An insurance company or insurer is a company specializing in insurance, whose economic activity consists in providing a security service, covering certain economic risks (insurable risks) to economic units of production and consumption.
Its activity is an operation to accumulate wealth, through the contributions of many subjects exposed to unfavorable economic events, in order to allocate the accumulated wealth to the few to whom the need arises. It follows the principle of mutuality, seeking solidarity among a group subjected to risks.
This mutuality is organized on a business basis, creating an estate to meet the risks. The unfavorable effect of these risks, taken as a whole, is substantially lessened because, for the insurer, the individual risks are compensated: only a few insured persons suffer them, as opposed to the many who contribute to the payment of the coverage. This allows a statistical management of the risk, from the economic point of view, even if it is retained individually from the legal point of view.
Financial activity
Financial activity is one of the three pillars of the financial markets, together with the credit or banking market and the securities or financial instruments markets. Their strategic, social and economic importance means that they are subject to strict administrative supervision with their own rules of operation, control and inspection.
Captive insurer
There are insurers or reinsurers wholly owned by another organization, generally neither an insurer nor a reinsurer. Their primary purpose is to insure all or part of the risks of their parent company or business group.
Characteristics of insurance companies
Insurance companies, in order to be able to face any risk derived from their activity, must have sufficient financial resources and, consequently, the legislation imposes certain restrictions on them.In order to be able to face any risk derived from their activity, insurance companies must have sufficient financial resources and, consequently, the legislation imposes certain restrictions on them.
- Given the desirability of permanence and stability in this sector, legal regulations usually prohibit this activity from being carried out by individuals.
- In order to guarantee the solvency of insurance companies, the legislation rejects the possibility of these companies engaging in any type of activity other than insurance.
- The exercise of a financial intermediation activity that must inspire maximum confidence among policyholders and investors means that these entities are subject to State supervision and control, both for the start-up of their activity and for their development.
Technical principles
Insurance entities must take into account a series of technical principles that enable them to assume the coverage of risks.The insurance companies must take into account a series of technical principles that allow them to assume the coverage of risks.
Individualization
It is necessary to define and delimit each of the existing risks in order to classify them and be able to evaluate and group them.
Accumulation
According to the laws of probability, the greater the risk pooling, the smaller the failures between the theoretical probability and the number of claims.
Risk selection
Insurers should only accept risks that by their nature, it is presumed, will not necessarily give rise to unbalanced results.
Distribution of risks
Also called division of risk. The existence of the technical-insurance risk leads the insurer to the need to ensure that the risks assumed under insurance contracts are qualitatively and quantitatively homogeneous, so that the mutual or compensation principle is fulfilled. This can be achieved by distributing them over time (setting up reserves or technical provisions for claims deviations in economically favorable or positive years), geographically (only valid when their consequences are not significant), by operating in various classes and types of insurance (by compensating losses among them), among the insured (through deductibles or underinsurance -part of the indemnity is borne by the insured), or among other co-insured or reinsurance companies, or even by applying an appropriate risk selection policy.
With the possibility of distributing the risks assumed among other insurance and reinsurance companies, the quantitative homogeneity of the same is achieved, which is more easily controlled and put into practice than the qualitative one, since it is based on another fundamental principle for the insurance company, the principle of distribution or division of risks, indicated in a general way above but which is specified in that it is preferable for the company (under normal and uniform conditions) to underwrite a large number of contracts with a high sum insured (since in this case the deviations are greater). However, for the reasons stated above, the application of this principle alone is insufficient, given the degree of heterogeneity of the sums insured and the diversity of the risks assumed, and furthermore it cannot be generalized to all companies, since it will also depend on the volume of business, their assets, the amount or amount of reserves or technical provisions constituted, and the control (reduction of deviations) of their technical-insurance risk in short.
Technicalities and insurance contract
From the economic and financial point of view, insurance companies are financial intermediaries that issue insurance policies or contracts as a specific financial asset, obtaining financing through the collection of the insurance price or premium, and constitute the appropriate reserves or technical provisions (passive operations) while waiting for the payment of the indemnity or guaranteed benefit (insured sum), either because the indemnifiable damage or loss (loss) has occurred according to the subscribed contract, or because its possible occurrence is estimated by actuarial methods and procedures.citation.
The insurance technique is based on the prepayment of resources that are invested in the long term, setting up special reserves, the so-called technical provisions, which guarantee, when damaging events occur, the payment of claims indemnities. The aforementioned reserves or technical provisions are usually invested by insurance companies in real assets(real estate) or in other financial assets (securities, asset operations).citation.
By the insurance contract, the insurer or insurance company, upon receiving a premium as payment, is obligated to indemnify the insured as agreed, if the expected event occurs. All this must be clearly established between the insured and the insurance company in a policy or contract..
Technical provisions and solvency margin
Technical provisions
Technical provisions are those provisions that derive immediately from insurance contracts, since they are formed with a portion of the contributions of the insured and correspond to the future obligation of the insurer towards them. They constitute the most important item of the liabilities of insurance companies.
The basic reason for technical provisions is based on the need to accrue the income and expenses typical of insurance companies, charging to each financial year those that actually correspond to it. They guarantee the fulfillment of the commitments assumed by the company and although their functions differ according to the type of provision in question, as a whole they perform the same economic function of reinforcing the company’s solvency margin through their perfect constitution and allocation to the specific purpose to which each one, in particular, corresponds.
Insurance companies are obliged to establish and maintain at all times sufficient technical provisions for all their activities.
Technical provisions must reflect in the balance sheet of insurance companies the amount of the obligations assumed arising from insurance and reinsurance contracts. They are constituted for an amount sufficient to guarantee, in accordance with prudent and reasonable criteria, all the obligations arising from the aforementioned contracts, as well as to maintain the necessary stability of the insurance company in the face of random or cyclical fluctuations in the loss ratio or possible special risks.
Solvency margin
Insurance companies must at all times have a sufficient solvency margin in respect of their business as a whole. It shall consist of the assets of the insurance company free of any foreseeable liabilities and net of intangible elements. Consolidable groups of insurance companies must have at all times, as a solvency margin, a consolidated unencumbered net worth sufficient to cover the sum of the legal solvency requirements applicable to each of the entities of the group.
