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Covering insurance: Glossary of terms, concepts

In the lexicon of insurance, these two definitions often ring true:

UNTOLD DRAMA: How the insurance reporter sees the beat.

THE PLAGUE: How the rest of the newsroom views insurance.

That’s my effort to bring a little humor to the insurance beat, which can, at times, seem humorless and bewildering.  A good handle on the terms thrown around is a necessity to penetrate the fog. The Insurance Information Institute has a very good glossary for many of the most mystifying words. Plowing through it will give you insight into how insurers operate and maybe a few story ideas. Here are some tips on the most basic concepts:

RISK:  The insurance industry has many different ways of talking about risk, but it all boils down to the possibility a check will have to be written to a policyholder.

Flipped car

Police respond to a flipped car on a residential street in Olivette, Missouri. Photo by Flickr user lissalou66

A long-tailed risk is a claim that might not come due until years after the policy was issued. Medical malpractice, which usually entails lengthy litigation, is a long-tail risk. Life insurance has an even longer tail. Home and auto policies, on the other hand, are short-tail risks. Long-tail policies allow insurers to make more money on investments, but also require large reserves for future claims and therefore conservative investment practices. Without, the insurer has not one risk but two – financial risk on the asset side of its books.

RESERVES:  At the time the premium is paid, insurers need to set money aside to pay potential claims. They’ll need to beef up those reserves if there is a big event, such as a hurricane. This also is where there is the most wiggle room and the opportunity for danger- if a carrier understates its risk or dips into reserves (through a practice called releases) to prop up profits. More than one seemingly healthy insurer has collapsed overnight by understating reserves.

PROFIT AND LOSS:  Nothing will start a debate faster than what is and what isn’t profit. When insurers pay out more in claims than they collect in premiums, that is called an underwriting loss.

That doesn’t mean the insurer didn’t make a profit. Insurers traditionally have a small underwriting loss and make their profit instead off invested premium and reserves. Even losses are open to interpretation, as insurers commonly report their anticipated claims (including IBNR, claims they think may have been Incurred But are Not yet Reported), not their total payments.

POLICYHOLDER SURPLUS: This is the amount of money, over and above all obligations, that an insurer is required to keep for unexpected expenses and losses. State regulators have firm rules about the surplus capital required before a carrier gets a license, and sometimes a different amount to stay in business. U.S. regulators also require insurers to use a complex formula to determine how much capital they need to cover the risks they insure, as well as the ones in their investments.

This Mamaroneck, N.Y., street flooded in the aftermath of Hurricane Irene in August 2011. Photo: Andrew Dallos

This number is their Risk-Based Capital requirement. Generally property insurers must have twice their RBC (an RBC score of 200 stands for 200 percent), or they trigger regulatory scrutiny. A low enough RBC will require regulators to shut down the carrier. Important as the RBC is, it is not publicized. Hunt for it on an insurer’s annual financial statement.

PML: When financial rating firms grade an insurer, or reinsurers sell disaster protection to a property insurer , they want to know its PML. The acronym stands for Probable Maximum Loss. It is a number generated by computer models that estimate the losses from events such as earthquakes, hurricanes and even epidemics. Most often the focus is on the PML associated with a specific frequency of occurrence. This can be expressed as a percent chance, such as a 1 percent chance. More often, it is reported in terms of the expected frequency of a loss that large, as in a 1-in-100-year hurricane, or 1-in-250-year earthquake. That is NOT a 100-year hurricane, since a single company can experience a 100-year loss even in a small storm, if it strikes the right place. PML is cumulative, so a 1 percent chance over five years becomes a 5 percent chance, and so on.

About the Author

Paige St. John currently works as an investigative reporter for the Sarasota (Fla.) Herald-Tribune, specializing in property insurance, hurricane coverage and state politics, along with whatever disasters are thrown Florida's way. She is a recipient of the Pulitzer Prize and awards from Scripps Howard, Green Eyeshade, National Headliner and SABEW.

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