Study Book Insurance I PDF

Study Book for the
Insurance Industry
Volume 1 Basic principles
A project of the East European Committee of the GDV
The study book consists of the volumes

Volume II Basic Principles
Volume II Classes of insurance
Published by the Berufsbildungswerk der Deutschen Versicherungswirtschaft

(BWV) e.V., in Munich on behalf of the East European Committee of the GDV
(GDV e.V.), Berlin
Responsible editors
Dirk Czaya
Petra Fleck
Katharina Hhn
Michael Theilmeier
Authors of this volume

Georg Erdmann
Gerhard Mayr
Esther Grafwallner
2010 Berufsbildungswerk der Deutschen Versicherungswirtschaft (BWV) e.V.

This book including its parts is protected by copyright.
Every use that is not expressly allowed by copyright law requires the previous
permission of the publisher.
Satz hgk:fotosatz Weingarten/Baden
Foreward
Foreward
This study book was initiated as a project of the German Insurance Association
(GDV). The authors, who have written the chapters on a voluntary basis, are experts
from the German insurance industry. The GDV makes this study book available to
partner associations, supervisory authorities as well as other institutions in countries where there is an interest.
The purpose of the study book is to enable the staff of insurance companies to
acquire a basic knowledge of insurance interrelationships. Complex facts are also
presented for new entrants into the industry. This book addresses staff who are
internally employed as well as those with customer contact.
The facts are based on European law and describe the implementation into German
insurance law in an exemplary fashion.
The study book, which is available in a German and English version, is divided into
the two parts:
Volume II Basic Principles
Volume II Classes of insurance
We hope that all readers obtain many insights as they read and with them much
success in transferring these to the workplace. We are grateful to all the authors for
their voluntary contribution to this work.
Munich and Berlin in August 2010
Contents
Contents
1
1.1
1.2
1.3
1.4
1.5
Basic principles of the insurance industry ......................................................

Risk management ...............................................................................................
Financial coverage of the risk ............................................................................
Classification of individual and social insurance .............................................
Importance of private insurance .......................................................................
Cost accounting ..................................................................................................
5
6
12
16
22
26
2
2.1
2.2
2.3
2.4
2.5
2.6
Organization of the insurance industry ...........................................................

Legal forms of insurance companies................................................................
Co-operation and concentration in the insurance industry ............................
Separation of insurance classes........................................................................
Structure of the organization.............................................................................
Organization of workflow...................................................................................
Methods of distribution in the insurance industry ..........................................
30
31
35
38
39
44
45
Legal basis of the insurance contract ..............................................................

Overview of the new German Insurance Contract Law...................................
3.1 Introduction .........................................................................................................
3.2 Legal sources ......................................................................................................
3.3 Insurance conditions ..........................................................................................
3.4 Persons involved ................................................................................................
3.5 Conclusion of the insurance contract ...............................................................
3.6 Commencement, duration and termination of the insurance contract..........
3.7 Duty to pay the premium ...................................................................................
3.8 Obligations ..........................................................................................................
3.9 The insurers duties ............................................................................................
3.10 Possibilities for the policyholders complaints and asserting his will............
52
53
54
55
57
58
62
71
81
85
89
92
4
4.1
4.2
4.3
4.4
4.5
4.6
Insurance practice and statistics ...................................................................... 94

Insurance risk ...................................................................................................... 95
Basic principles of the premium calculation .................................................... 97
Emergence and distribution of surpluses......................................................... 99
Insurance accounting ......................................................................................... 104
Insurance mathematics and actuarial science ................................................. 112
Fundamentals of claims handling ..................................................................... 116
5
5.1
5.2
5.3
Coinsurance and reinsurance............................................................................ 117

Functions ............................................................................................................. 118
Coinsurance ........................................................................................................ 118
Reinsurance......................................................................................................... 120
6
6.1
6.2
Cost accounting and results accounts............................................................. 131

Tasks and terms .................................................................................................. 132
Contribution margin accounting ....................................................................... 142
7
7.1
7.2
7.3
Controlling .......................................................................................................... 148

Nature of controlling .......................................................................................... 149
Strategic and operative controlling................................................................... 150
Controlling instruments ..................................................................................... 151
Basic principles
of the insurance industry
by
Dr. Georg Erdmann
Dr. Georg Erdmann
1.1
Risk management
Herr Otto Mller is the proprietor of a carpenters shop. He is thinking about what
risks threaten his business, his private home and himself. Basically, every entrepreneur and every private person must think about these problems. It must be the aim
to minimize such risks and if necessary to pay a premium to transfer them.
The planning, execution and control of security measures of all kinds is called risk
management. The choice of these words indicates that these risks must be controlled. It is necessary to recognize and then control them.
For private households risk management is simply part of housekeeping. In the case
of companies the responsibility rests either with the management or in special departments. It is important that the whole business and all the staff should be security
conscious. The starting point of all risk management considerations are the risks
and their consequences if they occur. It is necessary to analyze each risk separately
and consider if it can be controlled.
1.1.1
Security, risk, insecurity
Perils threaten security. In normal speech peril means the possibility that something economically unfavourable will occur. Instead of the word peril the term
risk is often used in the same sense. They are semantically basically the same. In
the science, however, three terms are used
Security (We know what will happen in the future.),
Risk (We can measure the occurrence of future situations with probabilities.),
Insecurity (We do not know what will happen in the future.) or (We cannot
measure the occurrence of future situations with probabilities.).
There are many different perils. They can lead to damage to belongings, strike
people down by illness and death, or lead to considerable claims for damages in the
event of carelessness.
Perils threaten:
People
Property
Pecuniary
by
damage, destruction, loss,

e. g. by
Unexpected financial
expenses for
indemnification
legal expenses
continuation of wages
after a fire
sickness
accident
death
disability
fire
burglary
machinery breakdown
tapwater
Basic principles of the insurance industry
For private persons and households, on the one hand, and companies, on the other,
there are different risks. Companies are also exposed to the danger of property and
pecuniary losses. More especially they are threatened by the so-called entrepreneurial risk, which includes the possibility that losses arise from the economic environment, from fluctuations in economic activity, from changes in the market and variations in customer behaviour.
entrepreneurial risk
uninsured
property damage
pecuniary loss
They are different depending on how they arise

Moral hazards
Physical hazards
are based directly on human behaviour

arson
carelessness when welding
dangerous driving
are generally not influenced by human

behaviour
lightning
natural disasters
1.1.2
Losses
The occurrence of a threatening event leads to a loss. Loss means, therefore, the
ascertainment or realization of the threatened peril.
Material damage
Intangible damage
is immediate financial loss for the

injured party
because of loss of assets
because of expenses incurred
affects the wealth directly because of

pain after an accident
loss of a close relative
Dr. Georg Erdmann
Material damage or financial losses can occur with a person or an object or with the
wealth as such. Accordingly, a distinction is made between bodily injury, property
damage and financial loss.
Bodily injury
Property damage
Pure financial loss
Injury or death of a
person
Loss, damage or
destruction of an object
Reduction in the wealth itself

(bad advice by a lawyer or
notary, which leads to financial
loss)
Property damage can affect the wealth of the aggrieved party in two ways:
Unplanned expenses
Loss of sources of income
replacement of household goods

motor vehicle repair
doctor and hospital expenses
death of the breadwinner

disability
unemployment
1.1.3
Analysis and control of risks
Loss prevention is an important task because of the many threatening risks and the
losses associated with their occurrence. A precondition for all security measures is
the timely recognition of risks (perils). The function of familiar street signs as danger
signals serves this purpose, for example. They warn of the need to be prepared for
the looming peril.
Risk avoidance is part of the security policy of the state to protect its citizens. There
are many legal rules to this effect: traffic laws, fire protection, commercial and
health police regulations.
But also every private person and every company is concerned to take measures
against threatening perils. As risk management such measures are of particular
importance in businesses, because technology, industrialization and scientific progress create new sources of danger all the time.
The analysis and handling of risk is generally called risk management. This approach consists of several stages. The process of risk management consists of three
different steps:
1) Risk analysis and evaluation
2) Handling of risk
3) Risk control
Re 1) Risk analysis and evaluation

In the beginning there is always a risk analysis. The carpenter has to examine which
perils threaten his business, his household as well as himself and his family members. This risk analysis process is composed of three different areas.
Risk analysis process
Risk recognition
Quantification of risks
Root cause analysis
It is only possible to get a grip on risks and deal with them if they and their causes
have been recognized. Consequently, the carpenter has to examine systematically
which events threaten his business. The following events are conceivable:
A fire destroys the building and the complete plant and equipment including stores of wood.
Valuable furniture is stolen
A storm strips off the roof and rain makes the wooden products unusable.
A valuable machine needed for the production is suddenly no longer available.
An important customer becomes bankrupt so that bills are not paid.
Not only the detection of possible perils is part of risk analysis but also the valuation
of the whole business. This is called the quantification of risks.
There are two ways of achieving this.
The carpenter will first of all inquire about the frequency of occurrence of particular
events. Have there been many fires in this business? How frequently have important
machines broken down? Has the workshop been plagued by thieves?
Furthermore, it is also very important to know what damage the individual risks can
cause if they occur. From this point of view they can be divided into three different
danger classes:
Catastrophic perils such as, for example, the complete destruction of the business
by fire
Perils that threaten the existence of the business, such as, for example, the breakdown of a machine or the failure of an important customer
Perils that do not threaten the continuation of the business, such as, for example,
the breakage of glass as a result of a storm
The measures to establish the level of the resulting damage are the reinstatement
costs as well as the loss of profits for the business. Besides the recognition and
quantification of the risks, within the framework of an analysis it is necessary to
establish their causes.
Risks can have their origins in the business itself, because, for example, there is a
lack of organization, the staff lacks risk awareness or the fire protection installation
is inadequate. But risks can also have their origins outside the business, as for
example, natural forces or the insolvency of important customers.
10
Dr. Georg Erdmann
Re 2) Dealing with risk

The most important task of risk management is to deal with the risks after they have
been analyzed. To this end appropriate wide-ranging measures must be decided on,
carried out and controlled. Dealing with risks is thus divided into three areas.
Dealing with risk
Alternative courses of action
Decision
Execution
After the proprietor of the carpenters shop has achieved a clear overview of the
situation by means of a risk analysis, with a risk management approach he can
choose between different courses of action. The master carpenter decides on the
following possibilities:
Risk retention
Risk avoidance or containment
Financial transfer of the risk
Entrepreneurs and private persons can retain the threatening risks themselves without taking any measures regarding their avoidance, containment or financial transfer. They assume that they will not be subject to the perils or that their occurrence
will not destroy their financial existence. Such a decision is very rare, because
everyone knows that businesses and all personal belongings can be completely
destroyed by fire or natural catastrophes.
Security and protection measures are possible alternatives by which the occurrence
of particular perils should be avoided or the degree of loss reduced. Since human
existence and the economy necessarily involve perils, there is no general risk exclusion. Rather, risk avoidance can only be considered for limited areas.
Preventive measures to avoid risk can only apply to the time before the loss occurs
as well as its subsequent containment. The laying off of risk by means of relevant
agreements with the contractual partner, splitting and spreading risk are also part of
risk avoidance.
Risk avoidance
Risk containment
by means of preventive measures
Risks cannot
be generally
excluded
For limited areas it is

possible to
transfer risk by
excluding liability
contractually
Split a risk by
sub-contracting
Spread risk
by distributing
the assets over
several types of
investment
Against the occurrence

of the risk (realization
of the peril)
Alarm system
Accident prevention
equipment
Inspection of
technical plant
early detection
measures
To contain the loss

(minimization)
Company fire
brigade
Emergency
power
generator
Detection and
rescue sytems
for traffic
accidents
Fire walls
11
Since risks cannot be entirely avoided and can only be reduced to a certain degree,
financial safeguarding by means of a series of early measures within the framework
of risk management is very important. The decisions with respect to these matters
very often consist of a combination of measures. Thus a business will, for example,
take the necessary safety measures against fire, burglary and accident, but also
carry part itself in order to save premium if necessary and to this end set up the
reserves needed, so that when a loss occurs it can be paid.
Re 3) Risk control
Subsequent to the stages of risk recognition and dealing with risk within the framework of risk control it is necessary to establish whether the desired targets could be
attained with risk management, in order to receive suggestions for improvement for
further risk management procedures.
Summary
1 Peril = Possibility of the occurrence of the loss
2
Nature of the threat
Persons
Property
Pecuniary
Reason for occurrence
Subjective preconditions
Physical preconditions
1 Loss = realization of a threatened peril

2
Types
Persons
Property
Purely financial
3 Results
unplanned expenses
loss of income
1 Need for security measures
2 Carrier: state, private persons, enterprises
3 Risk management route:
Dangers
Recognition
Avoidance
Reduction
Financial transfer (precaution)
4 Combination of different measures depending on the particular situation
12
1.2
Dr. Georg Erdmann
Financial coverage of the risk
Despite all safety measures the realization of perils and thus the occurrence of losses cannot be avoided. For this reason private households and economic enterprises are forced to take precautions to mitigate the economic effects by means of
complete or partial compensation.
There are different types of protection which can be employed by private households and economic enterprises. They differ according to their carriers and preconditions.
Possibilities for financial precaution
state benefit
individual self help
insurance
1.2.1
State benefits
State benefits can be claimed under certain circumstances in most countries.

