How life insurance differs from general insurance

General insurance is sometimes also known as ‘non-life insurance.’ In terms of how these two different types of policies are similar and different to general insurance, purists would reasonably argue that these are, in effect, two quite different industries. It is unusual although not unprecedented for individual professionals to cross over from one to the other. The two are similar in that both are reliant on premium income, invest that income, and make provision for claims payment and administration. They differ however in terms of the long-tail nature of the policy with general insurers needing to manage their business on a much shorter cycle of time. Both may also be subject to misdescription, either innocent or fraudulent, in that each type of insurer is dependent on having an understanding of material facts (‘facts which would influence the underwriter and the terms or pricing of the policy’). Both may also potentially be subject to fraudulent behavior at the point of claim. Such behavior is perhaps more apparent in general insurance but can also show itself in life insurance. One version of life insurance is that of funeral insurance, where for a small premium the insurer funds the cost of funeral expenses. This type of funeral or ‘burial’ insurance is very old and there is some evidence that the Greeks and Romans even had a type of provision through ‘benevolent societies.’ In more recent times the so-called Friendly Societies also had cheap cover available. Burial insurance has also shown itself in the micro-insurance market. Micro insurance is a form of insurance designed and distributed for low income families in accordance with their wealth and conditions. With administration costs being necessarily low, claims are often paid based on the evidence of a birth and death supported by appropriate documentation, spawning a new industry of forged birth and death certificates. Both non-life and life insurers are vulnerable to major events. In the case of property, the impact of a major weather incident will give rise to many damage claims of varying types, complexities and values. In the case of life insurers, they too are concerned with major incidents especially where there has been loss of life. Generally, their greatest concerns are of an entirely different nature, typically events such as pandemics which cause widespread death. Examples of this might be Asian influenza or Ebola, although fortunately neither of these has proved to be a major problem for insurers (or the general public) in recent times.

The basis of life insurance is simply that in the event of the death of a person insured under the contract, a payment is made to an agreed beneficiary. Other versions of this exist, typically critical illness. The ‘life-based’ insurance policy often falls into one of two types – a protection policy which pays out a lump sum, or alternatively an investment policy. In an investment policy the intention is to grow the amount contributed either by way of regular payments or a
lump sum, and which through shrewd investment on the part of the insurer will result in the growth of the capital amount contributed. The insurer calculates the price of insurance taking
into account the costs to be paid, plus administrative expenses.

Insurance and finance

Insurance is heavily affected by a combination of social and economic factors, regulation, intensifying competition and customer behaviors. Different levels of insurance penetration arise by product, location and channel. In order to improve penetration levels, it is critical that insurers optimize their financial performance and improve their service flexibility, as well as increasing insurance awareness amongst their customers in order to indirectly improve on the financial security of their policyholders.
In its broadest context, effective financial management comprises:
Asset and Liability Management: Also known as ALM, this is the process which manages the risk undertaken by an insurer (or other financial institution) as a result of a mismatch between assets and liabilities, either as a result of an institution not being able to meet its liabilities or as a result of a change in interest rates. Beyond this, it is also used as a technique to coordinate the management of assets and liabilities so that an adequate return may be earned. It is also known as ‘surplus management.’
Reinsurance strategy: Reinsurance is insurance that is purchased by an insurance company either directly or through a broker as a form of risk management. This can assist in risk transfer, income smoothing or ‘surplus relief’ which allows them
to take new business when they have reached their solvency margin. In some cases, the reinsurer can underwrite business at a lower cost than the insurer due to special expertise or scale efficiency. The insurer is known as the ‘ceding’ or ‘cedant’
Capital management: The accounting process by which an insurer maintains sufficient levels of working capital (the ‘short-term’ operating resource of a company) to help them meet their expense obligations, typically arising in the claims process as well as maintaining sufficient cash flow.
Calculation of embedded value: This is a calculation of the value of a block of business. Differing from short-term financial management, the process of embedded value allows calculation of the long-term profitability. The embedded value of an insurer is a valuation of its current business rather than its ability to win new business, and is often used as the ‘minimum value’ of the business. Making an allowance for future business is known as ‘appraisal value.’
Reserving: Also known as ‘loss reserving’ or ‘claims reserving,’ this is the calculation of the future cash flows of an insurer taking into account the likelihood of future claims expenditure. The total liability of an insurer is the aggregate of the claims reserves of individual policies. Insurers are obliged to release assets to meet their claims obligations
and it is for this reason that accuracy of claims reserving is critical, especially in a major loss scenario. The process of ‘reserve releasing’ occurs when insurers believe they have over-reserved, and this has the effect of increasing insurer profitability. Regulators have expressed concern that by releasing reserves in order to boost profits, insurers endanger
their ability to meet claims.
Hedging: This is often considered as an advance investment strategy, where the insurers make an investment in the event of losses occurring in a ‘companion investment.’ For an insurer, it is a form of insurance against investment losses.