itur ure e 9. Tax fro from m inc income ome and pro profit fit 10.. Mi 10 Misc scel ella lane neou ous s tax taxes es 11. Pro Profit fits s from from tran transfe sferr of lo loss sses es 12.. Tra 12 rans nsfe ferr rred ed prof profit its s 13. Surp Surplus lus for the year/ year/Defic Deficit it for the year The following offset generally follows, which is decided by the management and provides room for manoeuvre: Surplus for the year/Deficit for the year +/– Prof Profit/Lo it/Loss ss carri carried ed forwar forward d from from the previ previous ous year year + Withd Wi thdraw rawal al from from ret retain ained ed earn earning ings/ s/add additi ition onal al paid paid in capi capital tal + With Wi thdr draw awal al fro from m the the part partic icip ipat atio ion n righ rights ts cap capit ital al – Adjust Adj ustmen mentt in the ret retain ained ed earn earning ings/a s/addi dditio tional nal pai paid d in in capi capital tal – Repl Re plen enis ishm hmen entt of the the par parti tici cipa pati tion on rig right hts s capi capita tall =
Bal alan anc ce shee eett pro rofi fitt / loss
Dr. Georg Erdmann
Functions of the Schedule 1. Release function: function: the schedule releases the balance sheet and the profit and loss account from too much information. 2. Explanation function: function: the methods of drawing up a balance sheet and evaluation evaluation must be supplied. 3. Supplementary Supplementary function: there is additional information in the schedule, which which is not given in the balance sheet and the profit and loss account. 4. Correction function: if because of special circumstances the balance sheet and the profit and loss account do not succeed in communicating a picture of the assets, finances and the profits of the company that reflects the reality, it is necessary to provide provide additional information information in the schedule. (§ 264 264ii ii S. 2 HGB). 5. In the schedule of insurance companies the current values of investments investments must be given (§§ 54 54– – 56 RechVersV). RechVersV). Since 1997 1997 all investments except land must must be valued according to current value. Since 1999 this also applies to land. Functions and content of the management report The management report also has “only” one information function. In detail, the following should be shown: 1. Course of business business until the balance sheet date (historical (historical view) 2. Company situation situation (cut off day view) 3. Extraordinary events events between the end of the business business year and preparation preparation of the balance sheet (View of the period of time of the most recent past) 4. Future development development of company 5. Risk report
4.5 4. 5
Insu In sura ranc nce e math mathem emat atic ics s and and actu actuar aria iall scie scienc nce e
Insurance mathematics is a part of mathematics. It is chiefly concerned with mathematical modelling and also with the statistical estimates of insured risks (especially personal injury or property damage), the calculation of the price needed for taking over such risks (premium calculation), the calculation of insurance reserves or the necessary equity capital resources, controlling including including the reporting system, risk management and asset liability management. Insurance mathematics belongs to applied mathematics and is an important field of application for the theory of probabilities and statistics. To show the financial risks which are also in insurance contracts, methods of financial mathematics are also used. These can be subdivided as follows:
Life insurance mathematics
Health insurance mathematics
Pension insurance mathematics
Non-life insurance mathematics
Insurance practice and statistics
Because of the comprehensive application of insurance mathematics to all types of risk, financial mathematics can also be understood as a special case of insurance mathematics that focusses on financial risks. Statistics Tasks, working steps and statistical procedures – In order to be able able to calculate calculate premiums that fairly reflect risk and to regulate regulate at any time all claims that have to be indemnified, insurance companies need in motor third party liability, for example, information about claims frequency and the average level of losses of the various types of car. – In order to keep keep market share, share, insurance insurance companies companies need among among other things things information about the demand for products of households and companies, premium developments in the individual classes of insurance, the disposable income of the various groups of household households s and the price inflation rate for a wide variety of goods and services. – For adequate personnel personnel planning planning insurance insurance companies need, for example, example, inforinformation aboutinto the internal averageand age external and gross incomegender, of staff,possible broken down other things activities, fields among of employment internally and staff qualificatio qualifications. ns. Statistics includes the methods and procedures with which information about observable mass phenomena can be captured, prepared and analyzed The aim of the statistics is in the first instance to describe the current situation in order serve as a basis for the explanation of causal relationships and to assist in decision making.
Course of statistical examinations 1 Questions are formulated to fit the particular purpose
Data capture Data preparation Data analysis
Decisions on the basis of the data analysis
A precondition for the use of statistical procedures is that the events and the circumstances to be examined should be described exactly and be quantifiable. Statistics is not concerned with the individual case but always with a plurality of similar single phenomena. By term statistics and of circumstances arethe examined as wellisasunderstood the tables the andmethod figures by by which which events the events an examination are presented clearly.
Dr. Georg Erdmann
In descriptive statistics statistics the data needed are collected by a full inventory count: that is, by capturing all cases. In inferential or inductive statistics on the basis of a random sample, that should be as representative as possible, the recurring features of a population are established. Example: Population statistics Descriptive
Size of the survey
Census = the data of the whole population living in a certain area are captured
Micro-census = the data of ca. 1 % of the population living in a certain area are captured
Statis Stat isti tics cs as a procedure
Prepar Prep arat atio ion n of th the e da data ta from all households
Prepar Prep arat atio ion n of th the e da data ta from the random sample and extrapolation of the data for all households
Stat St atis isti tics cs as a res resul ultt
Tab able les s an and d gra graph phs s to de desc scri ribe be th the e str struc uctu ture re of the population of the German Federal Republic
The occupational description of an expert in insurance mathematics is insurance mathematician. They can also be called actuaries, especially if they have extensive knowledge of insurance that is beyond pure insurance mathematics. The aim of actuarial activity is to estimate and evaluate risks such as insurance risks, risks, investment risks and liquidity risks. Expressed broadly, an actuary is concerned with economic processes in which mathematical or statistical methods are used. Actuaries work particularly in insurance companies, but also in public authorities, consulting companies, surveyors or trustees. The department where they work is called an actuarial department. In German speaking countries there is no single job description of an actuary or training requirements. The professional name is also not protected. In other countries some occupational activities can only be carried out by actuaries with a special training. In other countries the membership of a professional organization is also required. For certain insurers because of legal requirements the Appointed Actuary is a required person, who has special legal duties in securing the financial integrity of the insurer and protecting the interests of the policyholders. This person must have the professional qualification of actuary and thus be a specialized and experienced insurance mathematician. In the Insurance Supervisory (VAG) requires insurances of thederiving person as Germany well as non-life and accident insurersLaw which have mathematical reserves from liability and accident insurance to employ an appointed actuary. He has the
Insurance practice and statistics
duties of guaranteeing the correct calculation of the mathematical reserve and the calculation of adequate insurance premiums. Moreover, in life insurance he makes proposals to the board of management regarding the distribution of the policyholders’ surplus. The institution of the appointed actuary is enshrined in the Insurance Supervisory Law (VAG, §11a). The following insurers must employ an appointed actuary: – Life insurers insurers (including (including pension pension schemes schemes and burial funds) funds) – Accident insurers insurers that offer offer accident insurance with return of of premium – Non-life / Accident Accident insurers with with annuity benefits benefits from accident accident and liability insur insur-ances. – Health insurers which provide provide comprehensive comprehensive tariffs that replace statutory statutory health insurance The appointed actuary must be reliable and have adequate knowledge of insurance mathematics and business experience. The appointed actuary is appointed or dismissed by the supervisory board, and if there is none, by “a suitably high authority” and must be nominated by the supervisory authority. The supervisory authority can demand that another appointed actuary be employed. Tasks of the t he actuary The appointed actuary has to guarantee that in the calculation of the premiums and the mathematical reserves the relevant legal regulations have been kept. This does not apply to burial funds and pension schemes, for which a statement according to §156a Abs. 3 Satz 5 VAG was not issued (“regulated pension schemes”), since in these cases the calculation is done according to the approved business plan. He has to examine the insurance company’s financial situation, whether the liabilities for the insurance policies can be fulfilled on a sustainable basis, and whether adequate equity capital is available at the level of the solvency margin. He has to confirm that the mathematical reserve in the balance sheet has been set up in accordance with the relevant legal regulations (insurance mathematical confirmation). (Exception: smaller associations associations in accordance with § 53 VAG). VAG). For burial funds and regulated pension schemes confirmation is required that the mathematical reserve is in line with the business plan. The appointed actuary has to explain in a report to the board of management (“Actuarial Report”) what the approach and assumptions are that underlie this confirmation. This does not apply to health insurers and regulated pension schemes and burial funds. In these companies the appointed actuary cannot “freely” determine the basis of calculation. In health insurance the fundamentals of the calculation of the mathematical reserve is based on legal regulations. The calculation of regulated pension schemes and burial funds is fixed by the business plan. Should the appointed actuary find that he is unable to confirm, or only in a qualified form, he hasalso in this to inform the board of also management under certain circumstances thecase supervisory authority. This applies toand circumstances which could prejudice or endanger the development or the portfolio of the company.