The cases are very limited, however, because in a mixed economy the emphasis is
on each individual taking responsibility for making his or her own provision. Only in
exceptional circumstances should tax funds be employed for such purposes. Yet in
the event of catastrophes there is often a national programme to help the victims.
Incidentally, for social political purposes the state makes use of insurance, especially social insurance.
For individuals, private households and economic enterprises the following state
benefits are also of significance:
Subsidies
Provision
Social welfare
Measures to support the

enterprise in the form of
lost allowances, credits,
pledges and guarantees
Claims of a particular
group (especially civil
servants, soldiers, war
victims) because of the
fiduciary duty of their
employers
State support for those in

a situation of need, which
prevents them leading a
decent life and which they
cannot change by their own
means and efforts
The provision of these state benefits generally differs from country to country. So
for example, the social state in Germany is much more developed than in Great
Britain. The provision of state benefits is provided as a rule on the basis of certain
objective criteria to those who fulfil them.
1.2.2
13
Individual self help
The simplest means of individual protection for private persons and households is
saving. By consuming less, money is collected which is available for future financial
needs. However, savings can never replace insurance protection against the occurrence of uncertain events. Savings accumulate gradually and are not freely available, whilst at any time there could be a need for money to pay for losses.
Also enterprises are not in a position by building up reserves to have adequate
sums available to pay for the economic effects of losses. Such a procedure is economically unsuitable, because such risks are incalculable in the individual case. Furthermore, resources which might not be needed would be tied up inefficiently.
Nevertheless, savings and reserves are also a necessary form of protection in addition to taking out insurance. Not all private and business risks can, namely, be covered by insurance. The entrepreneurial risk is in any case only to a limited extent
insurable. There is no insurance cover, for example, for the replacement and renewal of objects subject to wear and tear, such as machines, clothing or motor vehicles.
Savings must also be available if a policyholder quite consciously does not completely insure against all possible losses. Whoever agrees to a deductible in motor or
health insurance achieves a lower premium by doing so, but in the event of an insured loss he must pay the amount that is not covered himself.
1.2.3
Insurance of risks
A very suitable and thus very widespread way of financial protection against contingent need, which becomes reality if the threatened peril happens, is insurance. It
provides benefits in accordance with the insurance classes if particular events such
as fire, burglary, storm, hail, sicknesss, unemployment or death occur. The extent of
the insurance protection depends on the particular legal requirements or by contractual agreement in the individual case.
The means to pay for the insurance benefits are provided by the insured by means
of premiums or contributions. All expenses have, therefore, to be covered by the
appropriate contributions. This financial procedure is called the insurance principle.
Insurance differs from saving or the building up of reserves in that its benefits are
not limited to the saved resources of the individual insured. Rather, risks are spread
over a large number of insureds.
Insurance is different from savings protection in that it is not limited to a narrow
circle of people who have a right to protection, and it offers not only to basic protection, but also complete indemnity. Insurance differs from social welfare in that the
claimants need for help is not a precondition and it offers complete compensation
for the economic results of losses.
Insurance offers complete insurance protection right from the beginning without
having to save the money that would be needed to pay for a claim. By paying his
premium the insured achieves a legal right to the complete insurance benefit that
has been agreed.
14
Dr. Georg Erdmann
Insurance can take two forms:

Individual insurance is an economic branch and is based on the principle of benefit and benefit in return. (Principle of equivalence)
Social insurance is a part of the states social policy and has the purpose of social
equilibrium by means of the contributions. (Principle of solidarity)
Financial protection
Forms
Need check
Financing
Saving
Protection
Social welfare
Insurance
No
No
Yes
No
Saving money
Tax revenue
Tax revenue
Contributions of the insured
1.2.4
Term of insurance
Insurance is characterized by the following features:

1. Covering a need for money
2. Uncertainty, but the need can be estimated
3. Spreading economic risk over many entities
Re 1. Covering a need for money
It is the task of insurance to place at disposal the means to cover a possible need
for money. This need is triggered by the occurrence of a threatened peril and the
necessity to compensate for the economic results.
The need that arises must be a financial need. That is, it must be quantifiable in monetary terms. This is always the case when there are economic losses such as the
destruction of assets by fire. Consequently, objects are not insurable for whose valuation there are no objective criteria, such as a family photograph or the letters of a
deceased relative.
The level of need which should be covered by insurance can be calculated in different ways. In this way a distinction is made between concrete and abstract need.
Concrete need
Abstract need
This depends basically on the size of

the loss that occurs (stolen items, car
repair costs, burnt down building).
It is decided by the policyholder himself,

in that he fixes the sum insured for life
insurance or daily benefits in the accident
or health insurance.
15
Re 2. Uncertainty, but the need can be estimated

The monetary need must be uncertain. The occurrence and extent of the insured
event must not, therefore, be known. It must occur fortuitously. Admittedly, everyone is exposed to perils: it is nevertheless uncertain when and to what extent they
actually occur.
An event is fortuitous,
if it is not known whether it will occur at all: e.g. a hailstorm or an accident,
if it is known that it will certainly occur, but the timing is uncertain, such as the
death of a person in life insurance.
An insurance company can offer cover for perils only if the need for financial compensation can be estimated. Consequently, certain statistical documents are needed
for the premium calculation.
Re 3. Spread of risks
Insurance is based on the assumption that the perils threaten all persons, households and economic enterprises, but that only a few of them will be actually affected. For this reason we speak of spreading risks in the community of policyholders.
The insurer takes responsibility for the individual risks in return for a premium,
whereby the total premium income must be sufficient to pay for the losses that occur and cover the expenses.
Furthermore, risks can be spread over time, for example, by setting up reserves for
the need to pay claims in the case of annually fluctuating claims experience, such as
in the hail or storm insurance.
Many persons threatened by perils

(policyholders)
Premiums
Insurance business
Paying out the insurance benefits to the policyholder or injured third parties
There must be a balance between the premiums of the policyholder, on the one
hand, and the claims benefits and expenses [of the insurer], on the other. This need
for a balance is called the principle of insurance equivalence.
Premiums
Claims benefits
Expenses
16
Dr. Georg Erdmann
To achieve a spread of risks insurance companies use the statistical experience rate
which is commensurate to the loss occurrence according to the values resulting
from the probability calculation. Using further insurance techniques other methods
are used to spread risk, such as safety loadings in the premium calculation, coinsurance or reinsurance. The provision of insurance protection is an entrepreneurial service. From a legal point of view insurance is a promise of a benefit for the contingency that an insured peril occurs.
Because this kind of service appears particularly complicated and intangible on
account of the mathematical preconditions and the need for a precise legal delimitation of the extent of cover, it is particularly important that insurance companies
and their staff perform their tasks in a consumer friendly way. The circle of persons
insured by an insurance company should not be called a risk-bearing community as
often used to be the case in the past. They are customers of the insurance company,
who must be treated as individually as possible.
Summary
Ways of providing financial protection
Saving:
Limited amount of money to pay for
losses
Social welfare:
Basic provision for emergencies
Insurance features
Cover of the need for money
concrete need
abstract need
Provision:
Number of candidates limited by law
Uncertainly about the assessment

of the need
Fortuity
Statistical documents
Insurance:
Economic effects of losses made up
from premiums
Spreading of risk over many entities

Coverage of the insurance benefits and
expenses by means of premiums
1.3
Classification of individual and the social insurance
1.3.1
Demarcation of individual and the social insurance
In most countries insurance is divided into the two large fields of individual and social insurance. There are considerable differences between the two areas. Considering the range, social insurance in Germany provides only basic provision. Furthermore, its purpose is restricted to the insurance of risks connected with the
workplace. For this reason statutory accident insurance covers only accidents at and
on the way to work, not accidents which occur in leisure time, while engaged in
sport or at home.
17
Individual insurance provides insurance protection in all the areas not covered by
social insurance. In addition, it is possible in some cases to avoid contributing to
social insurance by taking out a private insurance policy for example, for students
covered by statutory health insurance. Furthermore, individual insurance complements the benefits provided by social insurance and supplements them by:
Additional benefits to those of statutory health insurance
Life insurance to augment the statutory pension
Private accident insurance
Private long-term care insurance.
The interaction of individual and social insurance is especially clear with respect to
provision for old age. According to the so-called three pillar concept, their foundation is statutory pension insurance, company pension schemes and private life insurance. Life insurance in particular serves the purpose of extending and increasing
the basic cover provided by statutory pension insurance.
Summary
Feature
Social insurance
Individual insurance
Creation of
the insurance
relationship
According to law
Compulsory insurance
for occupations with a duty
to insure
Agreement by taking out

an insurance policy
Insured risks
Sickness, workplace
accident, disability,
provision for widows and
orphans, unemployment,
long-term care
(risks of the person)
All insurable perils

(natural and legal persons)
Legal form
Social insurance carriers

as institutions or public
corporations with autonomy
(participation of the insureds)
Private and public statutory

insurance companies
Premium rating
Depending on the income

of the insured
(principle of solidarity)
According to risk
and benefit
(principle of equivalence)
Benefits
Legally uniformly
determined
Freely negotiable
18
1.3.2
Dr. Georg Erdmann
Individual insurance
Individual insurance is understood as being the insurance sold by private insurance

companies. And so instead of the word individual insurance the expression private insurance is often used. In the field of individual insurance contracts are taken
out on an individual basis according to the needs of the individual case. The premiums are calculated by the companies on economic principles and are appropriate
for the risk as well as the benefit offered.
Private persons, households and companies seek protection within the framework
of individual insurance against the economic effects of the most varied types of loss.
This insurance cover is offered by many classes of insurance which are based on
legal and insurance techniques.
1.3.2.1 Classes of insurance
The word Versicherungssparte (class of insurance) can be explained by comparing insurance protection to a tree, in which the individual branches indicate the
insurance classes. Instead of Sparte the word Branch is also used, although this
expression should be reserved for the term Wirtschaftssparte (economic class).
It is difficult to get an overview of all the individual classes of insurance. Their number is large. Nevertheless, they are not all equally important. Some branches produce only a small premium income and are only sold by a few companies.
Breakdown of the gross premiums according to class of insurance 2007
Class of insurance
Life insurance
Private health insurance
Motor insurance
General liability insurance
Personal Accident
Buildings insurance
Legal expenses insurance
Contents insurance
Transport insurance
Gross premium in 1,000m

83.4
31.5
20.1
6.8
6.4
4.7
3.2
2.6
1.7
Source: German Insurance Association (Publisher): Year Book 2009 The German insurance
industry Page 51
Within a class of insurance, broadly similar risks are bundled together that are insured against the same perils. This aggregation makes it possible to calculate a fair
risk premium due to statistical documentation and to create unified policy terms and
conditions for each class of insurance, in which the extent of the insurance cover as
well as the rights and duties of the contractual partners are regulated.
19
Insurance of buildings and goods and chattels against the peril of fire = fire insurance
Insurance of persons against expenses in the event of sickness = health insurance
Insurance of persons against liability for indemnification = liability insurance
Insurance of contents against fire, burglary, robbery, vandalism, tap water, storm
and hail perils = contents insurance
Insurance branches are further sub-divided into types of insurance according to the
insured risks. In these cases they are subdivisions of an insurance branch. Several
insurance types create a branch of insurance.
Insurance branch
Insurance type
Motor insurance
Motor liability insurance

Motor hull insurance
Motor accident insurance
Liability insurance
Personal liability insurance

Public liability insurance
Professional indemnity
Liability for financial loss
Fire insurance
Simple fire insurance

