Sunday 12th December, 2004


Expanding risk insurance

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There is little flame atop the Alma Tunnel in Paris, France, which marks the site of an historic accident. The tour guide will tell you that the bus cannot stop, but you can glimpse the flame as you pass by. A Mercedes S-280, had crashed into the tunnel's 13th pillar, and three persons had died, among them Diana, Princess of Wales. Such is the risk exposure to loss of life and damage to property and person, from the commute, and royalty is not exempt.

Motor vehicle insurance policies cover loss to vehicles due to accident, theft and fire, as well as injury to persons and loss of life, and commonly include loss of use of the property.

The objective of such insurance coverage is to return the insured to a financial position similar to where he/she was before the accident. It is impossible for the insured to make a profit on the insurance policy if there is a loss. Any such profit is tantamount to fraud, and is punishable by law. Any chance of gain is speculative, and cannot be insured.

The role of the insurance company is to facilitate the transfer of the risk. The insurer accepts the risk, or shoulders the risk, based on what is called risk selection, or an underwriting process. The underwriting process seeks to determine whether the risk is standard, or not. Standard risks are accepted for a standard premium. Sub-standard risks may still be accepted with a rating. This is a premium that is higher than the standard rates. Alternatively, sub-standard risks may be denied altogether. In this case you will have to shoulder the risk of loss yourself.

Rates are determined on probability studies, and claims experience. The more property claims there are in a given period of time and/or geographic area, the higher the claims experience, and the greater the tendency for higher rates. Hurricanes and heavy flooding this year, have increased the volume of claims. The amount of claims will most likely exceed the calculated probability of loss to property, in a normal year. We can reasonably expect that next year, property insurance premiums will increase.

Mortality tables

With respect to life insurance, rates are determined on the basis of mortality tables. Mortality tables reflect the experience of death per thousand of population, in every age group, according to gender. Prior to 2004, mortality tables reflected ages up to age 100. This year, new mortality tables (not yet in use by insurers) have been published which push our life expectation above age 100.

However, this introduces another category of risk: the risk of living too long. The danger with that is that the pensioner now has a greater probability of outliving his/her accumulated savings, and pensions that are guaranteed for a fixed number of years.

Spouses or survivors are especially at risk since pensions are typically guaranteed for the life of the pensioner, but not the life of the spouse. Alternative provisions must be made for survivors who will live beyond the guarantee period. Note too that women as a group have been living longer than men. Therein lies another risk!

There are all kinds of risks! In 1996, TWA's Flight 800 crashed over the Atlantic, killing all 230 people on board. TWA had just recovered from Chapter 11 bankruptcy, and top executives were celebrating in London. The financial loss was immense, and TWA is not a player on the world market anymore.

Sometimes the risk exposure is just too great, risk transfer cannot compensate, and “big pappy” executives celebrating in London, also bite the dust.



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