Insurance

Insurance

Insurers only insure pure risks, however not all pure risks are insurable. Discuss the ideal requirements of an insurable risk.

One of the requirements for insurable risk is that there has to be a high number of exposure units or homogeneous risks. Insurance companies depend on the pooling of resources, and then spreading these resources to cover the risks. Small group or individual exposure is not insurable. A risk cannot be insurable if it is an isolated case. Another requirement is that it must be an accidental loss, and it should not be intentional. The insured persons have to guarantee that they had no control of events and did not cause the events to happen in any way. Insurers want to know how the risk happened, and the insured has to show that he or she did not cause the risk in any way. The insured has to show that he was the victim. In some cases, the insurer takes a long time before determining the nature of the risk, and some of the cases are settled in court.

The other requirement is that the insurer has to be able to measure and determine the loss. The insurer has to determine the time that the loss occurred and the amount to be spent during the process. The insurer has to cover many expenses, including legal fees and license. Including all the risks enables the insurer to determine the full extent of the loss. The insurer has to know the time that the risk occurred. The other requirement is that the insurer has to be able to calculate the frequency and severity of a future loss.

The other requirement is that the loss is not catastrophic. This exempts insured people who have experienced losses at the same time, for instance during wars, earthquakes, and other weather related catastrophes that affect many people at the same time. Sometimes this causes a lot of tension between the insured and the insurer. The insured person feels that he or she deserves to be compensated for the loss that occurred since he or she paid the required premium. The insurer, on the other hand, does not recognize this. The insurer needs to educate the insured on such matters so that he or she knows what to expect. Another requirement is the insured person’s ability to pay for the premium. A risk cannot be insured if the person is not able to pay for it (Rosenbloom, 2001). One has to ensure that he or she can pay for the risk.
2. The general insurance industry is characterised by cyclical market conditions, alternating between hard and soft market conditions. Explain what is meant by this.

Like every other market, the insurance industry has periods of high growth, where it experiences renewals and high profits, and periods of slow growth, when it has to struggle to get business. Some economic conditions increase investment income, and insurers seize this opportunity trying to increase their business. They do this by reducing their rates and enforcing policies that are more flexible. This condition is called the soft market condition (Mannan & Lees, 2005).

The soft market conditions are characterized by low premiums. Insurance is more affordable during soft market conditions. Insurers are highly active during the soft market conditions, and they compete for businesses. They come up with attractive and competitive coverage lines with the aim of beating the competition. The soft market conditions enable organizations to have bargaining power and realize better rates because of increased competition. The soft market conditions are periods of creativity, as insurers struggle to introduce new products and services in the market. They become innovative, as they try to establish areas with the potential for insurance. Insurers do everything they can during the soft phase to guarantee that they retain their customers and that they acquire new clients (Herman, 2005).

The competition between companies and the reduced rates leads to a fall in profitability. During hard economic times, the insurers have to find ways to recover their investment income by increasing their premium (Mannan & Lees, 2005). During hard market conditions, the insurance industry faces increasing premiums and restrictive coverage. These premiums are not the results of the losses suffered by the insured person. In some cases, the buyer has to agree to higher deductibles, and the insurance carriers refuse to offer the limits of liability that the customer is willing to buy (Herman, 2005).

Hard market conditions are periods of high demand of insurers from customers and low supply from the carriers. The insurance companies do not compete for businesses at this time. Insurance companies undergo losses, and some may choose to leave a certain location or reduce and restrict their coverage lines. In dire situations, insurance companies may choose to close down due to the increasing losses it suffers.

In respect of the taxation implications of insurance products, answer the following questions:

(a) Explain the taxation implications of trauma insurance.

Trauma insurance is useful when a person suffers life threatening conditions such as cancer, strokes, and Alzheimer’s (Scriven, 2008). These conditions have to be serious enough to compromise the person’s current and future quality of life. They should have significant financial consequence. Many of the trauma conditions leave the patient in a poor state financially although the person might have medical insurance. This is because medical insurance does not cover trauma cases. The benefits paid for trauma patients cover their financial loss.

Trauma insurance premiums are not tax deductible if there are capital benefits received. However, if the employer pays the premiums, and he or she is the policyholder and the beneficiary, and if the policies advance the employer’s business, then the premiums are tax deductible (Hayes, 2007). When the employer pays the premiums, the proceeds are not subjected to the income tax. The person can use the trauma insurance for rehabilitation purposes, pay for ongoing nurse care, cover medical expenses, pay their debts, assist in adjusting to the new life, and other financial planning.
(b) In what situations are premiums for key-person insurance not tax deductible?

A key person is an employee whose loss would incur massive losses to the company (Scriven, 2008). The types of policies involved include a term or temporary life insurance, endowment, and accident insurance. Premiums for key-person insurance are not tax deductible if the purpose of the policy is not compensation for loss of profits. This happens when the insured uses the policy as an investment, or uses it to underwrite a business loan.

The organization is the beneficiary of the key person insurance, and it owns the policy. The law requires that the company intending to use this form of insurance informs the employee involved. The company can decide to declare the premiums as tax deductible if it charges the premium as a part of taxable income on the person insured. Permanent insurances used as a key person insurance do not qualify for tax deductions. In this situation, the proceeds are not assessable as income, regardless of how the insurance is used.

The payment is taxable if it is not received by the original beneficiary in case of a life policy. The authorities have to know and decide on the purpose of the policy. Premiums are not tax deductible if the policies are for capital purposes. The premiums are taxable if the company receives insurance benefits such as disability benefits. The premiums are not tax deductible if used for the purposes of providing funds to the key person’s debt. They are not tax deductible if they are taken out by the key person’s partner to pay for that person’s debts. The premiums are not tax deductible if they are meant to provide funds for the business.
(c) Explain the circumstances in which the 10-year rule for an insurance policy will be restarted.