Agricultural fire insurance
Industrial fire insurance
There are insurance companies which sell several branches together: for example,
the classes property and liability, accident and motor insurance. They are known as
multiline or composite insurers. Among them one has to distinguish between monoline or special insurers, which have restricted themselves to the sale of one class
of insurance. This specialization can be for strategic reasons (e.g. transport insurance) or be due to a supervisory requirement (e.g. life and health insurance).
1.3.2.2 How individual classes of insurance can be classified
The individual classes of insurance can be subdivided according to different criteria.
They can be classified according to the type of insurance benefit, the insured object
and the need covered.
Subdivision according to insurance benefit
Indemnity insurance
Fixed benefit insurance
Insurance benefit:
Compensation for loss.
The insurer has to replace the actual
loss, insofar as it is covered by the sum
insured.
Case of actual demand covered.
Insurance benefit:
Payment of the agreed sum insured.
There are no objective measures for
the insurance value.
Case of abstract demand covered.
20
Dr. Georg Erdmann
Example of indemnity insurance:

The policyholder insures an object worth 50,000 for 100,000. In the case of a total loss the insurer indemnifies only the actual loss of 50,000. If the policyholder
insures an object worth 100,000 for only 80,000, the indemnity is limited to the
sum insured, because he has only paid the premium for the lower sum.
Example for fixed benefit insurance:
The policyholder chooses a sum insured of 100,000 for the sum insured. There are
no restrictions if there is a claim.
Classification according to the insured object
Insurances of the person
Non-life insurance
Financial insurance
The risk consists of an

actual person. Financial
loss is indemnified.
Individually indicated
objects (buildings or
goods and chattels) are
insured in the insurance
policy. Single or several
perils can be insured.
The insurance relates to

the wealth as a whole,
not to single objects.
Reduction of wealth is
insured (e. g. because of
expenses due to a court
case or the liability
claims of third parties).
Life insurance
Health insurance
Accident insurance
Property insurance
Storm insurance
Household insurance
Liability insurance
Legal expenses
insurance
Credit insurance
1.3.2.3 Summary of the insurance classes of private insurance

Dividing insurance protection into insurance classes may cause gaps in cover for
the policyholder, which can be avoided by combined insurances. At the same time
they serve the purpose of simplifying the work, because only the acceptance of a
proposal and the issue of a policy are necessary. We must distinguish between combined insurance and insurance package policies.
Combined insurance
Insurance package policies
Coverage of a majority of perils on the

basis of one set of policy conditions in
an insurance contract. A new class of
insurance is created by this combination.
There is one premium rate. The policy
can only be cancelled as a whole.
Consolidation of several insurance

contracts on the basis of separate
general policy conditions for each of
them. For each class of insurance there
is a specific premium. The individual
insurance policy can be cancelled
independently of the other covers.
Examples:
Comprehensive household insurance
Comprehensive building insurance
Examples:
Family insurance as a bundle of
household, personal liability and
accident insurance
21
System of insurance classes

Indemnity insurance
Actual need for cover
Indemnity
Bodily
injury
Medical
expenses
Property
damage
Fire
Fixed benefit insurance

Abstract need for cover
Sum insured agreed
Financial
loss
Liability
Amount
Life insurance sum
Recurring
benefits
Daily benefits
Summary of insurance classes

Single proposal and one insurance policy
Combined (linked) insurance
Insurance package policies
One insurance contract

One insurance class
Several insurance contracts

Several insurance classes
1.3.3
Social insurance system
Besides private insurance in many countries, there is also a statutory social insurance system, which is either financed out of contributions or tax. In what follows
such a social insurance system will be explained using as an example the Federal
Republic of Germany.
In contrast to private insurance, social insurance is a part of social security in the
Federal Republic of Germany. In this way the state pursues it socio-political aims.
Consequently, alongside the insurance principle social insurance includes elements
that have nothing to do with insurance, such as, for example, statutory grants. As a
matter of principle social insurance has its roots in the contract of employment. The
insurance relationship occurs as a rule because of the law or because of certain
labour law or occupational features.
The individual branches of social insurance are regulated in a relatively complicated
way by a large number of legal provisions. They can be distinguished by five important features, however:
compulsion
labour protection
principle of solidarity
non-cash benefit
propagated by the social insurance carrier
Compulsion
For those in employment social insurance is usually compulsory. The start of the insurance relationship and the extent of insurance protection are legally prescribed
(compulsory character). This regulation serves the purpose of protecting the insured
and the social balancing process.
There is, for example, voluntary insurance for persons who are not compulsorily
insured within the statutory health insurance, because they have exceeded the
income limit.
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Dr. Georg Erdmann
Labour protection
Social insurance is restricted to covering certain risks of the person in connection
with work, such as health, accident at work, disability, unemployment and long term
care.
Contributions
The insurance benefits are paid for in the first instance by the contributions of those
insured and their employers, in part also by the employer alone. The insurance principle is broken by means of state allowances. The contributions are not levied in
accordance with the principle of equivalence, but according to the principle of solidarity in line with the income of the insured, so that a redistribution takes place.
Social pension insurance is based on the solidarity of the generations (generation
contract). The generation in work pays contributions in the expectation that the following generation will take over the same duty to guarantee the pensions.
Benefits
The purpose of social insurance benefits is in the first instance the recovery/restoration and the commitment of the labour force. In the forefront is the principle of payment in kind in the form of health insurance or the provision of therapy in the accident and pension insurance. In contrast, private insurance provides its benefits
mainly in the form of money payments.
Social insurance carriers
Social insurance is conducted by special social insurance carriers on a legal basis.
It is subject to the principle of self administration, which is carried out in the committees appointed for that purpose, which are comprised of those insured and the
employers. Legal action can be taken in the social courts against decisions of the
social insurance carriers.
1.4
Importance of private insurance
Insurance fulfils important economic tasks. Microeconomically it safeguards the

existence of private households and companies. Macroeconomically it provides
them with the unhampered continuation of the economic process.
1.4.1
Microeconomic importance
Private households and companies take out insurance policies, because they expect
that insurance protection will bring them advantages and thus economic utility. The
insurance protection constitutes an economic good that has a value as a market
benefit. It is a necessary safeguard, which transfers to the insurer the risk of negative effects on current sources of income and investments.
23
Insurance offers the possibility of independent provision, for which savings and
reserves would be inadequate. Furthermore, insurance protection is generally cheaper than always having to have resources available to cope with particular events.
With respect to the microeconomic importance of insurance, considerations of customer orientation must govern the form and development that the contractual relationship takes.
Risk transfer
By taking out insurance, private households and companies transfer particular, precisely defined risks to the insurer. In the first instance, the importance thus lies in the
reduction or removal of dangerous situations and the generation of security.
For companies the risks thus become calculable and the premium is factored into
the calculation of their products. The delimitation of the perils by this means enables companies to concentrate on those risks that are not covered, such as the
distribution risk.
Equalization of risk
If an insured peril occurs, the economic consequences of a loss of wealth are materially compensated for. Private households and companies are put in the same
position as if the insured claim had not occurred.
Example:
Property insurance makes the money available to rebuild a burnt down building as
well as to repurchase damaged or missing objects. Liability insurance frees the policyholder from his duty to provide compensation.
Financing
Private households and companies must offer collateral when they take up a credit.
Objects used to provide security for financing, such as buildings or vehicles, can
only serve this purpose if they are adequately insured. It is thus insurance that enables foreign capital to be taken up. In this connection a life insurance policy also
constitutes an important collateral for a personal loan.
A prerequisite for the financing of companies is that creditworthiness only exists
if the usual volume of insurance protection is available. In this way creditors and
shareholders can be offered increased security.
1.4.2
Macroeconomic importance
In the macroeconomic system insurance has an important position alongside productive industry and trade. Insurance is a service, the effects of whose benefits are
not restricted to private households and enterprises, but are also of importance for
the whole economy.
24
Dr. Georg Erdmann
Economic process
Insurance ensures that a loss is usually confined to the area of the policyholder and
does not affect other persons or businesses. The primary loss is thus localized and
the consequential damage for other economic entities is avoided. To this extent insurance prevents an interruption of the economic process. An uninsured loss in an
industrial enterprise would have a deleterious effect on creditors, suppliers and customers. Continued employment is not only guaranteed in the company directly
affected, but also within its sphere of activity.
Creditors
Suppliers
Fire in an industrial enterprise
Customers
Employees
Due to the concentration of the loss on the insured business insurance reduces the
susceptibility of the whole economy to negative effects and enables the uninterrupted continuation of management in an economic sense.
Discharge of the state
Insurance absolves the state and thus the public from the need for tax relief if a loss
occurs. For this reason public authorities have an interest in a functioning insurance
industry. They would otherwise have to take frequent action to prevent interruption
of the economic process and to relieve the labour market. Thus the state assists the
insurance industry by means of tax relief for insurance premiums and the introduction of compulsory insurance for certain risks. The aim of these measures is to protect the general public from unforeseen burdens.
Reservoir for capital
The insurance industry creates a reservoir for capital that is filled by the policyholders premiums. Since the premiums are paid in advance and in the case of life insurance saving and insuring are bound up with each other, insurance companies
have considerable sums to invest. They flow especially into promissory note bonds,
commercial papers, credits on real estate and property. With these funds particularly housing construction, industry and the state is financed. In this way insurance
companies contribute to the promotion of the economy and to the increase of the
national income.
25
Capital investments of insurance companies

Promotion of
Housing construction
Industry
State
Economic result:
Promotion of investments
Creation of employment
Demand for goods and services
Increase of the national income
Promotion of technical development

The insurance industry encourages technical development and the adoption of new
methods of production. It takes over the associated risks and in this way supports
the willingness of the economy to invest. Certain technical facilities such as energy
plants as well as modern road and air traffic could not be realized without suitable
insurance protection.
Social function
Finally, the protection of injured third parties by liability insurance is of great social
importance. There is a close connection between this and the promotion of technical progress. In many cases traffic victims and other injured parties could not assert
their claims for compensation against the injuring party if the latter were not insured. Consequently, liability insurance serves to protect the tortfeasor by freeing
him from the claims of third parties, as well as the injured party, who otherwise
would often not be indemnified. Motor liability is an important example of this,
which every owner of a motor vehicle is legally bound to take out.
Summary
Microeconomic importance
of insurance
Macroeconomic importance
of insurance
Continuation of the economic process

Freeing the state from providing benefits
Financing of the public purse and the
economy
Promotion of technical progress
Protection of injured third parties
Assumption of risks
Payment of claims
Facilitation of financing
Enabling the concentration on
risks that are not covered
26
Dr. Georg Erdmann
1.5
Cost accounting
1.5.1
Purpose of cost accounting
The purpose of cost accounting is to record systematically, control and consolidate

into information the money and the flow of money of an insurance company that is
engendered by the company value chain. Cost accounting thus achieves internal
and external tasks.
External cost accounting tasks
Reporting to creditors and shareholders about business success, liquidity and creditworthiness
Reporting to the public and the state about the safeguarding of jobs and the economic policy
Basis of assessment for tax purposes
Internal cost accounting tasks
Documentation of the course of the business
Controlling the cost effectiveness
Control of the financial equilibrium
Basis for operational decisions
1.5.2
Organization of cost accounting
Depending on the different task priorities there has developed a number of organizational possibilities
Financial accounting and the balance sheet
Cost and activity accounting
Budgeting
Operational statistics and comparative calculations
Cost
accounting
Areas
Financial
accounting
Cost
accounting
Budgeting
Operational
statistics
Primary
task
Documentation
Allocation
Allocation
Sundry
Operand
Wealth/Capital
Expenses/Earnings
Costs Operating
Performance
Income
Outgoings
Sundry
27
The four branches of cost accounting differ fundamentally from each other with
regard to contents, but they are associated with each other, they complement each
other and they are in part constructed on each other.
Bookkeeping
Bookkeeping creates the prerequisites for the compilation of individual bills and
together with these the accounting system of the insurance company. It is the planned, systematically ordered, complete record of the business transactions in an insurance company over a specific period of time. By means of this complete, orderly
and planned registration and chronicle of all business transactions the company can
at any time establish, e.g.:
how the assets and/or the debts have changed
whether the company has made a profit or a loss
Further important tasks of the bookkeeping are:
Basis of information for the branches of the cost accounting system (statistics,
cost-benefit accounting and budgeting) and thus for the company decisions
Basis of taxation by means of the basis of calculation profit and assets
Methods of information for third party stakeholders (e.g. policyholders, shareholders, creditors, supervisory authorities) by means of financial accounting
Proof in the case of legal disputes with representatives, the tax authority, courts,
banks
Bookkeeping is based on a great number of different rules (among other things,
laws and regulations) and among other things recommendations and customary
usages. The most important principles are the basics of orderly bookkeeping, which
are partly the source and partly the result of the legal regulations.
Cost accounting and results accounts
One of the most important functions of the cost accounting and results accounts is
the supervision of the economic efficiency of the business value chain. In this connection among other things the costs incurred in the production of the insurance
protection are allocated according to type, the place of production and the cost
centre. This information is among other things the basis for pricing and thus also for
the calculation of the insurance premium. The cost accounting and results accounts
is a purely internal business concern.
Budgeting, controlling and auditing
As preview accounting, budgeting has a future orientation. It is based on the data of
the other three branches of the business accountancy system. Within a complete
plan partial plans are compiled (finance, turnover, advertizing plan, etc.). The budget
is a control and management instrument for the companys management, because
targets are given in the process of making business decisions which can be compared to the actual results. (Target performance comparison).
Closely connected with the budget is controlling. In contrast to the branches already
mentioned in connection with business accountancy, in the case of controlling, as
28
Dr. Georg Erdmann
with auditing, it is a component part of the companys system of supervision. This