Dr. Georg Erdmann
The appointed actuary has to suggest a reasonable distribution of surplus to the board of management for the policies that are entitled to a distribution of surplus. This does not apply to health insurance. In the case of larger insurance companies the appointed actuary is generally either a member of the board of management or the head of the insurance mathematical department (actuarial department). Small insurers, e.g. many company pension schemes, do not have their own actuarial department. In this situation as a rule the consultant that works for the insurer provides the appointed actuary.
Fun unda dame men nta tals ls of cl cla aim ims s ha hand ndli ling ng
The expression “claims management” refers to the organized control of claims by insurance companies. Two meanings have to be distinguished: – Claims management management as a company controlling controlling task; task; in insurance insurance companies companies this term is popular as a name for the organizational unit (department, team), which establishes the work processes of the claims department. – Claims handling handling in the individual individual case. case. By claims handling the insurance insurance industry industry understands all activities in connection with the handling and settlement of claims (claims regulation). Claims management belongs to the business benefit processes and is an important part of the insurance production. It includes all business processes from the entry of the claim over each stage of the handling to the settlement or replacement. Process of claims management 1. Recording the claim – Excl Exclusio usion n of doub double le recor records ds – Acce Acceptanc ptance e of the claim claim notif notificat ication ion – Ope Openin ning g a clai claim m file file – Chec Checking king of the insur insurance ance cover cover 2. Dealing with with the claim – Obtaining statements statements from the policyholder policyholder,, the injured third third party, party, witnesses, witnesses, etc. – Under certain circumstan circumstances ces obtaining obtaining reports from from experts, doctors, doctors, etc. etc. – Che Check cking ing for fra fraud ud – Appra Appraisal isal of the claim claim by a clerk clerk 3. Claims regulation/S regulation/Settlement ettlement – Information of the policyholde policyholderr about the the result of the appraisal appraisal – Inst Instruct ruction ion to to pay or replac replace e – Re Rec cou ours rse e
Coinsurance and reinsurance by Dr.. Gerhard Mayr Dr
Dr.. Gerhard Mayr Dr
To minimize risks direct insurers and reinsurers work together. Already in the field of direct insurance a fragmentation of risks takes place in such a way that several insurance companies participate in a large risk, for example in the fire insurance of an industrial company. This procedure is called coinsurance coinsurance.. Reinsurance, on the other hand, is an insurance product for insurance companies. Reinsurance, That is, in this case an insurance company insures itself with another insurance company. This can be a specialized “professional” reinsurance company as well as another direct insurance company.
Coinsurance is the agreed participation of several insurers on a risk in such a way that each takes over a pro rata share of the sum insured or a certain amount. There are as many contracts as there are insurers. In the insurance policy the individual companies are listed by name with their shares. One insurance contract is thus concluded between the policyholder and each coinsurer for the respective share that is covered: that is, as far as the policyholder is concerned, each insurance company is regarded as a direct insurer. In the case of a claim the individual coinsurers are liable to the extent of their share of the total sum insured. Example: A manufacturing company is insured with a sum insured of € 100 MM. Using coinsurance five direct insurers take on the risk in such a way that one company participates with 40 %, two companies with each 20% 20 % and two companies each of which have 10 10 %. To facilitate the settlement of claims the leading company, usually that insurer with the largest share, conducts the negotiations in the name of the other participating direct insurers. A so-called leader’s clause is agreed, according to which the leading insurance company in the relationship with the policyholder is authorized to submit and receive notifications and declarations of intent. For its efforts the leading insurer generally receives a lead office commission or an overrider. The leadership clause or the trial conduct clause authorizes the leading insurer by name to regulate contractual matters, to receive premiums, regulate claims and under certain circumstances also to settle legal disputes with the policyholder on behalf of the other coinsurers. The lead office commission commission generally amounts to between 1 and 3 % of the other coinsurers’ premium share. The participation of the coinsurers on a risk is laid down in a schedule of distribution.
Coinsurance and reinsurance
Example: The following direct insurers participate pro rata on an industry fire insurance contract with a sum insured of € 16,500 6,500,000 ,000 at a rate rate of 1.4 1.4 ‰: A – 15 15%, %, B – 25 %, C (lead (lead office) offic e) – 30 30 %, D – 10 %, E – 20 %. a) Set up a schedule of distribution. Work out the individual coinsurers’ shares of the total sum insured and the premium (with and without insurance tax – notional tax rate 10 10 %). b) The lead office office C receives a lead lead office commission commission of 2% 2 % of the premium shares of the other coinsurers (without insurance tax). How much commission do the individual coinsurers coinsurers have to pay the lead office? Solution of a): The pro rata shares of the sums insured and the premium should be calculated from the total sum insured and the total premium respectivel respectively, y, using the given percentage rates for the shares of the individual coinsurers. coinsurers.
Distribution plan Distribution Premium without insurance tax
Solution of b): The lead office C receives as leader: … from insurer A B D E
2 % of 2 % of 2 % of 2 % of
Premium share without in insurance ta tax
Share of the lead of office co commission
Total lead office commission for Insurer C
69.30 € 115.50 € 46.20 € 92.40 € 323.40
Dr.. Gerhard Mayr Dr
Reinsurance is a unique security measure between insurance companies. Insurance business is based on the idea that in accordance with the principle of equivalence premium income, on the one hand, and insurance benefits and expenses, on the other, correspond so that a spread of risks is possible. Although the calculation is based on statistical information, a correct evaluation of the risk premium is not possible. The actual loss experience can depart considerably from the results as calculated. This possibility is called the underwriting risk. There are several reasons for it. Underwriting risk Phenomena Risk of random loss
Risk of change
Accumulation or catastrophe risk
Risk of error
The actual loss experience differs randomly from the anticipated trend. Moreover, unwanted fluctuations can occur because of the insurance of high risks.
For many risks the direct insurer has no or insufficient information on which to base a calculation. This inadequate basis of calculation makes it difficult to foresee structural changes in the risk profile.
A loss accumulation (e.g. (e. g. aircraft aircraft crashes, natural disasters) endanger the portfolio balance.
The premium calculation or the rating of the risks is based on erroneous calculations or estimates.
The purpose of reinsurance to reduce this insurance risk for the direct insurer. In this way theto greater stability and companies. security of the insurance business,reinsurers since theycontribute spread thetorisk several insurance Consequently, this enables a direct insurer to take over the cover for larger risks, too (industrial insurance or liability insurance for whole concerns). The direct insurer keeps only so much of the risk it has taken over for its own account as it can in accordance with insurance principles without putting its own portfolio at risk. Reinsurance is thus one of the most important ways of release for the direct insurer. The risk transfer takes place by concluding a reinsurance treaty. Its partners are known as direct insurer (cedant) and reinsurer. The acceptance of risks is known as active reinsurance or indirect business or business taken in reinsurance. In contrast, the outward transfer of risks is known as passive reinsurance. The original insurance relationship between the policyholder and the direct insurer is not affected by the reinsurance treaty: that is, the direct insurer alone remains responsible to thediffers policyholder for payments against the insurance In this way reinsurance fundamentally from coinsurance. (There thepolicy. policyholder has a direct claim against each of the coinsurer coinsurers). s).
Coinsurance and reinsurance
Insurance companies which only carry out reinsurance business are known as professional reinsurers. Direct insurers can also act as reinsurers in the market, however. In contrast to direct insurance there are no regionally limited reinsurance markets, because the supply and demand for reinsurance protection are traditionally internationally oriented and thus cross the borders of individual countries. internationally Reinsurance protection is required by both direct and reinsurance companies. Almost all direct insurers have to transfer part of their risks by means of reinsurance, but also reinsurers cover risks by means of further reinsurance (so-called retrocession) with other direct insurers or reinsurers. In this way, a large number of insurance companies participate participate in the risks. At the same time this fact explains the international nature of reinsurance, which serves the purpose of spreading risk worldwide (geographical diversifica diversification). tion). Important basic reinsurance terms Tranche Surplus
Extent of liability of a reinsuranc reinsurance e treaty Part of the the sum sum insured that exceeds the retention retention
Capacity Limit Line Deductible Quota share Cedant Cession Transferee
= = = = = = = =
Retention + surplus Extent of the reinsurer’s liability Retention in the case of a surplus treaty Share of the claim carried by the cedant Pro rata relationship Direct insurer Share of risk risk transferred from the direct insurer Reinsurer
5.3. 5. 3.2 2
Rei eins nsur uran ance ce for orms ms
The various reinsurance forms are distinguished by the type of contract. Facultative reinsurance relates to large single risks. The direct insurer that wants to take on this kind of risk or that has already taken it on, offers the reinsurer a share of it. The offer includes details of the policyholder, the type and size of the risk, the insurance period, the premium as well as the retention of the direct insurer. The term “facultative” means that the reinsurer is free to accept or reject the offer offer.. Thus facultative reinsurance involves case by case risk acceptance by the reinsurer, also frequently after other possibilities of gaining cover have been exhausted. Obligatory reinsurance constitutes the greatest volume of reinsurance business. It results in a stronger and longer term commitment between the contractual partners. In the case of obligatory reinsurance the insurance cover relates to the insurance portfolio as described in the treaty. The direct insurer is obliged to transfer certain risks to the reinsurer. In the same way the reinsurer promises to take over these risks. Obligatory reinsurance direct insurer reinsurance protection from the point of mandatorily time that theguarantees insurance the policy is concluded with the policyholder.
