Insurance applies the principle of risk spreading. Losses are spread across a large universe of insured persons, and the profits arise from investing premiums pending payouts and from paying out losses in the hope that aggregate payouts will be less than aggregate premiums.
Insurance also applies the principles of risk shifting. To mitigate the risk of total loss, insurance carriers will reinsure their risk portfolio by entering into agreements with third parties. Pricing and risk allocation methodologies can reflect one or more of several possible reinsurance approaches, such as “treaty” agreements between insurers to shift a certain percentage of a certain class of risk portfolio to the reinsurer or “facultative” agreements that cover certain layers of risk (such as excess coverage over a liability threshold).
Insurance also applies the principle of risk recovery. In writing the policies, underwriters reserve the right (“subrogation”) to pay the insured person’s loss and then sue the person causing the insured loss.
Consumer insurance – for life and health insurance, homeowners and automobile insurance — is highly regulated. Consumer lines of insurance involve the law of large numbers and thus enjoy economies of scale for operational effectiveness.
Outsourcers assist with the needs of property and casualty insurers, life insurers, reinsurance firms and insurance brokers. Service providers assist insurers and brokers in several areas:
- Business Acquisition,
- Policy Administration,
- Claims Processing,
- Management Reporting,
- Regulatory Compliance; and
- Reinsurance.