means that although controlling is dependent on information from business accountancy, it itself should nevertheless be interpreted as a service function for the
management. The company management, but also sections of the company, should
be supplied with information which enables them to manage the company and its
divisions in a future-oriented way. In addition, there is the important task of co-ordinating subtasks in the complex company system.
Auditing should further be distinguished from controlling insofar as it constitutes
the management of all business activities, processes and structures that is independent of the systems and processes. Among other things, compliance and economic
efficiency must be controlled.
Statistics
In order to be able to charge premiums that match the risk and to regulate all
claims that must be indemnified, insurance companies need in motor insurance,
for example, information about claims frequency and the average level of claims
for the various types of vehicle.
In order to protect market share insurance companies need among other things
information about the product wishes of households and companies, the premium development of the individual classes of insurance, the disposable income
of the respective groups of households and the rate of inflation for the most
varied range of goods and services.
To achieve adequate personnel planning insurance companies need, for example,
information about the average age and income, in all cases broken down among
other things according to staff with company internal duties and those with customer contact, gender, possibilities of employment with office work and staff qualifications.
1.5.3
Technical terms of the cost accounting system
Certain technical terms have developed in connection with the individual sections of
business accounting, in order to express various economic circumstances payment and benefit processes. Broadly, these are the following contrasting pairs:
receipt / disbursement
income / outgo
profit / expenditure
benefit / costs
In daily usage not much care is taken to differentiate precisely between these contrasting pairs. An exact separation of the individual pairs of terms is advisable, however, because a precise distinction of terms makes it easier to talk about business
economics.
Every entry for means of payment or liquid funds is called income. (Examples could
be premium income, as well as paid up owners equity or borrowed capital, interest
earnings or tax rebates). Every movement out of means of payment or liquid funds
29
is known as a disbursement. (Examples could be claims payments, payments for

working capital, dividends, tax payments).
Income, in contrast, means irrespective of the actual cash flow the equivalent in
monetary terms for goods and services sold.
An outgo, in contrast, means irrespective of the actual cash flow the equivalent
in monetary terms for the addition to the factors of production (goods and services).
It makes no difference in this respect as to whether the factors of production are
paid or consumed in the accounting period.
The profit for a period is the value of net income for all consumed goods and services. The expenditure for a period is the value of net income for all consumed
goods and services.
By benefit is meant the gross added value obtained in an accounting period insofar
as it can be traced back only to one of the activities relevant to the business target.
By costs are meant the quantified use of factors of production which are needed for
the production and sale of the businesss products and for the maintenance of its
business capability in order to achieve these aims.
Organization
of the insurance industry
by
Dr. Gerhard Mayr
Organization of the insurance industry
2.1
Legal forms of insurance companies
2.1.1
Overview
31
Legally every company that carries out insurance business is an insurance company
(IC). The legal form is regulated by the national legislator. In Germany the legal
forms that are currently approved are:
Stock company (including the European Company SE)
Mutual insurance company
Insurance company under public law
In other countries individuals, too, can quite easily be insurers, as is the case with
the names of Lloyds in Great Britain.
Insurance companies need the approval of the supervisory authority before they
start business. (In Germany this is controlled by the Insurance Supervisory Law
VAG). In Germany the business plan must be handed in with the submission for approval. It must clarify the purpose and the organization of the enterprise, the area
covered by the intended business operations, as well as the conditions by which the
future obligations of the company should be permanently met. Among other things,
the constitution of the company, the classes of insurance to be sold, company policies, contracts for the outsourcing of functions, proof of required capital (guarantee
funds) and a business case for the first three business years must be submitted.
2.1.2
Joint-stock company
The joint-stock company (Plc) is a company with its own legal personality, whose
authorized capital is split into shares. Its carriers are the shareholders as owners and
suppliers of the owners equity. The companys creditors are responsible for the liabilities of the company only to the extent of the companys assets. In Germany the
German Stock Companies Act stipulates the legal norms.
Foundation
1. The foundation by one or several persons who take over the shares by means of
outstanding capital contributions
2. Minimum face value of the authorized capital of 50,000. In the case of insurance
companies the regulation of capital resources, which can require higher
amounts, must be considered.
3. Shares are either par value shares (at least 1) or a share without a par value
(same share of the authorized capital).
4. Articles of association certified by a notary (constitution)
After the supervisory authority has granted the license, this is registered in the commercial register. With the registration the joint stock company receives its legal capacity.
32
Dr. Gerhard Mayr
Important rights of shareholders

Voting rights in the Annual General Meeting according to the face value of the
shares or in the case of shares without par value according to their number,
Profit sharing rights (dividends),
Subscription right on the issue of new (young) shares, so that the shareholder
can secure the current proportion of voting rights by taking up the subscription
right
receives compensation for the sale of the subscription right, that a watering
down of the share price occurs by the average price after the increase in capital, because in general the issue price of new shares is lower than the stock
exchange price of the old shares before the increase in capital.
Institutions of the PLC
a) Annual General Meeting (AGM)

Shareholders meeting, use of the voting right
Important functions:
Appointment of the shareholders representatives on the supervisory board
Resolution regarding the use of the balance sheet profit
Release of the members of the board and the supervisory board
Changes to the articles of association
Measures to increase and reduce capital
b) Supervisory board (SB)

Controlling body of the supervisory board, appointed every four years
Composition:
up to 2,000 employees: two thirds shareholders representatives, one third employees representatives (the number must be divisible by three; the number is
determined by the level of authorized capital)
more than 2,000 employees: half shareholders representatives, half employees
representatives (equal rights)
Important tasks:
Control of the management
Appointment and dismissal of the board
Checking the annual financial statement, of the management report and the
boards recommendation about the disposal of the balance sheet profit
Report for annual general meeting
Calling of an extraordinary annual general meeting
33
c) Board of management
Management of the company on own authority
Important tasks:
Report to the supervisory board about the course of business and the situation of
the company
Compilation of the annual financial statement and the draft for the auditor of the
annual accounts
Calling of the annual general meeting and recommendation about the disposal of
the balance sheet profit
Insurance stock company: Announcement to the supervisory authority in the
event of insolvency or if liabilities exceed assets
2.1.3
European Company (Societas Europaea SE)
The European company is a legal form for a stock company in the European Union.
Since 2004 this has enabled the EU to found companies according to broadly unified
legal principles (Regulation 2157/2001 concerning the Statute of the European Company (SE) of 8.10.2001).
Subject to the EU-provision an SE founded in accordance with the law of the SEs
state of domicile will be treated as a stock company in each member state.
Nature of the European Company:

Own legal personality
Limited liability company
The capital is split into shares
Domicile in an EU state, transfer of domicile into another EU state possible at any
time.
Shareholders exercise their rights of ownership in the annual general meeting
The management can be carried out in two ways:
(1) Board manages the business and is controlled by the supervisory authority
(dual system as is usual in Central Europe)
(2) An administrative organization (Board of Directors) that consists of three
boards including an executive director (mono system usual in Anglo-Saxon
countries)
Shares are transferable in accordance with the respective national regulations.
Listing is not absolutely necessary.
2.1.4
Mutual insurance company
A mutual insurance company is an association vested with legal capacity, which

pursues the insurance of its members according to the principle of mutuality. It
receives the legal capacity with the approval of the supervisory authority. It is like
a stock company registered in the commercial register. The company name has to
contain the addition a.G. The assets of the association are liable only for the associations commitments. The members are not liable with their assets.
34
Dr. Gerhard Mayr
The membership is acquired by the establishment of an insurance relationship with

the mutual, so that the beginning of the membership coincides with the beginning
of the insurance. As consideration the policyholders have to pay provisional premiums or an apportionment later.
Premiums
provisional premiums
with
without
obligation to pay an additional premium
apportionment
with
without
highest premium
The provisional premium is required for the estimated future need. If the provisional
premiums are insufficient, in accordance with the articles of association additional
premiums are required or the insurance benefits are reduced. The obligation to pay
additional premiums can, however, also be excluded by the articles of association.
This is meanwhile the rule for mutual insurance companies. Then in effect there is
no difference from the fixed premium of an insurance stock company.
The apportionment is not payable in advance but afterwards when the need arises,
such as on the death of a member if there is a funeral expenses fund. The articles of
association fix a limit for the apportionment. Such an apportionment process is only
found in smaller mutual insurance companies.
Foundation
A defined number of founders is not prescribed. Foundation is possible with two
people. A reserve fund must created for the financing, the level of which depends on
the regulation for capital resources.
Company functions
a) Highest Representation
This is broadly equivalent to the annual general meeting of a stock company and is
the gathering of members or the representatives of the members.
b) Supervisory Board
This consists of at least three persons. The articles of association can fix a higher
number, which must be dividable by three (21 at most). Two thirds of the supervisory board is elected by the Highest Representatives and one third by the employees.
c) Board of Management
This consists of at least two persons. The same regulations apply as for a stock company.
2.1.5
35
Insurance companies under public law
State law applies to insurance companies under public law, which is also decisive
for the supervision of services. The state supervision of insurance companies is responsible for supervisory control . They are mainly public law institutions for which
the liability is guaranteed by public bodies. They were founded, for example, by
states, territories, local associations and regional banks. Nowadays most insurance
companies under public law sell all classes of insurance. However, the business is
restricted to a particular region or state (regional principle), so that they cannot compete with each other.
Bodies
The large insurance companies under public law have a board of management,
which runs the business and represents the insurance company externally and a
board of directors which mainly exercises rights of control.
2.2
Co-operation und concentration in the

insurance industry
2.2.1
Co-operation
There is co-operation when economically independent companies commit themselves contractually to work together.
Example:
An insurance company, a bank, an investment company and a building society work
together in order to offer the customers all financial services from one source.
Aims:
Completion of product range (Everything from one source)
Better utilization of the sales capacity
Protection from competition
Policyholders capital stays with the co-operating companies
Access to new customer groups
Improvement of the insurance image
Extensive information about customers
Problems:
Overtaxing the sales personnel
Agents commission must be factored into bank products
Bancassurance concepts do not always offer customers the cheapest products
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Dr. Gerhard Mayr
Overlapping products
Different size and strengths of the contractual partners can to lead to dependency
relationships
Conflicts of interest between the contractual partners (e.g. in the targets or according to customers good bank customer but bad insurance policyholder)
2.2.2
Concentration
2.2.2.1 Cartel
The cartel is a contractual horizontal agreement of companies that remain legally
separate but give up a part of their economic independence.
The aim is that the market should be influenced by cartel contracts. The cartel members want to limit the competition in their commercial sector in order to be able to
increase their profit. Cartels contradict the economic and social political goals of our
economic system and are thus a few exceptions aside forbidden.
Example:
The industrial fire insurers decide to calculate a common risk premium (calculation
cartel).
On breach of the cartel contract a contractual penalty is agreed.
Calculation cartels are strictly forbidden. Also a non-binding recommendation for
the risk premium (net premium) is not allowed by the association.
The European Union has also taken up this matter and certain gentlemans agreements between insurance companies are excluded from the cartel prohibition.
These exceptions are regulated in the Group Exception Regulation for Insurance
Companies. The regulation that currently applies was last extended to and runs out
in March 2010. Exemptions from prohibition are among others non-binding examples of general insurance conditions, the exchange of statistics about risk coverage
and the setting up of insurance collectives (so-called pools see 5.3.4 in this respect). In this respect the EU is of the opinion that co-operation in these areas improves efficiency for the insurance companies, from which consumers also benefit.
2.2.2.2 Consortium
The consortium is the horizontal agreement of companies in order to carry out certain tasks that are usually of limited duration.
Example:
Various insurance companies share a risk (coinsurance)
2.2.2.3 Affiliated companies
Affiliated companies are formed primarily because of capital and personal connections as well as by means of company contracts.
37
a) Concern
The concern is a horizontal, vertical or unconnected union of companies that remain
legally independent but whose economic independence has been given up because
of a unified management.
In the insurance industry the separation of lines of business leads to the creation of
concerns. If all classes of insurance are to be offered, then separate companies must
be founded for life, health and composite insurance respectively (previously legal
expenses insurers were also separate).
Horizontal concern
Company unions at the same production and service level: e.g. an insurance concern with general, life, health and legal expenses insurance.
Vertical concern
Company unions with successive production and service levels: e.g. reinsurance
and direct insurance companies.
Unconnected concern
Unions which straddle branches: e.g. insurance banks motor manufacturers
Subordination concern
A company controls one or more companies by means of capital or voting majority.
The controlling company is often a holding. It is usually a purely financing and administrative company without insurance business.
Controlling company
Insurance company
or
Holding company
Company
for life
insurance
Company
for health
insurance
Company for
general and
accident insurance
(composite insurer)
Group of companies which are legally separate entities, but under unified control
without a parent company
The companies are combined by one management without any of them being dependent on the others.
b) United companies
United companies (trusts) are a union of companies which have given up their legal
and economic independence.
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Dr. Gerhard Mayr
2.2.2.4 Goals and problems of concentration