5.3. 3.3 3 5.
Dr.. Gerhard Mayr Dr
Typ ypes es of re rein insu sura ranc nce e
5.3. 5. 3.3. 3.1 1 Ov Over ervi view ew The types of reinsurance have developed out of the direct insurer’s purpose in taking reinsurance. It can happen that the direct insurer wants to avoid significant variations in claims experience and so gives up high sums to make the portfolio more well balanced. But it is also conceivable that the direct insurer only wants to transfer the claims burden to the reinsurer after a certain level. Reinsurance can be taken
on the basis of the sum insured
on the basis of the claims
Reinsurance based on the sum insured Claims based reinsurance (proportional reinsurance) (non-proportional reinsurance) The direct insurer invites the reinsurer to participate in a certain proportion of the reinsured portfolio: portfolio: i. e. premium, liability liability and claims are split proportionately between direct insurer and reinsurer.
The reinsurance benefit is defined by the level of the claim only. The reinsurer’s liability begins when the direct insurer’s deductible is exceeded. The reinsurance premium is negotiable.
22.214.171.124 5.3.3. 2 Propo Proportional rtional reinsu reinsurance rance (Reinsur (Reinsurance ance based based on the sum insured insured)) With proportional reinsurance the reinsurer’s participation is based on the sum insured, by the transfer of a quota share and/or the peaks of certain risks. This is called reinsurance based on the sum insured or proportional reinsurance, because the sum insured, premiums and claims are shared pro rata by direct insurer and reinsurer. In the case of a quota share treaty the reinsurer participates with an agreed constant percentage (quota share) of all the risks ceded to the treaty for its duration. This quota share (e.g. 10 10 or 25 %) determines the distribution distribution of the premiums and the claims. The purpose of a quota share reinsurance treaty is to reduce the fluctuations of the cedant’s small and medium sized claims, and thus to reduce the size of an insurance loss. The reinsurer participates with the same share on all risks in the insurance portfolio. With surplus reinsurance the reinsurer participates only on those risks whose sums insured exceed a certain amount. The insurer decides on the highest amount that it is prepared to accept as the retention.
Coinsurance and reinsurance
This retention is called a line. Its level is fixed by the individual companies in line tables. It depends on the capacity of the insurance company, the degree of danger of the individual risk and the particular class of insurance. That part of the sum insured that exceeds the retention and is ceded as reinsurance is called the surplus. The reinsurer’s obligation to accept is usually limited in that it takes over a certain number of lines (e.g. 10 lines). It follows from this that the direct insurer can give ten times the amount it keeps for its own account to the reinsurer. Surplus reinsurance serves the purpose of improving the balance of the insurance portfolio if there is great variation in sums insured (e.g. in industrial fire insurance). Example quota share treaty: A liability insurer has a quota share treaty with a reinsurer: quota share 30 %, Limit € 2 m: i.e. the reinsurer reinsurer accepts accepts the quota share share of maximally maximally € 2 m, even if the actual sum insured of the policy concerned is higher. The direct insurer can cover this amount facultatively (= from case to case) with a further reinsurance. Work out the reinsurer’s share of the premium and claim for the following treaties of the direct insurer: Sum insured A) € 600,000 B) € 1,200,000 C) € 2,500,000
390 € 810 € 1,240 €
84,000 € 360,000 € 1,600,000
Solution: Share of premium a) 30 % of € 390 b) 30 % of € 810 c) Rei Reins nsure urerr takes takes over over up to to a limit limit of € 2 m 30 % of 4/5 of the premium (= € 992)
117.00 € 243.00
Share of claims a) 30 % of € 84,000 b) 30 % of € 360,000 c) 30 % of 4/5 4/5 of of the the clai claim m (= € 1,280,000)
25,200 € 108,000 € 384,000 € 517,200
Dr.. Gerhard Mayr Dr
Example surplus treaty: For a household insurer there is a surplus treaty with a retention of € 100,000 (= 1 line). The reinsurer takes over € 500,000 (= 5 lines). In the direct insurer’s portfolio there are i.a. the following insurance policies: Sum insured
a) € 600,000 b) € 250,000 c) € 85,000 d) € 750,000
700 € 204 € 1,875
7,200 € 56,300 € 24,000
Work out for each policy the reinsurer’s share of the premium, liability and claims.
Solution: There is a corresponding reinsurance quota share to work out for each single policy Policy a): Proportionality Retention Surplus
Distribution of premium, liability and claims between direct insurer and reinsurer in proportion 1:5: Proportionality
Direct insurer Reinsurer
240 € 1,200 € 1,440
3,150 € 15,750 € 18,900
Coinsurance and reinsurance
Policy b): Proportionality Retention Surplus
Distribution of premium, liability and claims between direct insurer and reinsurer in proportion 2:3: Proportionality
Direct insurer Reinsurer
Policy c): Retention Surplus
€ 100.000 €
100.000 100.00 0 (no surplus, since sum insured < € 100,000)
Direct insurer carries premium, liability and claims alone
Policy d): Proportionality Retention Surplus
+ € 1 10 00,000 1 + € 150,000 (the amount by which the treaty capacity is exceeded) + € 5 50 00,000 2
Distribution of premium, liability and claims between direct insurer and reinsurer in proportion 1:2: Proportionality
Direct insurer Reinsurer
625 € 1,250 € 1,875
8,000 €16,000 € 24,000
Dr.. Gerhard Mayr Dr
Example Quota share + surplus treaty (mixed form) A direct insurer agrees in a quota share treaty a reinsurance share of 25 %, a retention from the quota share of € 80,000 (= 1 line) and as surplus 3 lines. Work out the reinsurer’s share of the premium and claims for an insurance policy of € 240,000. Solution: Since the quota share surplus treaty is a combination of a quota share and surplus reinsurance treaty, the calculation of the share of the premium and claims for the insurance policy must be done in 2 steps: Share of the Share of the Direct insurer Reinsurer 1st step (Quota share reinsurance treaty): Splitting up of the sum insured of € 240,000 pro rata for direct insurer and reinsurer: Sum insured € 240,000
2 nd step (Surplus reinsurance treaty) Division of the direct insurer’s quota share into the agreed retention and surplus
(Retention) € 8 80 0,000 Sum:
Direct insurer’s share: Reinsurer’s share:
(Surplus) € 100,000
80 8 0,000 € 1 16 60,000
Proportionality 1/3 2/3
For an insurance policy of € 240,000 the reinsurer receives 2/3 of the premium and pays 2/3 of the claims.