Companies pay tax on insurance bonds before they declare returns. These bonds are beneficial for people earning high income because they are tax effective. The ten-year rule states that a person has to maintain insurance bonds for ten years before withdrawing the original amount of money invested and the accumulated tax earnings without being charged the capital gains tax or any personal income tax. The ten-year rule will restart, once a person stops and starts payments. Insurance bonds are taxed at a rate of 30%, and they are not reported on the investor’s returns.

The ten-year rule of insurance policy will restart if the holder misses one year of regular investments and then pays in the following year. The ten-year rule will also restart if one exceeds the 125% amount, which is the amount that a person can contribute to previous year’s amount (Financial Guide, n.d.). Failure to contribute the 125% for one year means that any amount that is contributed further will start the ten-year period again. The 125% amount makes the insurance bonds more tax effective. The ten-year period can restart if the investor chooses to increase his premiums or increase their contributions towards the investment. Additional investments are made to the bonds. These contributions are tax paid so long as the insured does not make any withdrawals.

Investors who hold the bonds for more than ten years can cash them in without having to pay any taxes. Investors can choose to leave the investment, and they do not have to cash it. They can also decide to sell their investment. However, when the investors choose to withdraw in the eighth year, they have to pay the marginal tax rates, and the amount is included as a part of assessable income. Proceeds from the investment can be used as life insurance, where the nominated beneficiaries will use the amount directly.

(d) Discuss the effects of arranging life insurance under a superannuation plan.

The superannuation fund enables a person to pay their premiums to the insurer from the balance in their fund. These contributions towards the premiums are tax deductible to some people, enabling them to save some money. The amount that a person pays for the premiums is less since it is paid using the before tax dollars, as the amount is not subject to marginal tax. Trustees with a superannuation fund may receive insurance cover irrespective of their reinsurance. The superannuation fund may arrange for the life insurance to provide the cover for its members. The employer contributes to the superannuation fund that offers minimum cover for life insurance.

Members who receive life insurance from their superannuation are not taxed. If the superannuation fund decides to take a life insurance cover with an insurance company, there is no need to pay for any goods and services tax (Cch, 2009). Superannuation increases the number of people with life insurance because it guarantees large volumes and encourages people to participate. There are no reasonable benefits limits that were a previous hindrance to people. Under the superannuation arrangement, the trustee does not have to pay much for policy costs. In some cases, one does not have to undergo medical cases when taking life insurance using superannuation.

Despite the benefits, members have to be wary of the contributions they make because it will decrease their retirement savings if the employer decides to cut the premium from the savings fund. The members may not be able to realize their retirement goals when this happens. When members contribute to the fund using their income, they get to save some money, because the taxable amount decreases. It might be more difficult for the beneficiaries, once the amount is in superannuation funds because of the complications involved in the process.

Explain the function of ratemaking in life insurance

Ratemaking determines the premiums charged for insurance. The rate has to cover the losses and earn some income for the insurer, in addition to covering expenses. The insurers guarantee that they are able to cover allocated and unallocated loss adjustment expenses. Moreover, they should ensure that they are able to cover defense and cost containment expenses, as well as adjusting and other Expenses. Other expenses that the insurer has to cover include taxes on premiums, licenses, fees, and commissions. The insurer has to remain profitable to be successful and to protect the insured against losses. However, legislation protects individuals by setting limits to what the insurers can charge as rates.

Ratemaking enables the insurer to avoid or prevent any losses that may occur. The insurer has to determine the most suitable rates since he can lose business when he implements high rates. He has to decide what is fair to consumers without seeking ways to exploit them. If the consumer sets rates at an extremely low price, he will lose his business since he will not have a way to cover all his expenses. This will limit him and the chances of expanding his business. Insurers need surplus for them to remain in operation. When the rates are low, the insurer has to use the surplus when covering the deficiency. Low rates are not attractive to investors who are interested in making profits.

Rates act as provision for contingencies, as they help the insurer in case of unexpected occurrences. Insurers should guarantee that the rates are stable. They should not change rates frequently, as they need to provide some stability for the insured. However, the set rates should be flexible enough to allow for any changes such as changes in the industry or legislation (Brown & Gottlieb, 2007). Insurers should revise the rates to ensure that they reflect the figures in the market and the industry and to guarantee that they remain fair.

References:

Brown, L. R., & Gottlieb, R. L. (2007). Introduction to ratemaking and loss reserving for property and casualty insurance. Winsted, CT: ACTEX Publications.

Cch. (2009). Australian master superannuation guide 2010/11. New South Wales, Australia: CCH Australia Limited.

Financial Guide. (n. d.). Insurance bonds. Retrieved from http://www.financialguide.com.au/guides-and-tips/insurance-bonds/

Hayes, T. (2007). Tax breaks can ease insurance pain. Retrieved from http://www.smartcompany.com.au/financial-services-and-insurance/tax-breaks-can-ease-insurance-pain.html

Herman, D. R. (2005). The Jossey-Bass handbook of nonprofit leadership and management. Hoboken, NJ: John Wiley & Sons.

Mannan, S., & Lees, P. F. (2005). Lee’s loss prevention in the process industries: Hazard identification, assessment, and control, volume 1. United Kingdom: Elsevier

Rosenbloom, S. J. (2001). The handbook of employee benefits. New York, NY: McGraw-Hill Professional.

Scriven, D. (2008). Guide to life risk protection and planning. New South Wales, Australia: CCH Australia Limited.