Goals
Use of synergy effects (purchasing, production, marketing)
Increase of share value and higher dividends (shareholder value)
Lowering the premium
Greater security
Strengthening the market power or weakening the competitors
European or worldwide activities
Customized financial concepts
Problems
Curtailment of the competition
Curtailment of supply
Exploitation of power (e.g. by means of collective agreements, legislation)
Staff reduction
Conglomerates that are difficult to manage
Loss of identity of the individual insurance company
2.3
Separation of insurance classes
For the protection of policyholders insurance companies are not allowed to sell all
classes of insurance. According to German supervisory law the division into classes
of insurance applies to life and substitutive health insurance.
Reasons
Life insurance is characterized by the accrual of savings premiums in the mathematical reserve and in profit sharing schemes. If it were sold with non-life insurance,
which is subject to great fluctuations, there would be the danger that losses from
the non-life insurance would be made up from the life insurance surplus. In the case
of health insurance the ageing reserve in particular, which contains all the risk premiums for old age, should be protected from non-life losses.
For legal expenses insurance there is the special case that the claims handling must
be transferred to another company (claims handling company). The transfer counts
as functional outsourcing. In this way a conflict of interest should be avoided. If the
claimants legal expenses insurance and the liability of the defendant were with the
same company, the legal expenses insurer would have to deal with a claim against
itself. By means of the transfer of the benefit to an independent claims handling
company this conflict is avoided.
2.4
39
Structure of the organization
The structure of the organization constitutes a companys hierarchical framework.

While the structure of the organization establishes the basic framework (which tasks
will be tackled by which people and which material resources), workflow management regulates the work and information processes within the framework. The company is organized on the basis of the structure of the organization. To this end the
companys global task is broken down into sub-tasks and the company as a whole is
divided into business areas (section). The business sections are allocated to the
tasks that have to be completed. In doing so the relationships between the individual areas have to be exactly regulated.
Paradigm models are broken down into functions according to the following factors:
according to products or product groups (e.g. property, liability, accident, motor
insurance)
according to economic functions (e.g. acquisition, production, sales, financing
and administration)
according to region (e.g. according to business areas or home/abroad)
according to customer groups
The structure of insurance company organization is not in practice derived from
these paradigm models. In practice, blends of functional related factors (acquisition,
financing, administration) are found.
2.4.1
Product related structure
The insurance business is, for example, divided into the following business areas:
Management
Underwriting area (with respective proposal, contract and claims processing)
Financial area (financing, investments)
Administration (e.g. personnel, administration, legal department)
The underwriting areas are basically constructed on a product related basis (life,
health and composite area), and composite is usually further divided into classes of
insurance.
The processing of insurance business by classes is traditionally done according to
specialization, for each of which there is a management that is responsible for fundamental questions, the organization of the insurance protection according to price
and coverage for the particular class, as well as the monitoring of the daily business.
Below this level is contract and business processing. The processing of proposals
(new business) and portfolio administration belong to contract processing. This is
referred to as the processing of new and renewal business. These are often combined as business departments with corresponding claims departments, which in
the insurance of the person are called benefits departments.
40
Dr. Gerhard Mayr
Specialist department for a class of business

(e. g. motor insurance)
Management
Fundamental questions
Co-ordination
Collective bargaining policy
Business
Initial processing
(Proposal processing)
2.4.2
Renewal processing
(Portfolio administration)
Claim
From time to time also
for several combined
classes of business
Functionally oriented construction
The insurance companys mission is divided into functions, e.g.

Management
Acquisition
Sales
Production
Administration
Financing
Management includes planning, organization and control. It combines the business
production factors. It makes the decisions about company policy, especially the specification and implementation of the company goals.
Acquisition includes particularly the basic materials, the personnel and further services.
Sales are vitally important for an insurance company. Branch offices and the sales
force are usually part of the sales or distribution.
Production is usually broken down into proposal, contract and production processing. There are other sub-functions besides these, such as underwriting, reinsurance and coinsurance.
Administration includes activities that are not directly connected to the production
of insurance protection, such as personnel administration, the administration of
working capital, IT. It is a continuation of the supply function.
Financing should safeguard the performance in particular even when there are
unexpected losses.
41
Structure of organization according to functions

Type
Acquisition and Sales

administration
Production
Breakdown
according to
functions or
areas
Basic materials
Internal support
Initial
processing
Personnel
Sales force
Renewal
processing
Financing
Investments
Claims
handling
2.4.3
Structure based on customer groups
The customer group orientation should achieve a better matching of the insurance
coverage for the individual customer groups as well as customized in-house support. The customer is offered a range of insurances which meet his needs. The trend
is away from simply offering products to solving problems. The structure of the organization and also the processes have to focus on the solution of problems. The
specific risk situation of each individual customer group should be considered both
by the sales force in counselling as well as by in-house staff in dealing with policies.
Structure based on customer groups
Private customers
Corporate customers
Private households
simple
wealthy
Industry
Private customers, e.g.

young people
young families
single households
wealthy households
older people
Independent professions, e.g.
doctors
lawyers / notaries
tax advisers / auditors
artists
Other commercial
Independent
professions
42
Dr. Gerhard Mayr
Advantages of customer group organizations

Insurance selection customized to the need of the customer group
Quick adjustment of the insurance selection to the changed customer need
Package solutions sell few single insurance policies
Cut out the competition
Stronger identification with the customers
Insurance calculated according to the customer groups
One voice to the customer for the complete product range
Short communication path
Better use of qualifications, especially for younger members of staff
Problems
Difficult to implement, especially with the sales force (agency contracts still in
force)
High costs and friction losses when restructuring
Errors in the contract and claims processing
Staff difficult to replace: long training period
Overlapping customer groups
For small insurance companies scarcely possible (Contract portfolio, number of
customer groups)
Unclear delineation of insurance classes
2.4.4
Centralization and decentralization
Centralization means the concentration of administrative work of an insurance

company in the head office. Decentralization means the general transfer of this
work to the branches.
Reasons for decentralization
Close to the customer
Close to the sales force
Flexibility because close to the market and quick decisions
Consideration of regional differences
The head office is relieved of administrative tasks
Local presence (image advertizing)
Reasons for centralization
Less co-ordination of work and controlling
Better control of the underwriting and claims handling policy
Fewer problems if staff are not available
Better distribution of work and specialization
Duplication of work avoided
43
Cost reduction because of elimination of personnel and material costs

The branches become less important because of complete processing by the
sales force
2.4.5
Overview of call centres
With a call centre the customer comes into direct contact with a competent business
partner. Call centres are telephone service departments in which incoming calls are
distributed over an automatic call distribution system to the staff of the centre.
The automatic call distribution system provides a well-balanced utilization of staff.
Incoming calls are accepted within a few seconds. At peak times the calls can be
switched to other clerks (e.g. those responsible for correspondence) or to external
staff. The staff in the call centre as well as being very resilient must also have a
sound knowledge of the products. During the discussion the employee can call up
all the relevant data about the customer onto the screen and update it during the
call. In the call centre up to 80% of all incoming calls can be completely processed
from the acceptance of proposals to policy changes and claims handling as well
as tariff information, product information or complaints. In this connection the call
centre is often called first level processing. If the question cannot be completely
answered the call is forwarded to the specialist departments (so-called second
level). For the processing of documents it can also make sense to divide the
processing into first level (routine questions) and second level (complex technical
detail).
The call centre can not only be used for inbound questions, i.e. for questions from
outside for the insurance company, but also for outbound questions, for telemarketing. In telemarketing the telephone system dials the numbers of selected customers. If the customer can be reached, his contract details appear on the screen. The
employee in the call centre can then give the sales talk supported by this data. The
call centre call (outbound) can also be used to maintain the business portfolio. The
maintenance of the business portfolio can be carried out prophylactically (e.g. if a
tariff is increased) as well as for actively winning back customers
Advantages of the call centre
Always accessible
Quick assistance in the event of a claim or for contractual questions
No transfer (several times) to special departments
Complete processing
Easy to deal with complaints
Use for advertizing campaigns (outbound) the customer is approached by
telephone
Comfort call in the face of surrender or to pre-empt it.
Disadvantages of the call centre
Complexity of the material makes it necessary to have highly qualified staff
Overlaps with the service activities of intermediaries
Under certain circumstances double work with doubled costs
44
2.5
Dr. Gerhard Mayr
Organization of workflow
The organization of workflow in an insurance company includes the design of the individual work processes in order to complete tasks, their assignment to particular
responsible persons and the rules for the combination of the individual work processes for the overall performance. Within the structural framework of the organization the processes are ordered realistically in space and time. The work places and
work processes created in this way are linked with each other. Workflow management is thus based on an analysis of the processes and the ensuing process synthesis.
Examples of processes in the insurance company
Proposal process (from the process in the sales force until the policy is dispatched)
Claims regulation process (from the first claims report until the final regulation)
Process of the in-force business (from policy alteration to sending the new policy)
2.5.1
Examples of the claims handling process
The work can also be done at the first and second level in the claims regulation process. While at the first level mass claims up to a certain level are processed, high
claims or bodily injury claims are taken care of at the second level. In this connection, so-called workshop management plays an ever greater role in motor insurance. When a claim is reported, the insurer tries to send the customer or the injured
party to a workshop that is contractually bound to the insurance company in order
to reduce claims costs (A price discount can be agreed with the workshop in return
for a large total volume of repairs).
2.5.2
Outsourcing
Outsourcing is the removal of services or parts of the administration and production

to subsidiaries or to other companies.
In the insurance industry the following can be outsourced:
Distribution
Claims handling (e.g. for major claims and for bodily injury)
IT
Investment administration
Administrative areas (e.g. security, cleaning, cantine)
Accounting
Personnel
45
Advantages
Lower wages and salaries (other collective agreements)
Less protection against dismissal
Lower social benefits
Flexible reaction to variations in production
Increased awareness of costs and earnings awareness
Winning of third party contracts
Tax advantages (e.g. with regard to Value Added Tax; Profit Tax)
Better internal control
2.6
Methods of distribution in the insurance industry
2.6.1
Overview
Insurance companies bring their insurance products to the customers. Sales or distribution of insurance protection means, therefore, in the first instance the bridging
of the gap between the insurer and customer.
The sales or distribution of insurance protection is not a one off activity, but the
issue of an insurance policy means a long-term relationship with the customer,
which must be fostered accordingly (so-called portfolio servicing).
As a rule insurance contracts are concluded by means of a sales organization (e.g.
an intermediary or broker). The expression for this is indirect distribution. In contrast, in the case of direct distribution direct relationships are established between
the customer and the insurer. In this case the customer turns directly to the insurance company in order to obtain insurance protection.
2.6.2
Indirect distribution by sales organizations
2.6.2.1 Company sales organizations