Coinsurance and reinsurance
126.96.36.199 5.3.3. 3 Non-p Non-proporti roportional onal reinsuran reinsurance ce (Reinsuranc (Reinsurance e based on claims) claims) In non-proportional reinsurance the reinsurer’s liability is determined exclusively by the amount of the claim. There is thus no proportional distribution of the individual risk and the premium required for that. Rather, a separately calculated premium is agreed for the non-proportional cover. In the case of excess of loss reinsurance the reinsurer pays that part of a claim that exceeds a contractually fixed amount. This amount that the direct insurer carries for its own account is called the deductible or priority. The reinsurance cover begins from this deductible. The reinsurer is liable only if the deductible is exceeded. Claims below this limit must be borne by the direct insurer alone: the reinsurer does not participate in them. The purpose of excess of loss reinsurance is thus to protect the direct insurer from large claims. The degree to which the reinsurer participates in a particular claim depends, therefore, on its size and is not already fixed as soon as the reinsurance treaty has been agreed, as is the case with surplus reinsurance. In the case of stop loss reinsurance the reinsurer does not cover the amount of a particular single loss which exceeds the direct insurer’s deductible but all the claims that exceed the direct insurer’s contractually agreed retention ratio. Consequently, the reinsurer is liable only when the claims expenditure of the direct insurer exceeds a certain loss ratio. A highest loss ratio is always fixed for f or the liability of the reinsurer. This form of reinsurance is called stop loss, because it limits a direct insurer’s total claims expenditure for the business year. It is especially important for classes of insurance that are subject to annually fluctuating claims expenditure, such as hail and storm insurance. The premium for excess of loss reinsurance is generally fixed as a percentage of the annual premium, which the direct insurer earns from the reinsured portfolio. Example risk excess of loss: For a risk excess of loss the following conditions apply: Direct insurer’s deductible € 5 MM; Reinsurer A takes over Layer 1 from the deductibe up to a limit of € 15 m, Reinsurers Reinsurers B and C take over the Layer 2 from € 15 m up to a limit of € 35 m with the same shares. Work out each reinsurer’s share of the following claims: a) € 4 m, b) € 13 m, c) € 27 m Solution: Claims Claim amount – Direc Directt insurer’ insurer’s s deductib deductible le (Max € 5 m per claim) = Subtotal – Liability of Reinsurer A (Max € 10 m per claim)
8,000,000 € 8,000,000
= (Total Liabilitmax. y of Rof ei€ ns 20 . Bm & per C (eclaim) ach 50 %)
– – –
Dr.. Gerhard Mayr Dr
Example stop loss: A hail insurer has agreed a stop loss with the following conditions: Retention 75 % of the annual premium for the portfolio; Stop loss maximally 50 % of the annual premium income following the retention. As agreed, at the end of the year the direct office reports to its reinsurer that the annual premium amounted to € 89,500,000. The year’s expenditure for claims: a) € 78,670,800 b) € 103,290,000 c) € 124,358,000 What is the reinsurer’s contribution to the year’s claims expenditure in the cases of a), b) or c)? Solution a): Claims expenditure for the year
– Ret Retent ention ion (75 % of of € 89,500,000) = Stop loss
67,125,000 € 11,545,800
The reinsurer pays € 11,545,800 of the claims expenditure for the year Solution b): Claims expenditure for the year – Ret Retent ention ion (75 % of of € 89,500,000 €) = Stop loss
The reinsurer pays € 36,165,000 of the claims expenditure for the year. Solution c): Claims expenditure for the year – Ret Retent ention ion (75 % of of € 89,500,000) = – Sto top p los loss s max. 50 % of € 89,500,000
= Share, which the direct direct insurer has to carry itself in addition addition
The reinsurer carries the maximum possible share of the stop loss payment of € 44,750,000. (The direct insurer in addition to its retention of € 67, 67,125,000 125,000 pays
Coinsurance and reinsurance
5.3. 5. 3.4 4
Othe Ot herr wa ways ys of at atom omiz izing ing ri risk sk
5.3. 5. 3.4. 4.1 1 In Insu suran rance ce poo pools ls An insurance pool is(direct a jointinsurers venture and for the atomization risk in which several insurance companies reinsurers) joinof together in order to carry risks collectively. The pool members undertake to bring all risks into the pool that meet certain criteria, in order to participate in all the business of the pool for their previously agreed shares. Each member participates in the risks covered by the pool only to the extent that its share has been previously laid down in the agreement. Each pool member takes on this share not only of risks which it has underwritten, but also of risks that have been brought into the pool by other pool members. Either a corporate pool member or a pool administrator has the responsibility for managing a pool. Expenses are divided among the members. Pool agreements serve above all the purpose of atomizing and collectively bearing risks that are new, especially dangerous or unbalanced. Thus a financially strong risk bearing community is created with large underwriting capacity. In Germany the following insurance pools exist at present: The German Atomic Insurance Pool (Atompool) Provides liability and property cover against perils connected with the erection and running of nuclear reactors and similar plants. Pharma Reinsurance Pool (Pharmapool) For the business of liability insurance of pharmaceutical companies in accordance with the German Pharmaceuticals Act. Until the end of 2003 there was in addition the German Aircraft Pool (for aviation insurance). 5.3.4. 5.3 .4.2 2 Fin Financ ancial ial Rei Reinsu nsuran rance ce Starting in the USA forms of reinsurance were developed that focus on annual financial statements, supervisory regulations, fiscal and financial targets. In this case the transfer of insurable risk is not in the forefront. Because the driving force behind it is financial and economic success, this form of reinsurance is called financial reinsurance. These types of reinsurance contract are constructed individually and generally “tailor made”. Investment income is explicitly and as a matter of principle taken into account in the price calculation, and as a rule over the duration of the contract, which is usually long, a balance of interest is found that is unique to each agreement. For these contracts to be recognized as reinsurance in accounting, supervisory and fiscal law, there must nevertheless be a minimum amount of risk transfer. A few examples of financial insurance are described below:
Dr.. Gerhard Mayr Dr
Funded cover The direct insurer sets up an interest bearing fund with the reinsurer, which is used for the reinsurance share of future claims. The fund can take on a negative value in the case of negative experience, so that the direct insurer has liabilities towards the reinsurer. Treaties that finance acquisition costs (especially in the field of life insurance) At the beginning a direct insurer can incur heavy expenses in acquiring new business for an insurance portfolio. By means of treaties that finance acquisition costs at this stage the reinsurance treaty is constructed in such a way that the direct insurer achieves a payment surplus and profit, which in the ensuing period is then repaid with interest to the reinsurer. Spread loss contracts With spread loss contracts the reinsurer provides up front financing of claims, which in the ensuing period is amortized by the direct insurer paying regular instalments. 5.3.4. 5.3 .4.3 3 Alt Altern ernati ative ve Risk Risk Tran Transfe sferr Parallel to classical reinsurance and financial reinsurance Alternative Risk Transfer (ART) is considered to be a third type of reinsurance. By ART is understood the financing of risks with non-traditional covers of the insurance companies. That is, in this case the insurance cover is created outside the insurance market by capital market investors acting as the insurers’ secondary risk carriers. In this construction insurance insurance risks are transferred into the capital market with original (Insurance Linked Bonds) or derivative financial titles (Loss derivates or insurance futures contracts). The repayment and/or the payment of interest of the particular financial instrument is made dependent on the development of a special loss portfolio (indemnity trigger) or a parameter that is external to the company (index trigger). These instruments are employed especially in the coverage of catastrophe risks (e.g. CatBonds), since in this way the underwriting capacity of the classical reinsurance reinsuranc e market can be considera considerably bly increased.
Sources Farny, Dieter: Versicherungsbetriebslehre. 4th Edition. Karlsruhe: VVW, 2006 Liebwein, Peter: Klassische und moderne Formen der Rückversicherung. 2nd Edition. Karlsruhe: Verlag Versicherungswirtschaft, 2009 Pfeiffer, Christoph: Einführung in die Rückversicherung: Das Standardwerk für Theorie und Praxis. 5th Edition. Wiesbaden: Gabler, 1999 Rockel, Werner; Helten, Elmar; Loy, Herbert; Ott, Peter; Sauer, Roman: Versicherungsbilanzen: Rechnungslegung nach HGB, US-GAAP und IFRS. 2nd Edition. Stuttgart: Schäffer-Poeschel Verlag, 2007
Cost accounting and results accounts by Dr.. Georg Erdmann Dr
Dr. Georg Erdmann
Tasks and terms
Cost accounting is company internal accounting which serves the purpose of capturing and allocating periodic loss of value caused by the production of business. In this connection only those costs are relevant that are actually directly related to the company’s business. External and extraordinary elements are not taken into account in cost accounting. In this way it serves the following purposes: – Control of the the efficiency of the business business process process and identification identification of sources of loss – Calculatio Calculation n of the risk risk premium (or (or fixing of the premium limit) limit) Cost accounting supplies information – for decid deciding ing on on future future plans plans – for check checkin ing g decisi decisions ons – for revie reviewin wing g perfo performanc rmance e – on the liquidity liquidity status of the insurance insurance company company (together with with the management) management) – for carrying carrying out compara comparative tive calcul calculation ations s Thus the information from the cost accounting constitutes an important controlling instrument for the management. In the case of results accounting the benefits are captured analogue to the cost accounting and are delineated both temporally and according to type of business. The accounting goal of results accounting is to calculate the benefits produced in an accounting period or the revenues gained in the market, as well as the offsetting of the benefits or revenues by the production of relationships to reference figures. The insurance company’s benefits are economic goods created by the employment and combination of production factors, irrespective of how they are utilized. They have a quantity component (volume of created benefit) and a price component (valuation of the volume). The following types of benefit and revenues can be distinguished: – Bene Benefits fits with within in the the compa company ny – Reve Revenues nues from from sold sold insuranc insurance e products products – Revenues not not derived from insurance products sold sold (especially (especially investments) investments) By setting up the costs and benefits accounting parallel to each other, the business success (profit) can be quantified by calculating the difference between costs and benefits, This makes an important contribution to the decision-making process and the achievement of plans. The capture and evaluation of the relevant business events is divided into three sub-
sections by the cost accounting:
Cost accounting and results accounts
In accordance with the criterion “accounting way of the costs” the following cost accounting systems can be differentiated. Irrespective Irrespective of the type of cost accounting system, the accounting way of the costs is broken down into three subsections. – The cost-type accountin accounting g stands at the start of of cost accounting accounting and and has the function of capturing and breaking down all the types of cost that have been incurred in the course of the particular accounting period. Question: Which costs have been incurred? – In cost centre accounting accounting the costs costs are allocated allocated to the business business areas (cost units) units) in which they have been incurred. This distribution is made in the course of the cost accounting and has a dual function: firstly, for cost control and to know what has influenced the costs it is necessary to know where the costs were incurred, and secondly exact unit product costing is only possible if the costs of those departments which deliver these benefits are allocated to the company products. Question: Where have the costs been incurred? – The purpose of product cost cost accounting accounting (cost accounting, accounting, unit product product costing, costing) is to calculate the unit costs of all goods and services created (unit costs). Question: Why have the costs been incurred?