Company sales organizations are part of the insurance distribution. These are usually employees in the sales force.
Features
Employment contract that is dependent on the insurance company
Not self-employed
No entrepreneurial risk
Bound by instructions
Salary (plus commission and expenses)
Collective agreement
Right to holiday
Obligation to contribute to social insurance
46
Dr. Gerhard Mayr
Main tasks
Winning and training of insurance representatives
Support of difficult insurance classes
Carrying out special tasks
In some insurance companies normal customer contact (prospecting, sales closure, portfolio support as well as help in claims handling)
2.6.2.2 Means of distribution that are linked to the company (insurance agents)
By this means of distribution is meant a self-employed businessman (insurance
agent) who is tied to the insurance company by means of a contract of representation or an agency agreement. He is permanently entrusted with the task of arranging
or concluding insurance contracts.
The typical insurance agent acts on behalf of an insurance company or for a concern. He is, therefore, known as a tied agent or tied representative. From a legal perspective the name representative of a concern or of various companies is more correct, since he represents several companies with which he has contracts, because of
the various classes of insurance.
Features
Legally recognized businessman
Free to arrange his own activities
Free to determine his own working hours
Book-keeping
Commission (no salary)
Registered at the trade licensing office
Free from the duty to pay social insurance
Submission of income tax and trade tax on the basis of self-employed commercial
activity
Compensation entitlement
Principle tasks
Making customers aware of the need for insurance
Arranging insurance contracts
Servicing policyholders
Assisting in claims handling
2.6.2.3 External sales organizations
Insurance brokers
The insurance broker is a self-employed businessman who arranges contracts for
other people without being contractually tied to this task. The insurance broker has
his own contract with the customer (so-called broker contract) and in contrast to the
insurance agent does not have a fixed relationship to the insurance company. He
has a duty to the customer and not the insurer. This leads to a special kind of liability
47
towards the customer. The payment is in the form of commission, which is part of
the insurance premium and is paid by the insurance company to the broker.
Advantages from the point of view of the insurance company
No expenses for setting up a sales force
No claim for compensation
Brokers are knowledgeable
Brokers often take work off the insurance company
Brokers often bring large contracts
Disadvantages from the insurance companys point of view
The insurance company scarcely has contact with the policyholder
The contracts are often not long-term
The broker represents the policyholders interests
Commission and premium pressure
Competition between the brokers and own agents
Independent sales organization
The independent sales organization usually has several hierarchical levels. At the
lowest level the placing of insurance (sales) often by part-time staff is the main
activity. If the sales results are good, the sales persons can be promoted to higher levels. Besides the placing of insurance there is organizational activity, i.e. the finding
and training of new intermediaries. A member of staff who has been promoted participates in the turnover of the intermediaries below him (third party turnover). The
higher the member of staff rises, the less sales work he does and the more the administrative work increases. Remuneration and career progress follow exclusively
the performance principle.
No direct contribution to turnover,

many members of staff
5
4
3
2
1
A
Large contribution to turnover,

no members of staff
48
Dr. Gerhard Mayr
Independent sales organizations try to sell their products with as many members of
staff as possible, who are organized in a pyramid structure. At the lowest level A the
sales persons have to sell as many insurance policies as possible in order to move
on to Level 1 and to earn from the turnover of the members of staff of Level A. At Level A only the own turnover is evaluated. From Level 1 onwards not only the own
but also the turnover of others is quantified as part of the total turnover, and with
this the possibility of moving higher up the hierarchy.
Opportunities
Highly motivated sales personnel
Good possibilities to earn well if good at selling
Good opportunities for promotion and earnings
Targeted customer approach (e.g. by analyzing the wealth and insurance relationships)
Financial service offers that are customized for customer groups
Comprehensive counselling (everything from one source)
Risks
Sometimes poor counselling because of inadequate knowledge
Aggressive selling
Strong (also psychological) sales pressure
High cancellation rates
High staff fluctuation
Low earnings at the lowest hierarchical level
Low follow up service for policyholders, because there is no fixed portfolio
Often expensive financial and insurance products
Often intensified sale of products with higher commission (that are not needed)
Other external sales organizations
Co-operation with banks
Annex distribution (sales over third parties, whose core business has nothing to
do with insurance distribution) e.g.:
Mail-order companies
Motor traders and manufacturers
Automobile clubs
Credit card sellers
Tour operators
Food store chains
They offer specific insurance policies, which in certain circumstances are connected
with their product. Thus insurance protection is offered to the supporting product
only in limited areas which often overlap with already existing insurances (e.g. credit cards, travel insurance policies). If these providers succeed, however, in developing an independent distribution channel, there can be real competition to the traditional sales channels (e.g. ADAC, which offers all forms of motor insurance).
2.6.3
49
Direct marketing
In the case of direct marketing selling is done directly by the head office without
involving sales organizations. The contact between the customer and the insurance
company takes place exclusively by letter, telephone or other electronic media.
In the case of direct marketing it is the customer who takes the initiative. He must
know which insurance policies and which sums insured he needs and which insurance can best meet this need.
Advantages
No commission, and consequently lower costs and cheaper premium
No agent visit (customer can decide himself)
No unnecessary insurance policies or policies with too high a sum insured
Lower cancellation rate
New customer groups are reached
Shorter work processes
Professional counselling by the head office if desired (e.g. telephone, letter, Internet)
Disadvantages
No arousing of needs by the sales force
No personal counselling / contact
Low insurance penetration, because the need for insurance protection is suppressed
Poor support / missing adjustment of the insurance contracts
Missing assistance in claims handling
Business is difficult to direct
Only simple products
Relatively expensive direct advertizing (low success rate)
To some extent aggressive underwriting (e.g. in motor insurance)
To some extent high complaint rate
2.6.4
Insurance consultants
Insurance consultants advise and support the self-employed, companies, private

clients and public authorities about all forms of individual insurance and are, therefore, committed to a form of counselling that is oriented to the personal need that
has been ascertained. They produce risk analyses for their clients, advise about
insurance cover, which is customized to the needs of the particular client, and they
negotiate about this with possible insurers. They represent their clients before the
insurers if there are claims. They continuously check that the insurance covers in
force are updated.
In so doing they play an advisory and professional role, the placing or the sale of
insurances being forbidden for them. On request the client receives the names and
50
Dr. Gerhard Mayr
addresses of relevant insurers. One of the main tasks is to achieve the cheapest and
most suitable insurance cover for the client. Insurance counsellors must be neutral
and independent: i.e. they must not work on behalf of an insurance company, but
generally receive their fee from their client according to an agreed hourly or daily
rate.
The direct instruction and also the direct payment by the client avoids some of the
possible adverse affects of one party representing the clients interests.
The profession of insurance counsellor is one of the legal advisory professions and
can only be performed if the responsible Chamber of Industry and Commerce has
granted authority. The professional title insurance adviser is legally protected.
2.6.5
Legal aspects of insurance sales and marketing
The European Union Directive on Insurance Selling (Directive 2002/92/EG of the European Parliament and Council of December 9th 2002 concerning insurance selling)
was published on January 15th 2003 in the official gazette of the EU. The directive
was needed, on the one hand, to facilitate freedom of services in the field of insurance sales and, on the other, to comply with consumer protection requirements.
The following important points are regulated in the Directive:
Recording of the intermediary in a register that is accessible to the public
The duties of the intermediary to provide information
Counselling and documentation duties (Counselling report)
Creation of an arbitration post
Safeguarding of customer monies
In the course of implementing the EU-Directive on Insurance Selling new rules were
introduced with effect from May 22nd 2007 in Germany, among other things in the
trade regulations as well as in insurance contract law. These clearly define the types
of intermediary. Thus henceforth insurance intermediaries are either insurance
agents or insurance brokers.
Since May 22nd 2007 permission has had to be obtained in order for an intermediary to sell insurance, and the Chamber of Industry and Commerce is responsible
for granting this. This is contingent on certain requirements.
Thus the intermediary has to be personally reliable, i.e. he cannot have been legally
convicted in the last 5 years prior to submission of the application. Furthermore, his
financial affairs must be in order, which is usually the case if no insolvency proceedings have begun or they have been rejected owing to a lack of substance and he has
not made an affidavit before the district court a court which executes civil
judgments. He must continue to show that he possesses a professional indemnity
policy with a certain minimum cover. Finally, proof of professional competence is
needed. This professional expertise can be proved by a professional examination of
the Chamber of Industry and Commerce that has been passed. A large number of
other legally controlled qualifications are also recognized as being adequate proof
of competence.
51
Furthermore, an intermediary register has been set up, in which every intermediary
has to be entered. The entry application must be made for the intermediary at the
Chamber of Industry and Commerce that is responsible.
The insurance agent represents the interests of the insurer. For insurance agents
there is fundamentally the duty to provide counselling as needed. They must, however, only refer to the insurers and their products with which they have a contract.
The customers must be told who these insurers are. During their first meeting the
intermediary has to give the customer the so-called first information in writing,
from which can be seen:
the name and business address of the intermediary
the intermediarys registration number
the intermediarys status (broker or agent)
the mediation offices in case of disputes
During the counselling the wishes and needs (better: the objectively existing need)
of the customer is established. The advice to the customer should match the complexity of the insurance product, the person and the customer situation. As defined
in law the level of the insurance premium should also be a measure of the counselling requirements. Reasons must given for the advice the customer receives, so that
the customer can also understand later why he chose a particular insurance product.
The basic facts of the counselling must be recorded in the counselling documentation, which the customer must receive at the latest before the contract in written
form has been concluded. The customer can dispense with counselling and documentation of the counselling, but he must do this in a separate written statement
which contains a warning that such a waiver could be disadvantageous for him in
pursuing and achieving claims for damages against the intermediary.
The new legal regulation stipulates that the agent and broker are personally liable
for wrong advice and for inadequate compliance with the requirements described
above. The tied agent as well as the agent that represents several companies can let
themselves be contracted out by an insurer. In this case the insurer takes over the
liability against which professional indemnity insurance would otherwise have to be
taken out.
Sources
Farny, Dieter: Versicherungsbetriebslehre. 4th edition. Karlsruhe: VVW, 2006
Schulenburg, J.-Matthias Graf von der: Versicherungskonomik Ein Leitfaden fr
Studium und Praxis. Karlsruhe: VVW, 2005
Legal basis
of the insurance contract
by
Esther Grafwallner
Legal basis of the insurance contract
53
Overview of the new German Insurance Contract Law

By Professor Helmut Schirmer
On January 1st 2008 a new Insurance Contract Law (VVG) came into force in Germany that replaced the old one of 1908. The preparation for this new codification
had begun in the middle of 2000. The guidelines of the EU directive for intermediaries have been included.
The aim of the new law is to strengthen the rights of the policyholder, to increase the
transparency of insurance products for the policyholder and to incorporate court
verdicts into the earlier insurance contract law and to develop it further. The duty to
counsel the policyholder as developed by jurisprudence is henceforth subject to law,
the commensurate duties of intermediaries are based on the intermediary directive.
Violation of the policyholders duties to conform (obligations) has received a new
system. The consequences of a breach total or partial loss of insurance coverage
fundamentally make causality a precondition. The only exception is fraudulent
intent by the policyholder. A distinction has to be made between the degrees of responsibility. If the policyholder is merely slightly negligent, the insurance coverage
remains unaffected. In the case of gross negligence, there is contribution. Contribution means that the insurance cover can be limited depending on the degree of the
policyholders responsibility. Only in the case of policyholder intention, however,
may the insurer not need to pay the benefit. This system is supported by the insurers numerous informational duties, by means of which the policyholder should
know of the negative consequences of not complying with the obligations. (Duty to
warn).
Many of the insurers duties to inform have the aim of drawing the policyholders
attention to the content of the future insurance cover even before making a contractual declaration. A general right of revocation extends the policyholders freedom of
decision.
For large risks as defined by EU directives, however, freedom of contract remains
broadly as before. Agreements that do not conform to the new insurance contract
law (VVG) remain fundamentally valid.
54
3.1
Esther Grafwallner
Introduction
The contracts taken out between insurance companies and their customers are called insurance contracts. Their contractual partners are called insurers and policyholders.
insurer
insurance policy
policyholder
An important feature of an insurance contract is that the insurer safeguards against

an unforeseeable event. In other words, in return for a fee it takes over the risk that
a peril might occur. For carrying this risk and the promise of a benefit that is bound
up with it, the policyholder owes the insurer financial consideration, the premium.
insurer
carrying of risk
policyholder
payment of premium
The insurer and the policyholder have the freedom to agree whether an insurance
contract should be concluded and what its contents should be. This freedom of contract is limited in various ways:
3.1.1
Compulsory insurances
Basically, everyone can decide for himself whether he wants to insure certain risks
of his life. However, it can be in the public interest that this freedom is restricted by
the regulation of a compulsory policy of insurance. A motor vehicle, for example, is
considered a potential source of danger, but the driver may not be able to pay easily
in case of a claim for damages. Consequently, the legislator has decided in this case
to introduce compulsory liability insurance. There are other such compulsory insurances in many other areas, such as, for doctors or lawyers, for example.
3.1.2
Obligation to enter into a contract
Insurers as well as policyholders are generally free to decide whether and with
whom they want to take out an insurance policy. In some areas of insurance this
freedom is abolished by the obligation to enter into a contract. This means that the
insurer is compelled to accept a proposers application (e.g. in motor insurance, 5
II Compulsory Insurance Law for Motor Vehicle Drivers (PfIVG)).
55
3.1.3
Laws and regulations
In order to protect the policyholder as the weaker party from discrimination, freedom of contract is limited in various laws and regulations, which at the same time
constitute the legal sources of the insurance contract.
3.2
Legal sources
3.2.1
Insurance Contract Law (Versicherungsvertragsgesetz VVG)
The most important basis is the VVG, first passed on May 30th 1908 and which on January 1st 2008 was thoroughly reformed. Important contents of the reform are the
introduction of many advisory, explanatory and informational duties of the insurer as well as extensive consumer protection, which has been very largely harmonized.
The VVG is a special law for insurance contracts and therefore overrides or supplements the general regulations about the form of contracts as they are particularly
found in the Code of Civil Law (BGB). Only if there is no regulation under the VVG
regarding a specific matter, are the more general regulations of the BGB used.
The basic principle of freedom of contract applies to the insurance contract. For this
reason the contractual parties can depart from individual standards of the VVG, unless the legislator wants to safeguard particular rules or minimum contents for one
party or even both parties. Thus a distinction should be made between
Non mandatory norms
Half mandatory norms
Mandatory norms
It is possible to depart
from these norms,
either to the advantage
or the disadvantage of
the policyholder.
It is only possible to
depart from these norms
to the advantage of the
policyholder.
It is not permitted
to depart from these
norms.
In the VVG they are not

specifically identified.
In the VVG they are

specifically identified, as a
rule at the end of a section
and combined with the
information that they
cannot be departed from
to the disadvantage of the
policyholder.
They are also

specifically identified
in the VVG.
56
3.2.2
Esther Grafwallner
VVG Regulation regarding the duty to provide information

(VVG-Informationspflichtenverordnung VVG-InfoV)
The Insurance Contract Act (VVG) is supplemented by some ancillary laws and regulations. In practice the most relevant of these is the VVG-InfoV. It has its basis of
authorization in 7 Abs. 2 VVG and regulates in detail the content of the insurers
duty to provide information before the conclusion of the insurance contract and for
its duration.
3.2.3
Insurance Supervisory Law (Versicherungsaufsichtsgesetz VAG)
The VAG regulates in the first instance the relationship between insurance companies and the Insurance Supervisory Authority (so-called Federal Financial Supervisory Authority BaFin, for short) and is thus public law, whereas the Insurance
Contract Act (VVG) regulates the private legal relationships between insurance companies and policyholders.
The VAG sets certain minimal requirements for insurance companies and ensures
their compliance by giving BaFin various possibilities of intervening in the event of
violations. The background to this is that the public has a great interest in the financial stability and legality of insurance companies, in order to make sure that they
survive and remain effective.
3.2.4
Code of Civil Law (Brgerliches Gesetzbuch BGB)
The BGB applies to all contracts regulated by private law and thus basically also to
the insurance contract. Being general law, the BGB is not used, however, if special
regulations of the Insurance Contract Act (VVG) apply. Especially relevant for the
insurance contract are the regulations about forming contractual obligations by
means of the general terms and conditions ( 305 ff BGB).
The General Insurance Conditions (Allgemeine Versicherungsbedingungen AVB) are
a special form of the general terms and conditions. The VVG regulates how they are
to be incorporated into the insurance contract, so that the regulations of the BGB are
not relevant in this respect. The possible contents are also regulated as far as possible in the VVG. There are regulations in the VVG which can be departed from (non
mandatory norms), but the insurer is, nevertheless, not completely free in terms of
its AVB. So, for example, very important principles of the VVG have to be respected.
In this case a single regulation of the AVB can be invalid because of 307 BGB
(Control of contents), even though the VVG permits a deviation.
57
Example:
X-AG has a clause in its AVB which contains the following:
If the policyholder causes the loss intentionally or recklessly, the insurer is not
obliged to pay the benefit.
In accordance with 81 VVG the insurer can reduce its benefit in proportion to the
policyholders degree of blame if the policyholder brought about the insured claim
intentionally or recklessly. According to 87 VVG it is possible to deviate from 81
VVG either to the advantage or the disadvantage of the policyholder, and in the past
the insurer was released from paying the benefit if the policyholder had acted recklessly (the so-called all or nothing principle). The newly introduced more or less
principle of the VVG reform, however, does not release the insurer from paying the
benefit for gross negligent (reckless) behaviour, but only permits a reduction of
benefit. This is such a basic principle of the VVG that it cannot be completely undermined. The X-AG clause is, therefore, invalid according to 307 BGB.
3.2.5
General Anti-discrimination Law

(Allgemeines Gleichbehandlungsgesetz AGG)
The intention of the AGG is to prevent or eliminate discrimination for reasons of

race or ethnic origin, religion or philosophy, a handicap, age or sexual identity (1
AGG). This law also applies according to 19 Para. 1 No. 2 AGG to insurance contracts and limits insurance companies freedom of contract, because they are not
allowed to reject lightly a contract because of one of the above mentioned reasons.
20 AGG regulates the cases in which under certain circumstances different treatments are possible because of one of the above named features, without being discriminatory. Thus, for example, a different treatment is possible because of gender
if there are reasonable grounds for this (e.g. the greater risk of men to suffer a heart
attack can be included in the premium calculation). Expenses in connection with
pregnancy and motherhood may not again as an exception in this respect lead to
different premiums or benefits.
3.3
Insurance conditions
The General Insurance Conditions (AVB) are preformulated contractual conditions

for many contracts, which must comply with the regulations contained in 305 ff
BGB.
Since the conclusion of insurance contracts is high volume business for many classes of insurance (e.g. in motor insurance), the use of the AVB is the common practice. For special risks, however, it is quite possible either to depart from individual
conditions of the AVB by means of special agreements or even to make completely
separate agreements. Whether and to what conditions an insurer departs from its
AVB is a question of its risk assessment policy, the so-called underwriting.
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Esther Grafwallner
Until the introduction of the Third EG-Directive into German law in July 1994 the supervisory authority had to approve the AVB for each class of insurance before they
could be used. This led to very similar AVB in each class. Today insurance companies can develop their own AVB which can differ for different target groups or products even within one company.
The minimum content of the AVB is explicitly itemized in 10 Insurance Supervisory Law (VAG). The unique feature of insurance contracts is that the AVB not only
regulate the basic conditions of a contract, as for instance payment conditions, but
also define the content of the contract itself, the promised benefit.
For this reason the minimum content includes especially the regulations
for which events the insurer is obliged to provide a benefit and
in which case this benefit is excluded, nullified or restricted due to particular
reasons.
Other subject matters relate to the wording of the basic conditions, such as the maturity date of the benefit, payment conditions and courts of jurisdiction. In the case
of compulsory insurances, such as motor third party liability, further minimal contents can be prescribed in the relevant special laws.
3.4
Persons involved
The insurance contract is concluded between the insurer and the policyholder.
These two parties are the contractual partners. Apart from the contractual partners,
other persons can also participate in the insurance contract. That will not make them
contractual partners, however.
3.4.1
Insured person
The insured person is the one for whose benefit the insurance contract has been
taken out. Insofar as the policyholder and the insured person are not the same person, it is an insurance for the account of a third party. This is specifically regulated in
43 ff Insurance Contract Act (VVG).
Example 1:
A Plc, which has been paid to store the goods of third parties, takes out an insurance
policy against fire and natural perils for these goods. If there is a claim, the customers are entitled to the settlement.
Example 2:
The tour operator takes out travel cancellation insurance for the benefit of his travel
customers.
Example 3:
Mr Mller has private health insurance. His children are included in the tariff and
therefore insured with him, but they are not contractual partners.
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In non-life insurance the insured person is the one whose risk is covered by the
insurance policy.
Obligation to pay the premium

Policyholder
Insurance policy
Insured person
Insurer
risk
cove
This has to be distinguished, however, from a number of persons on the side of the
policyholder. It is naturally also possible for several persons to be contractual partners.
Example:
The married couple Huber takes out a household insurance policy for their joint
dwelling. Both sign the insurance policy and are joint debtors for the premium.
The insured person is not liable for the payment of the premium if he is not identical
with the policyholder, but he acquires the rights under the insurance contract. However, the insured person cannot demand the insurance policy from the insurer but
only from the policyholder ( 44 VVG). He needs it, on the other hand, if he wants to
exercise his rights arising from the insurance policy or assert them juridically.
The insurer, on the other hand, is only obliged to provide the benefit to the policyholder if the insured person has agreed.
Special case: Life Insurance
In life insurance, too, the policyholder takes out a policy in principle in his own
name. If the policy is on the life of another, the latter is called the insured person.
In this case, however, insofar as the sum insured exceeds the burial costs, the written approval of the insured person is absolutely necessary, see 150 Para. 2 VVG.
For children there are further special regulations. The reason for this is obvious: the
insured person should be protected from the possibility that his or her death becomes financially interesting for another person. Therefore in 162 VVG there is a special regulation for the situation that the policyholder deliberately causes the death of
the insured person.
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3.4.2
Beneficiary
The beneficiary is the person to whom the policyholder has given the right to request the payment of the sum insured when there is a claim. The law of life insurance, disability income benefit and accident insurance recognizes authorizations of
claim payment.
The policyholder can confer the right to the insurance benefits, without the agreement of the insurer in the case of doubt. If the insurer, therefore, only wants to permit a particular right of benefit (e.g. to the heirs), it must stipulate this explicitly, and
at the same time stipulate that this right may only be changed with its approval.
Furthermore regarding the right to insurance benefits, a distinction is made between revocable and irrevocable rights. The difference is the point of time when the
right to benefit is acquired against the insurer.
Acquisition of the right to benefit
Revocable right to the