6.1. 6. 1.1 1
Cost Co st-t -typ ype e ac acco coun unti ting ng
In an insurance company we distinguish between the following costs: – Personnel costs costs (salaries, social social costs, such such as the employer’s employer’s contribution contribution to social security, company pensions, holiday pay, sickness benefit, Christmas bonus, among others). The costs of the sales force (travel expenses, salaries, commissions) are often broken down into these items. – Costs for intermediaries (all commissions commissions to self-employed agents and brokers including allowances of all kinds) – Costs Costs of worki working ng capita capital, l, e.g. e.g. – Depreciation and amortization and repair costs – Running costs, e.g. costs costs of material and electricity – Rents for offic office e space, data processing processing systems, systems, motor and other working working capital – Miscellan Miscellaneous eous operating operating expenses, such as telephone telephone costs, costs, post, travel travel expenses, among other things – Taxes chargeable chargeable as expenses, e.g. e.g. for motor, motor, fire brigades and and value added tax. Claims expenditure for own account (after subtracting the shares of the reinsurer). Under this item payments and the loss reserves for the accounting period are recorded. – Reinsurance costs: they arise arise from the reinsurance reinsurance premiums premiums paid minus minus the reinsurance commission and profit shares. A further important type of expense are imputed costs. These are costs for which there has been no expenditure or another level of expenditure. Examples of imputed costs are imputed depreciation and amortization, imputed interest, imputed
rents and imputed risk costs.
Dr. Georg Erdmann
– Cost-accounting Cost-accounting depreciation depreciation and amortization: for depreciation depreciation and amortization amortization criteria are often relevant that are irrelevant for a calculation of material requirements and control accounting, such as the principle of balance sheet continuity as also fiscal criteria. Should a plant have been written off to a reminder value of € 1, for further book depreciations not permissible, if the plant is stillexample, in use. The fact of further use means,are however, that past even depreciations were too high and thus wrongly estimated. This can be corrected within the cost accounting, so that plants still in use can be accounted for, even if they have already been completely written down in the financial accounts department. – Imputed interest: interest: In the financial financial accounts accounts department department only effectively effectively payable interest is accounted. Thus interest is set off against borrowed capital only, and interest on owners’ capital does not apply. In cost accounting, however, imputed interest on the assets needed for the business and thus also the interest on the owners’ equity is accounted. The owners’ equity admittedly does not produce an effective interest payment, but due to the investment of the owners’ equity in the business, the possibility of using it for another external capital investment has been denied. – Imputed rents: rents: If the insurance insurance company pays pays no rent for the use use of its own prempremises, the cost accounting has to take imputed rents into account. This makes a comparison compariso n possible with companies or entities that do not have their own premises available. – Imputed risk costs: By setting setting up imputed imputed risks certain certain loss risks risks should be captured. In this connection imputed risk costs should be mentioned for which there is no equivalent in the financial accounts department (risk of loss of an investment) and such by which there is a premium oriented difference (credit risk, guarantee risk, etc.). Apart from insurance related risks other risks emerge out of the activity of the insurance business, business, such as the contractual risk, the investment risk or the portfolio risk. Within the framework of cost-type accounting the following terms occur: Fixed costs are independent of the production volume, whereas variable costs are dependent on the level of the output (or the degree of employment). Before a business can begin production, certain basic preconditions must be fulfilled (purchase or hire of equipment, setting up of an organization, etc.). Output (production) presupposes the creation of operational readiness. The creation of operational readiness produces costs, which are called fixed costs. Their level remains the same, whether 50 cars are turned out each day, or 2,000. Examples: – Rents (Rent must must be paid, irrespective irrespective of whether whether all members members of staff work or only half of them) – Pers Personne onnell costs costs for employ employees ees – Cost of working capital for depreciation depreciations s and amortizations – Interest for the use of borrowed borrowed capital (credit interest) interest) Variable costs are production related expenses, i.e. variable costs are costs which increase with increasing production. They are thus dependent on the use of the
capacity by the production of goods.
Cost accounting and results accounts
They vary with the volume of the output. Examples: – Pro Produc ductio tion n cos costs ts – Manufa Manufactu cturin ring g costs costs – Ma Mate teri rial al cos costs ts – Dis Distri tribu butio tion n costs costs Direct costs Direct costs are costs which can be directly allocated to a reference object (cost centre or cost object). Direct costs are the costs for material, wages, among other things, which are demonstrably used for a particular object, a single order or a special policy. Direct costs are usually variable costs, since they are caused by the production, of a product, for example. They could be avoided if this product were not manufactured. Overhead costs Whereas direct costs can be directly allocated to a particular cost object (proposal, policy), this is not the case with overhead costs. They cannot be allocated to a particular product, since they have been incurred for several products or for all products of the cost areas.
6.1. 6. 1.2 2
Cost Co st ce cent ntre re ac acco coun unti ting ng
In cost centre accounting the individual types of expense are spread over the cost centres in which they were incurred. Such cost centres are part of the business such as, for example, the purchasing, assembly, administration and distribution functions. The purpose of this accounting lies first of all in the cost control and cost organization and it also serves the purpose of determining calculation calculation rates, in order to allocate overhead costs to the individual products. Cost centre accounting inquires as to where the costs were incurred. Cost centre direct costs (e.g. staff salaries) can be directly allocated to the cost centres. Overhead costs (e.g. administration expenses, energy expenses and similar expenses) have to be allocated to the individual cost centres using a key. How cost centres can be set up a) Depar Department tments s or organiza organization tion of the the insurance insurance compan company y Important cost centres are intermediarie intermediaries, s, branch offices as well as departments of the head office. It is an advantage that the different types of cost are easy to calculate, being to a large extent direct expenses of the cost centre, as well as being easy to control. There are disadvantages in further charging the area costs
to the cost object, because the allocation connection is often not clear.
Dr. Georg Erdmann
b) Among the business functions are management, management, procurement, procurement, production production (business, claims, reinsurance), sales, administration and financing. This organization can be consistent with the structure of the organization if it conforms to business functions. It is an advantage that it easy to allocate the area costs to the cost objects since the allocation principles are easily recognizabl recognizable. e. There are disadavantages in allocating the types of cost to the cost centres if the structure of the insurance company does not match the business functions. c) Are Areas as of res respon ponsi sibil bility ity The allocation is advantageous if the productivity and efficiency are applied when the cost accounting is further developed to a planned cost calculation or if individual areas are managed as profit centres (independent profit areas). Type of cost units From an allocational point of view a distinctio distinction n should be made between a preliminary cost centre and a final cost centre. The costs calculated for the preliminary cost centre are not allocated to the cost object, but assigned to the final cost centre, which utilizes the products of the preliminary cost centre. The preliminary cost centre is thus something in which internal company products are used, which are used in the accounting period by other areas of the business. Consequently, the terms indirect cost centre and primary cost centre are used. The most important preliminary cost centres are staff divisions of all kinds, a large part of the administrati administration on areas (personnel, property management, internal administration) the temporary posts for special services. In large insurance companies the area technical equipment and installation, including IT, is usually treated as a preliminary cost centre. Cost centres in practice In practice cost centres are usually set up to reflect the actual structure of the company. This results in the following organization of the cost centre plan for a composite insurer or an insurance concern with a standard structure: Decentralized areas – Intermediaries, Intermediaries, further subdivided subdivided into into types of intermediary (agents, (agents, brokers) brokers) or according to other aspects – Own company company entities, if if necessary subdivided subdivided into departments as in the main main business. – Inspectorate, Inspectorate, further subdivided subdivided into into types of inspectorate (universal or or special inspectorates for intermediary support, acquisition, claims handling, individual classes of insurance, individual customer groups) – Clai Claims ms regul regulatin ating g offic offices es
Cost accounting and results accounts
Centralized areas (Head office) – Prod Products ucts and staff staff divis divisions ions – Manuf Manufactur acturing ing departments departments (insurance (insurance departments departments)) – Business for insurance for initial processing proclasses, cessing customer and renewal and processing, processing, further subdivideddepartments into functions, groups, regional areas – Claims departments, departments, further further subdivided subdivided into functions, functions, insurance insurance classes, classes, types of claim, customer groups, regional areas – Rein Reinsura surance nce depa departmen rtments ts – Sales departments, departments, usually usually includes includes the department department for sales force support support – Administration Administration departments, departments, especially especially personnel, personnel, property property management management and accounting (mainly preliminary cost centres) – Finance department including the investment investment department – Internal product departments (preliminary cost centres) – Technical equipment and installation, installation, including IT – Supporting services, services, e.g. typing typing pools, registry registry,, fleet, post room, telephone telephone and facsimile Allocation of the area costs The close of the cost centre accounting is the allocation of the area costs to the cost objects. In practice this is the most difficult cost accounting problem, since in this allocation step keys for the allocation of the costs have to be used to a considera considerable ble degree. Before the costs of the final cost centre are allocated, the costs of the preliminary cost centre are assigned to the final cost centre. For example, the costs for personnel and property management and the costs of the technical equipment and installation must be allocated, which generally happens with the help of keys (e.g. the costs of the personnel department according to numbers, IT costs according to time shares for the areas responsible for the assignment). The fact that some of the preliminary cost centres produce reciprocal products for each other can be approximately allowed for by means of a practical sequence of allocation steps. Those preliminary cost centres should be settled first which deliver to many other areas and whose cost amounts are high. In allocating the costs of the final cost centres, keys should be used that are customized for each company, provided they are not direct costs of the cost object.
6.1. 6. 1.3 3
Prod Pr oduc uctt cos costt acc accou ount ntin ing g
The unit costs of the business products are calculated by means of product cost accounting. The allocation of the direct costs to the cost object is direct, the allocation of the overhead costs being indirect over the bases of calculation in the cost centre accounting. The unit costs or also the manufacturing costs of a product are needed in the short-term profit and loss account and as the basis for the company
Dr. Georg Erdmann
From the management perspective the aims of product cost accounting are among other things the – optimization and control of the profitability profitability of the insurance insurance classes classes and investinvestments, by the product cost accounting preparing the data for strategic estimates of the contributio contribution n margins – calculatio calculation n of the premiums premiums for the insurance insurance classes classes – product sales sales decisions decisions (sell aggressivel aggressively, y, brake, stop products) These goals are achieved within the framework of cost object unit accounting and cost object time accounting. Cost object time accounting is accruals accounting, which broken down into products determines all the products and costs as well as the business result in the accounting period. Cost object unit accounting is individual specification oriented accounting. It establishes the manufacturing costs or production costs of the business product units (unit costs) and is thus the actual calculation. Types of unit cost Depending on the utilization of the benefits produced in the insurance company, a distinction is made between preliminary cost objects and final cost objects. Preliminary cost objects are internal benefits, which are designated for renewed use in the own insurance company and which are thus activated in the internal balance sheet and are written down in line with their expected useful life. This relates in the first instance to the conclusion of contracts and the sales force. In particular cases, the costs for a complete rearrangement of the administration, for an own IT programme and similar investments can also be dealt with in the same way. Final cost objects are particular products for the business market. They are first of all the types of insurance protection which are offered by insurance companies or concerns, and secondly products of the insurance company that have nothing to do with protection. Among these are in the first place the capital and rent utilization (investments), which are sold in special markets, as well as further benefits, such as management services in syndicate business, business management assignments for other companies, insurance intermediary services, intermediate businesses of other kinds and IT services for third parties. Above all, in the internal account the costs and revenues for byproducts in the form of different services should be ascertained with great care, so that their profitability is transparent. In practice, in accounting the non-insurance business is often mixed with insurance business, because they are to some extent produced by the same factors of production and in the same cost centres. Insurance contracts or insured risks as cost objects? The allocation of the costs to cost objects assumes that between the costs that have to be allocated and the cost objects there is a one to one allocation relationship. An examination of the productivity correlation in the insurance company shows that the correlations between elements of the factors of production, on the one hand,
and the services that are produced, on the other, are different.
Cost accounting and results accounts
The operating expenses, apart from commissions, are linked with respect to their origin to the individual insurance contracts: that is, their level is mainly determined by the features of the insurance contracts, irrespective of whether in the individual insurance policies one risk or several risks, large or small risks, are insured. For example, if there is a causal relationship between collection costs and a household policy as a whole, this is independent of whether this includes the fire peril or the five risks of the combined household insurance policy. Or: the costs for the preparation of a motor insurance certificate are almost completely independent of whether the policy covers only the motor third party liability or the insurance of partial risks. Or: the costs of claims handling in life insurance do not depend on whether a large or small sum insured will be paid out. The insurance contract constitutes a joint production of insurance protection consisting of subsets of different types and size. The costs are only calculable for the combined product: not, however, for its parts. It follows that product cost accounting for the capture of the operating expenses has to be carried out according to the types of insurance contract. The risk costs, namely claims expenditure, reinsurance expenses and imputed interest on the insurance liabilities and security, exhibit on the contrary a causal connection to single insured risks: that is, their level is determined by features of the insured risks without taking into account whether or not they are bundled together in few or many insurance contracts. In this way the cost of claims for combined household insurance policies can be allocated to the individual perils of fire, burglary, tap water, storm and vandalism. The reinsurance costs for a motor excess of loss treaty can be directly allocated, even if these are all bundled in an all risks contract. For the calculation of the claims, reinsurance and interest expenses the product cost accounting must be broken down according to the types of insured risk.
Dr. Georg Erdmann
Diagram of cost accounting in the insurance industry Types of cost
unit costs – di d irect costs
unit costs – ov o verhead expenses
cost centre EK
cost centre GK
primary cost centre costs
internal cost allocation (secondary)
primary cost centre costs
Problems in allocating costs 1. Despite complicated complicated assignment keys a causally justified justified distribution of overhead costs is only to some extent possible. 2. With simple assignment keys the allocation is relatively arbitrary (e.g. Departments. The different fluctuation – and consequently more work for the personnel department – is not taken into account). 3. Occasionally the costs are allocated according to the principle of financial viability. This principle contradicts cost allocation based on the principle of causality. (Principle of financial viability = a highly profitable class of insurance is allocated more costs – or: Class, for which the “cost matching” premium matches the risk and which is higher than the competition competition,, is “relieved” of costs). 4. The costs incurred must be broken down into non-recurring and recurring costs. The non-recurring costs (e.g. new business commission for life insurance) should be spread over the average policy duration. (The sum of the running costs and the annual share of the acquisitio acquisition n or non-recurring costs are the relevant operat-
ing expenses per year).
Cost accounting and results accounts
5. Problems also arise, for example, in connection with the cost allocation for combined and packaged policies (allocation of the costs for underwriting: for example, for a family protection policy). 6. A distinction must continue to be made between fixed and variable costs. The underwriting costs of a life insurance policy are broadly similar – irrespective of whether a sum insured for € 20,000 or € 80,000 is processed. The commission costs, however, depend directly on the sum insured. 7. The identification of operating costs costs is recorded in numerous items of the profit and loss account, because the expenditure (costs) are captured partly according to type and partly according to functions or business areas. (For example, salary expenses in expenditure for insurance business, for insurance claims and for investments). The total amount cannot be established, because parts of the operating expenses (for example, expenses for claims handling) are included in the item “claims expenditure”. 8. The net result of the operating expenses after withdrawal of reinsurance commissions and profit shares can distort the picture. 9. In many insurance companies a fixed extra for operating expenses is added to the risk costs. This means for low sums insured the operating costs are scarcely covered, for high sums insured the customer is burdened with operating costs that are much too high. Example contents insurance: Premium rate: 2.0 ‰ 1.2 ‰ risk costs = 60 % of the premium 0.8 ‰ operating expenses = 40 % of the premium 2.0 ‰ a) Sum insured € 50,000; Share of the operating costs € 40 b) Sum insured € 200,000; Share of the operating costs
For a sum insured of € 200,000 the policyholder pays a four times higher share of the operating costs than for a sum insured of € 50,000, because these costs increase proportionately with the sum insured. This is justified for new business and renewal commission, commissi on, because these expenses increase proportionately to the sum insured. The costs for the underwriting and policy issue processes will, however, hardly be four times those of a policy for € 50,000. Possible solutions – Suitable cost cost discounts are granted; there are no cost extras; extras; instead a minimum minimum amount applies. – The operating costs costs are divided divided into sum insured insured variable variable and sum insured insured fixed costs. (Commissions – variable costs – fixed costs). For sum insured fixed costs a fixed amount (unit cost extra) is allowed for.
Dr. Georg Erdmann
Example contents insurance: Premium rate 1.7 ‰ +
units costs extra
1.2 ‰ risk costs 0.5 ‰ operating costs (variable) € 30 operating costs (fixed) a) Sum insured € 50,000. The customer pays € 25 variable and costs – in total € 55
b) Sum insured € 200,000. The customer pays € 100 variable and € 30 fixed operating costs – in total € 130
Cont Co ntrrib ibu uti tion on ma marrgi gin n acc ccou ount ntin ing g
Cost accounting procedure Besides the three areas of cost accounting (cost-type accounting, cost centre accounting, product cost accounting) two cost accounting procedures have to be distinguished, namely: full cost accounting and marginal costing. Whilst in the case of full cost accounting all costs (direct costs and overhead costs) are spread over the individual cost objects, in the case of marginal costing at first only part of the costs – for example, only the direct costs – are allocated to the cost objects. The overhead costs are dealt with at the end in this case. Full cost accounting thus foresees a complete allocation of all costs onto the cost object. On the one hand, this is also its great advantage, since there cannot be any gaps which can be used to avoid cost controlling by those who do not want to take responsibility for costs they have induced. On the other hand, the result is that the distribution of overheads is only possible by breaking down costs. In doing this the principle of cost causality is inevitably violated, which can result in various strains in individual cost centres. This means that full cost accounting cannot deliver the basis for business planning. In marginal costing, as already mentioned, the distribution of particular costs, such as fixed costs, is waived. In the insurance industry contribution margin accounting is being increasingly employed as results oriented accounting on the basis of marginal costing. Features of contribution margin accounting Contribution margin accounting allocates only the direct costs and revenues that can be assigned to the cost centres and cost objects. The enterprise reports the overheads as a whole. In this way a more or less correct allocation of the overhead costs to the cost objects and cost units (= branches and insurance policies) is avoided with the help of keys. As reference figures (= headers) cost objects (products), cost centres and other
items can be chosen.
Cost accounting and results accounts
Controlling using contribution margin accounting – Control of periodical periodical contribution contribution margins margins for other allocation allocation bases. bases. Using the same procedure contribution margins can be calculated from insurance business with individual company groups, in certain sales areas, with branches and intermediaries. To do this, the allocation bases (headers of the contribution margin accounting) must be suitably changed. – Control of the periodical contribution margin of customer customer portfolios portfolios or individual individual insurance contracts. By using this itemization it is possible to control which contribution margins a business connection with a particular customer brings over a period of time. The contribution margin for only one accounting period is, however, hardly meaningful). – Premium decisions: decisions: The premium revenues revenues for the individual individual classes classes of insurance insurance must cover at least the calculated direct costs. Furthermore, the contribution margin should also cover part of the overhead costs. In the underwriting policy it must be checked on a case by case basis as to whether additional business brings a positive contribution margin. If this were the case, the overall results of the insurance company would improve, because an additional contribution margin would be available for the overhead costs. But if the premium for this business is not even sufficient to cover the direct costs that can be allocated directly, then this business must be declined. However, premiums and underwriting decisions must be made only for the individual case with the assistance of contribution margin accounting. If the insurer oriented its complete pricing policy on the contribution margin, the overheads would probably not be covered in the long-term. A long-term general premium policy is thus only possible with full cost accounting. – Programme decisions: decisions: If capacity capacity is tight – for the sales force or or for advertizing measures – contribution margin accounting can give good information. The insurer will then choose the class of insurance for more intensive sales and advertizing measures from which it can expect the higher contribution margin. Advantages of contribution margin accounting – A more or less correct correct allocation of overhead overhead costs to the cost cost objects and and the cost centres is avoided with the help of keys. – The overheads are mainly fixed fixed costs. If If the business business is shrinking, shrinking, in the case of full cost accounting individual contracts contracts have to be declined, because the share of fixed costs per cost object (= fixed costs per contract) increases without the premium being able to be increased – or the gross premium would be higher than the market premium and the business would shrink even more.
Dr. Georg Erdmann
Example: The fixed costs of an insurance company’s motor vehicle liability insurance are € 200,000. With 10,000 policies the fixed cost share per policy is € 20. If the number of policies decreases to 5,000, for example, the fixed cost share per policy increases to € 40 per policy: that is, the insurer would have to raise the premium. Then the number of units would presumably further sink. Summary Construction Constructi on of contributio contribution n margin accounting (Head office) Revenues per class of business – Dire Direct ct costs costs per class class of of business business = Contribution margin per class of business The overheads are not distributed, but shown together as a block by the insurance company. Total of the contribution margins – Ov Over erhe head ad cos costs ts = Insurer’s profit
Example: Contribution margin accounting head office (simplified) Relation Indusrevenues trial & costs fire
AgriSimple cultural busifire ness fire
Premium 80 revenues
Rest Total Investnon-life non-life ments
Investment revenues Total 80 revenues
Cost accounting and results accounts
Relation Indusrevenues trial & costs fire
AgriSimple cultural busifire ness fire
Depreciation & amor tizetion of new business
f.o.a. Reinsur- 20 ance expenses
Costs of working capital
Rest Total Investnon-life non-life ments
Business result = 336 – 314 = 22
Explanation This insurer offers only non-life insurance. The premium revenues (= directly allocated revenues) are allocated to the insurance branches. Then the direct costs, for €
example, of the of the industrial fire insurer ( there 4,000)is are allocated to this class. For the fireclerks insurance departmental management a total of € 1,000, for the whole of non-life (for example, board of management, non-life) non-life) € 3,000 for personnel costs. “Total fire insurance” and “Total non-life” have no revenues, since the premiums are allocated to the individual sub-classes of insurance. In the case of “Total fire/non-life” only the costs of the departmental management are shown. The intermediary expenses (commissions) are also distributed as directly allocated direct costs to the sub-classes of insurance. € 5,000 (under intermediary costs) could not be directly allocated. They are captured under “insurance company as a whole”. To this, office allowances could be credited to the agents. Belonging to the operating costs are, for example, depreciations and amortizations, repair costs, material and electricity costs, as well as office rents, IT plant, and so on. Here, too, direct costs (for example, € 2,000 for industrial fire) and overhead costs (for example, € 23,000 under “insurance company company as a whole) are differentiated.
Dr. Georg Erdmann
Contribution margin flow
– Direct Direct cos costs ts of of the the sub-classes
Contribution margin Contribution of the sub-classes – Direct Direct cos costs ts of of the the insurance classes – Cont Contri ribu buti tion on margin of non-life – Dire Direct ct co cost sts s of capital – Cont Contri ribu buti tion on margin of lines of business – Tota otall cos costs ts of of insurance co. Profit
–3 –4 66
80 – 58 22
Explanation The direct costs are subtracted from the directly allocated direct revenues of the sub-classes of insurance. The result (= € 73,000) is the contribution margin for the sub-classes of insurance. (Contribution margin = surplus from direct revenues and direct costs which should cover the overhead costs). If the direct costs of the departmental management are subtracted from the contribution margin of sub-classes of insurance, the contribution margin of the non-life line of business is obtained, a total of € 66,000. If the direct revenues (= interest, dividends, etc.) and direct investment costs are taken into account, the contribution margin for the classes of business is obtained (€ 80,000). This contribution margin has to cover the overheads (€ 58,000). This gives a business result of € 22,000.
Cost accounting and results accounts
Example of premium calculations: For contents insurance the insurance company has calculated a premium rate with a full cost account of e.g. 2 ‰. The contribution margin is 1.6 ‰: that is, with 1.6 ‰ the claims and direct operating expenses are covered. If the insurer in particular cases cannot achieve 2.0 ‰, it can go down to 1.6 ‰. But these policies then cover only the direct costs – not their share of overhead costs. If many policies between 1,6 1,6 ‰ and 2,0 ‰ are accepted, then the contents insurer will probably make a loss, since this class must also carry its share of the overhead costs.
Example for controlling customer relationships For example, the total costs of the customer Schulz have been observed over the last five years (premiums, commission and claims added together) Domestic buildings insurance Premiums – Commissions – Claims Contribution margins
– € 320 – € 9 9,,200
€ 1 1,,640
– € 7,720
The total contribution margin is tive.
Combined shop contents insurance
Trader’s combined policy
– € 2,880 – € 4,600
– € 1,440 – € 13,000
€ 1 16 6,520
– € 2,840
so that the development of costs is posi-
This accounting could be even more finely tuned if further direct costs were brought into it. In practice often only the premiums and the claims are accounted for, whereby large claims are capped.
Controlling by Dr.. Georg Erdmann Dr
Nature of controlling
The term “controlling” is often translated into German by the word “kontrollieren” “kontrollieren” (double-check), based on the English word “control”, and this is how the task of controlling is perceived. Controlling, however, does not mean to double-check, but manage, plan or supervise. Controlling is not geared to the past, as is accountancy, but is future oriented, in order to safeguard the long-term future of the enterprise. A company management that sets itself objectives needs a system that will enable it to – receive and evaluate information information about about the procedures procedures in a company company – plan and and manage manage with with this this informat information ion – supe supervis rvise e the compa company ny proces processes ses – recognize dysfunction dysfunctions s early early and react immediately immediately – learn from experience experience and incorporate the insights into the new planning and and management. Controlling is the totality of tasks which the co-ordination of the company leadership has as well as the supplying of the company management with information, in order that its objectives can be realized. Controlling supports the board in corporate management, especially in – plan planning ning and co-o co-ordin rdinatio ation, n, – the analy analysis sis of devia deviation tions, s, – the capture capture and and preparatio preparation n of informatio information, n, – the organizat organization ion of a comprehensi comprehensive ve reporting reporting system system – perfo performan rmance ce reviewin reviewing g and reporting reporting.. Sub-areas of controlling Controlling consists the four functional sub-areas information, planning, corporate management andofcontrol. 1. The information function should capture the communicative and directive connections between decision makers, makers, the totality of controlling tasks and the basis of information. 2. The planning function function consists consists of the sub-areas sub-areas – Supp Supply ly of the relevan relevantt control control instrum instruments ents – Strat Strategic egic defin definitio ition n of aims – Oper Operative ative defin definitio ition n of strategi strategies es 3. By corporate management is understood the objective orientation of company activity. Its main purposes are: – Supp Supply ly of contro controllin lling g instrume instruments nts – Provision of information appropriate for the level of the decision-makers decision-makers
– Co Co-o -ord rdin inat atio ion n
Dr. Georg Erdmann
4. The efficient employment of the above-mentioned corporate management instruments presupposes continuous control. The main focus of control is the comparison of the planned target with the current specifications using a comparison of the two figures. Where controlling can be used in an insurance company – Cost controlling controlling is the planning, corporate corporate management management and control of the costs incurred in company business activity that is undertaken to achieve company targets, especially the cost targets set. – Distribution controlling is the planning, planning, corporate corporate management management and control control of the sales organizations organizations whose aim is the realization of the sales targets. – Claims controlling controlling is the planning, planning, corporate management management and control control of the claims that occur. – Process controlling controlling means means those steps steps which are concerned with with making comcompany processes as focussed and co-ordinated as possible. From an organizational point of view controlling is usually institutionalized in insurance companies in the form of staff divisions or staff departments, which are under the immediate direction of the management. Because of its proximity to the directors the function of controlling is expressed as corporate management, as well as being important for the whole company.
7.2 7. 2
Stra St rate tegi gic c an and d op oper erat ativ ive e co cont ntro roll llin ing g
Depending on the time frame a distinction is made between strategic controlling (time frame long-term, three to five years) and operative controlling (time frame short-term, one month to two years). In the course of strategic planning the company management establishes the targets it wishes to reach in the longer term. This is a rough plan, lasting for a period of at least three years. Operative controlling, controlling, on the other hand, generally covers a business year. The short and long-term goals to be targeted are establishe established. d. The areas of activity of strategic controlling are – Participation Participation in the capture and further development development of the planning planning and corporcorporate management system – Service task. task. By service task task is meant the function function of controlling controlling to prepare decisidecisions: that is, to filter out the most important data and to prepare accordingly. – Security and controllin controlling g function. By By means of constant constant supervision supervision the company company processes and decisions are controlled so that the existence of assets / and the survival of the company are assured. The targets of operative controlling can be, for example: – Inc Increa reasi sing ng pro profit fit – Dec Decrea reasi sing ng cos costs ts
– Understandi Understanding ng the deviations deviations between planned planned and realized results results
For the targets aimed at plan figures are developed (for example, cost reduction by 10 % of premium collection). The plan figures for the near future can also be adapted from historical data. Furthermore, controlling accompanies target-focussed business activity and supports it with information and co-ordination.
Controlling ins instruments
Important controlling instruments are the following: – Performance figures figures systems: systems: performance performance figures are calculated calculated from the actual actual figures and these are evaluated. – Target/Actual comparison. comparison. Plan Plan data (target figures) are compared compared with the actual earned data and the deviations are examined. – Budgeting. The planning planning simulates target values in the form of of quantifications quantifications (for example, number of units of new business in a class of insurance) or values (e.g. reduction of claims expenditure in a class of insurance), which are then later compared with what has actually been achieved. – Information and and reporting systems. systems. Information Information about the the targeted goals is collected, evaluated and presented. Controlling instruments in insurance companies A performance figures system in insurance is a systematic collection of business indicators that is compiled either for the internal business comparison or for the comparison of entities (= branch performance indicators) or to control the business results. Besides the business performance figures about efficiency to be found in all companies, the performance figures relating to productivity and production are of great importance. As indicators of business changes, developments and results they indicate to the controller when and to what extent intervention is necessary. Basically, the whole cost accounting is suitable for cost controlling. Investment indicators can also provide capital controlling with information. For the insurance company, distribution and internal business indicators are important. The hit rate is the ratio of insurance offers to closed contracts:
Hit rate new business
Total acquisitions of new business * 100
Number of visits
Hit rate business in force
Total acquisitions of business in force * 100 Number of visits
If the insurer combines them, it obtains the total hit rate of its sales staff. The significance is limited, however, because the rate changes greatly with the (individual)
specifications specificati ons of the target visits.
Dr. Georg Erdmann
The cancellation rate is significant for the insurance company. It gives the ratio of the withdrawn policies to those taken out in an accounting period and directly affects the income of the sales personnel (new business and renewal commission). To prevent sales personnel forcing up their new business commission and bonuses by acquiring hazardous business, insurers grant these only for longer term business that is in force. The rate can be calculated by various parameters: parameters: for example, units or premiums. Cancellation rate of new business
Cancellation (unit) * 100
New contracts * 100 Cancellation rate of business in force
Cancellation Cancellatio n (premium) * 100 Business in force (premium)
The premium growth rate indicates to the insurer how its portfolio is developing from the beginning to the end of an accounting period. Using the example of motor insurance the following values are obtained (slice view): Development of private motor business Insurance Premium class vol. 1. 1.1. 1. Bus.. Yr Bus
Bus. in force cancellation in Bus. Yr Yr.. %
New bus. New bus. in Bus. cancellaYr.. Yr tion in Bus. Yr Yr.. € % 90,000 24,000 114,000
Premium vol. 31.12. Bus.. Yr Bus Yr..
Growth rate in %
Furthermore, a short term calculation of the growth rate can give the insurance agency an ongoing indication of whether the insurance target will be reached or not. The agency owner can then react before the year is over when his financial targets would be unattainable. For the area of cost controlling controlling the calculation of the administration cost ratio is important. It shows the relationship of the agency costs to the revenues and finds its logical conclusion in profit centre considerations, since here the responsibility for expenses and revenue are transferred to the agency. Only personnel and administration costs should be regarded as expenses, the revenues corresponding to that part of the renewal commission which is earned by customer service. The administration cost ratio is calculated as follows: (Expenditure for personnel + general administration) administrati on) * 100 Administration Administrati on cost ratio
Revenues from customer service
Example: From the cost accounting the insurance company has the following data: Expenditure for administration costs Expenditure for energy Salaries Social expenditure Expenditure for rents Expenditure for taxes
Administration Administratio n costs
227,400 * 100
32,000 24,000 14,000
Revenues from renewal commissions Administration cost ratio
372,250 So far the loss ratio has been ignored in considering the performance figures. The loss ratio is calculated as follows: Loss ratio
Total claims of business class in agency’s portfolio * 100 Premium volume of portfolio
Selected performance figures for sales management (using the example of a branch office) 1) Production output 1) – Target compa compared red to new busin business ess 1) – Clas Class s compari comparison son new new busine business ss 1) – Cont Contribu ribution tion margi margin n new busine business ss 2) Costs and profits profits 2) – Lo Loss ss ra rati tio o 2) – Ex Expe pens nse e rat ratio io 2) – Grow Growth th rate rate gros gross s premi premium um 3) Portfolio 3) – Comp Composi osition tion of port portfoli folio o 3) – Ave Average rage prem premium ium per contr contract act 3) – Can Cance cella llatio tion n rat rate e 3) – Cont Contribu ribution tion margin margin per contrac contractt / customer customer Balanced scorecard as a controlling instrument In the past few years the concept of the balanced scorecard, developed by Kaplan and Norton, has gained universal recognition. The balanced scorecard is an achievement-oriented and strategic management instrument that brings together qualitative and quantitative performance figures
from the perspectives of finance, customers/market, processes and members of
Dr. Georg Erdmann
staff. On the basis of a clear vision strategic targets are abstracted from these perspectives into a causal relationship with each other, as well as being operationalized and made quantifiable by performance figures. Aims of the balanced scorecard – Conversion of the company strategy into into measurable measurable targets. targets. – High degree of of transparency transparency and shared understandin understanding g of the strategy strategy (cause and effect relationships) and of the strategic aims at all levels of the company. – High degree of of acceptance, motivation and identificatio identification n by the members members of staff (promotion of the company culture) – Communica Communication tion of achievement-ori achievement-oriented ented results results and value drivers drivers – Impr Improved oved cust customer omer rela relation tions s – Incr Increase ease in comp company any valu value e – Effec Effective tive and effici efficient ent cultivat cultivation ion of the market market – Stra Strategic tegic manag managemen ementt of investme investments nts By “balanced” is meant theperformance equilibrium between short targets, monetary and non-monetary figures as welland as long-term between external and internal criteria. From this a holistic view of the company emerges. The word “Scorecard” indicates that the company is observed from the point of view of strategicall strategically y relevant reports. The balanced scorecard contains four perspectives for comprehensive corporate management: 1. Financial perspective perspective (Appraisal of the company achievement achievement from the investors’ point of view) 2. Customer perspective (Appraisal of the company achievement from the customers’ point of view) 3. Organization Organizational al and process perspective (Which processes processes are important for the company and how efficient are they?) 4. Learning and development perspective (How will the company’s long term success be safeguarded? – Personnel, IT, Organization) Solvency II as a requirement for the controlling in the insurance company Solvency II is a project of the EU Commission for a fundamental reform of insurance supervision supervisi on in Europe, especially of the solvency regulations regulations for the supply of equity th capital for insurance companies. On July 10 2007 the European Commission submitted a proposal to the European Parliament and Council for a Solvency II framework regulation. According to a directive regarding the relevant implementation regulations Solvency Solvency II will be implemented at a national level. As with Basel II (solvency regulations for the equity capital requirements for banks) there will be a 3 pillar concept. In contrast to the banks, however, the focus is not on single risks, but the concept is holistic with the focus being on total solvency. As well as quantitative aspects (Is adequate solvency capital always available?), qualitative aspects are also
considered considere d (Does the company have adequate risk management?)
The 1st pillar deals with the level of the minimum solvency capital, the minimum capital requirements (MCR minimum capital requirements) and the target solvency capital that has to be set up, the solvency capital requirement requirement (SCR) in relation to the deductible equity capital (eligible own funds). The 2nd pillar applies to the risk management system and above all contains qualitative requirements, such as the qualification of the board members of insurance companies (the so-called “fit and proper” criteria). The 3rd pillar regulates the reporting duties of the insurance company: the reporting duties to supervisory authorities (supervisory reporting) as well as information that must be published (public disclosure). With the reporting duties a close connection to other legal reporting duties should be attained, especially to other legally required reporting duties, such as that in the field of accounting, especially IFRS (International Financial Reporting Standards).