insurance benefits
At the time
of the claim
Irrevocable right to the

insurance benefits
On conferring
the right to benefit
The revocable right to benefit is the rule. The beneficiary only acquires the right to
the insurance benefit at the time of the claim. Up to this time the policyholder can
revoke or change the right to the insurance benefits at any time. The policyholder
keeps all the rights and duties arising from the contract and can thus, despite granting the right to the benefits, mortgage the claims under the insurance or assign the
rights from the contract.
In the case of an irrevocable right to the benefits the right to the insurance benefit is
acquired immediately. As soon as the relevant declaration has been made to the insurer, the right to claim the insurance benefits can only be annulled with the agreement of the beneficiary. The policyholder remains, however, also in the event of an
irrevocable right of benefit the contractual partner of the insurer and must fulfil all
the duties arising from the insurance contract.
3.4.3
Premium payer / Contribution payer
The policyholder is the contractual partner of the insurer and is the premium debtor.
If a third person takes the place of the policyholder in paying the premium, he is the
premium payer. He does not become the premium debtor by doing this, however.
The insurer need only accept the premium from another person than the policyholder if it was agreed between the insurer and the policyholder or it is a legally sanctioned special case.
61
In accordance with 34 Insurance Contract Act (VVG) the insurer must accept payment of premium
from the insured person in case of insurance on account of a third party,
from the beneficiary, insofar as he has already gained a right of benefit as well as
from a bailee.
This regulation applies irrespective of whether the policyholder has a right under
civil law against the premium payer that the latter should pay the premium. The reason for this regulation is that the third party beneficiary has an interest in the insurance cover and should not bear the consequences of the late premium payment.
3.4.4
Representatives of the contractual partners
Insurance contracts like all other contracts can be concluded without action and
declarations of intent by the parties if one or both parties is represented by a proxy.
As a matter of principle the insurer as well as the policyholder can confer power of
representation to any person they like.
Example:
Mr Scholz instructs his brother to take out a liability policy for him and gives him the
proxy needed for him to do this.
In this case the rights and duties as well as the imputation of knowledge ensue
solely from 164 ff Code of Civil Law (BGB).
However, if one of the parties lets himself be represented by someone who acts as
an intermediary or takes out insurance contracts commercially, this is the insurance
broker for the policyholder, and for the insurance company it is the tied or multiple
agent.
insurance intermediary
( 59 VVG)
insurance broker
insurance agent
tied agent
(represents only the
one insurer)
multiple agent
(represents
several insurers)
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For all these intermediaries there are special regulations; namely those that establish, on the one hand, a certain degree of qualification and financial liability (implemented by the integration of the intermediary guidelines into various German laws
in 2007) and, on the other, other regulation govern that the relationship between the
contractual partners and the intermediary. These regulations, which are found in
59 ff Insurance Contract Act (VVG), are described in more detail in what follows.
3.4.4.1 Insurance brokers
The insurance broker is obliged to base his advice to the policyholder on an adequate number of insurance contracts that are on offer in the market (compare 60
Para. 1 VVG).
This means that he first has to ask the policyholder about his wishes and needs and
then advise him about the best product on the basis of a comprehensive market
overview. It is not sufficient simply to offer a relevant insurance product. A different
situation arises only if the broker informs the policyholder of the restricted choice.
The insurance broker can either (only) be asked for advice by the policyholder or be
authorized to conclude a contract. In the latter case, he is authorized to effect the
optimal insurance cover for the policyholder.
3.4.4.2 Insurance agents
The insurance agent is appointed commercially by one or more insurers to arrange
insurance contracts.
The insurance agent is the eyes and ears of the insurer. His knowledge is thus
imputed to the insurer. The insurer is responsible for incorrect information of the
agent, unless the insurance agent and policyholder have colluded to damage the
insurer.
3.4.4.3 The insurance intermediarys duty to advise
The insurance broker as well as the insurance agent have a duty towards the policyholder to inquire and advise. If this duty is violated, the customer can enforce damages against the agent himself. With regard to the information, the duty to question and advise is the same as the insurers, which is why you are referred to section
3.5.3. The insurance agents duty to advise ends with the conclusion of the insurance contract, whereas the insurers and the insurance brokers continues for the
duration of the policy.
3.5
Conclusion of the insurance contract
3.5.1
Proposal and acceptance
The insurance contract comes into force, like every other contract, in accordance
with the regulations of the Code of Civil Law by two corresponding declarations of
intent (145 ff BGB). They are called proposal and acceptance.
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The proposal for taking out an insurance policy must be so specific that the other
contractual partner can accept the proposal with a simple yes. That is, the exact
tariff with the sum insured and the premium must be already known.
In the insurance industry the proposal is usually made by the customer. The initiative is taken by an insurance intermediary, however, who advises about the need for
and the extent of the insurance cover. In the case of so-called direct marketing, the
applicant contacts the insurance company directly due to brochures or newspaper
advertisements: for example, by a hotline or over the internet.
proposal
policyholder
insurer
insurance policy
acceptance
In principle insurance contracts do not need a set form and can, therefore, be taken
out in the form of a text: for example, by e-mail. In such cases the insurer places a
form, in paper or electronically, at the policyholders disposal.
As well as the actual contractual declaration the insurer will include in this form
other important matters that are relevant for its assessment or processing.
Information about the risk
For its risk assessment the insurer can ask questions that relate to the nature of the
risk. Other than in the Insurance Contract Law before the reform of 1. 1. 2008, the
insurer cannot ask questions across the board about circumstances that could increase the risk, because as a rule the policyholder cannot assess whether something
is actually relevant for the insurer. The insurer must, therefore, consider very carefully in advance which facts are important for him (e.g. age, previous medical conditions, previous losses, etc.). The policyholder is obliged to answer these questions
completely and truthfully. If he does not do this, the insurer can in accordance with
19 ff Insurance Contract Act (VVG) modify, cancel or withdraw from the policy.
Contractual period of commitment
As a rule the future policyholder is bound to his proposal for a defined period.
Within this period of time the insurer has to undertake the risk assessment and
under certain circumstances accept the proposal. If the insurer accepts the policy
belatedly, this amounts legally to a new proposal, which must again be accepted by
the policyholder in order that an effective contract is concluded.
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Miscellaneous explanations
Furthermore, the future policyholder will have to make further declarations, depending on the class of business, such as a declaration of release from professional discretion or a declaration acknowledging awareness of the General Insurance Conditions (AVB) and all additional information in accordance with 7 VVG.
Acceptance
The acceptance can be effected by means of a specific declaration or be implied. The
latter means that from the behaviour of the contractual parties the will to conclude
the contract is recognizable. An implied acceptance of the proposal by the insurer
can be the dispatch of the insurance policy or a premium note without comment.
The implicit acceptance by the policyholder can be the payment of the premium. In
contrast, it is definitely not sufficient simply not to respond.
Handing over the insurance policy is not necessary to make the insurance contract
effective. In line with 3 VVG it serves only as evidence that the insurance contract
has been concluded and has purely declaratory effect.
3.5.2
Divergent insurance policy
If the insurance policy differs from the proposal, because, for example, the insurers
risk assessment had shown that there was a higher risk, thus warranting an exclusion or a higher premium, the implicit declaration of acceptance would not correspond to the policyholders proposal. In accordance with the regulations of the Code
of Civil Law (BGB) this case would constitute a new proposal for a (changed) contract, which further would in turn have to be accepted by the policyholder. In this
case, however, the Insurance Contract Law (VVG) has set up a special regulation in
5. According to this the divergency is approved if the policyholder does not dissent to the change within one month after receipt of the insurance policy with the
changed contents. In this case a lack of response is recognized as a notional declaration of intent, in contradiction to the usual regulations. A precondition for this is,
however, that the insurer should specifically draw the policyholders attention to the
diverging conditions and the legal consequences of not responding.
Variation 1
proposal
policyholder
insurer
divergent insurance policy

+ advice
disagreement
no insurance contract
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Variation 2
proposal
policyholder
insurer

+ advice
no response
changed insurance contract

Variation 3
proposal
policyholder
insurer

+ no advice
no response
insurance contract comes into force as originally proposed
3.5.3
Insurers duty to give advice prior to contract
6 of the Insurance Contract Law (VVG) imposes on the insurer the duty (newly
introduced into the VVG) to give advice prior to contract. The insurer is obliged to
ask the policyholder about his wishes and needs and to advise him accordingly, and
to justify the advice finally given. Questioning, advising and justifying must be documented.
The content and extent of this counselling duty is governed by the specifications of
the Directive on Insurance Intermediaries (Directive 2002/92/EG), which imposes the
corresponding duties on the insurance intermediary. The German legislator wanted
to extend these duties to the insurer as well as the insurance intermediary. However,
in practice the insurer will generally have to use the insurance intermediary in order
to fulfil these duties, since the insurer itself often does not have any contact with
customers. The action of the insurance agent, which according to 278 Code of
Civil Law (BGB) acts as a vicarious agent of the insurer, is imputed to the insurer, in
contrast to the insurance brokers action.
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The advantage of imposing the above mentioned duties on the insurer as well as the
insurance agent is that in the event of a violation the policyholder can assert a claim
for damages against both of them.
The duties of questioning and advising do not apply if the policyholder is represented by a broker. In this case, based on the brokers appointment agreement, the
duty to make inquiries and advise is already fulfilled by the broker which represents
the interests of the policyholder. Furthermore, large risks as defined in Art. 10 of the
Introductory Law to the Insurance Contract Act (EGVVG) are exempted from the
duty to advise, since such policyholders usually possess sufficient expertise. The
most important exception to the duty to advise is distant selling business, since in
this case making inquiries and counselling is either impossible or very difficult. (See
in this connection Wandt, Handbook of the specialist lawyer insurance law, Luchterhand, 3rd edition 2008, 1st chapter, marginal 270).
The insurer does not have a general duty to question and counsel, but only one that
arises from a specific situation. This means that from the particular situation in
which the insurer and policyholder find themselves, there must be indications from
which the insurer can draw further conclusions.
Example:
The policyholder tells the sales person of insurance company X that his son has just
left home. The policyholder has taken out a household policy with X. In this case the
sales person should point out that the household policy does not cover the sons
new flat and that he should ask whether cover is needed for this.
As well as the situation which must offer a reason for counselling, according to 6
of the VVG the intensity of the counselling depends on the premium payable for the
insurance cover. This rule should protect the insurer from making an unreasonably
large investment in a counselling session, which is likely to earn him very little premium.
For the sake of proof, questioning and counselling must be documented.
In accordance with 6 III VVG the policyholder can forego counselling as well as documentation. In order not to undermine the counselling and documentation obligation, the effectiveness of this waiver is bound to particular preconditions. The waiver declaration must be in writing on a separate document, and the policyholder
must be explicitly informed that waiving could be disadvantageous if he wants to
sue the insurer later.
Similar obligations with regard to questioning, counselling and documentation
apply also to the insurance intermediary ( 59 ff VVG). The insurers as well as the
insurance brokers duty to counsel goes even farther, however, insofar as they can
be obliged to ask follow-up questions and give advice throughout the duration of
the contract, if required.
3.5.4
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Insurers duty to give information prior to contract
The pre-contractual duty to give information is regulated in 7 Insurance Contract

Act (VVG). One of the innovations of the VVG reform is that a distinction is no longer
made between consumers and other policyholders: the information is to be given
for all insurance policies and all policyholders.
Consumer in the meaning of 13 Code of Civil Law (BGB) are all natural persons,
who have made a legal transaction for their own private purpose, not for their commercial or freelance activity.
An exception to this principle is made only for insurance contracts for large risks, for
which under the terms of 7 VVG there is a restricted duty to give information,
insofar as the policyholder is a natural person. This information is to be provided in
text form. It is thus also sufficient if it is transmitted by e-mail or fax.
The insurers duty to give information prior to contract applies only to the insurer
itself, but not to the insurance intermediary as well. If the insurer uses an insurance
intermediary, it has to make sure that the intermediary contract stipulates that the
intermediary has to comply with these duties in its place. If a broker is involved
when the contract is concluded, the insurer has to fulfil its duty to provide information to the broker.
The insurer must convey the following to the policy holder in good time before he
submits his declaration of intent in order to conclude the contract
his policy conditions including the AVB and
the important information in accordance with 7 VVG in connection with 1 VVInfoV and
insofar as the policyholder is a consumer (here the VVG-InfoV makes an exception from the newly introduced principle described above) a product information
sheet as well as
the statement on the right of revocation in accordance with 8 VVG and
insofar as it is a life insurance policy, a disability income benefit, an accident
insurance of the life insurance kind or a health insurance policy, further particular
information in accordance with 2 and 3 VVG-InfoV
The background to this instruction is that before concluding the contract the policyholder must be able to inform himself comprehensively and in good time about its
contents.
3.5.4.1 Contractual requirements including the General Insurance Conditions
(AVB)
The contractual requirements dealt with in the AVB have already been described in
Section 3.3.
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3.5.4.2 Important information in compliance with 7 VVG in conjunction

with 1 Insurance Contract Act (VVG-InfoV))
The VVG-InfoV stipulates in detail the content and extent of the important information that has to be provided. This information includes in particular important
information about the insurer, its payment commitments (premium and additional
costs), duration and termination of the contract. The important information does
not, however, include specific details of the insurance cover.
3.5.4.3 Product information sheet
Since the reform of the Insurance Contract Act (VVG), the insurer has to provide the
policyholder with a product information sheet, insofar as he is a consumer.
The product information sheet is the first information the policyholder has to receive. The legislators intention is that the policyholder should receive a file which
puts together all the important information for him in a logical order. The product
information sheet, that must be named as such, provides an overview of the most
important insurance details. In this connection, the insurer must point out that the
information is not complete. Assuming the policyholder will often not read the General Insurance Conditions, the legislator wants to ensure that that he still receives a
good overview of the contents. In addition, the product information sheet must be
written in a simple and easily comprehensible way.
The product information sheet contains information about the insurance contract,
such as the description of the insured risk and the benefit and risk exclusions that
are important in practice, as well as the particularly relevant obligations.
3.5.4.4 Statement on the right of revocation
Under the new regulation of 8 Insurance Contract Act (VVG) all insurance contracts
can in principle be revoked, irrespective of which distribution channel was used to
acquire them. In this way the numerous regulations of the old VVG have been substituted by the right of revocation that used only to apply to contracts acquired by
distant selling being extended to all insurance contracts.
The revocation period is 14 days, for life insurance policies 30 days, and begins
when the policyholder has received all the above mentioned information. Only policies acquired by distance selling, which in compliance with 8 Para. 4 Insurance
Contract Act (VVG) in conjunction with 312e Code of Civil Law (BGB) have another
beginning to the revocation period, are regulated differently. In these cases the
revocation period only begins if furthermore the special obligations arising from
312e BGB have been met.
In some explicitly defined cases there is no right of revocation. This is the case for
insurance contracts
with a duration of less than one month
with provisional cover (Caution: the right of revocation nevertheless exists in this
case if the policy was acquired by distance selling)
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for a pension scheme based on a regulation from an employment contract (Caution: the right of cancellation nevertheless exists in this case if the policy was
acquired by distance selling)
for large risks.
The insurer is obliged to inform the policyholder of the existence or non existence of
its right of revocation, and if it exists, the legal consequences of exercising it.
9 VVG stipulates the legal consequences of a revocation in accordance with 8
VVG. The insurer must return that part of the premium which had been paid for the
period after the declaration of revocation reached it. Furthermore, a precondition is
that the insurer had informed the policyholder in due form of the revocation and its
legal consequences and that the policyholder had given his consent that the insurance cover should already commence before the expiry of the revocation period.
For life insurance the special regulation of 152 VVG applies.
3.5.4.5 Information in accordance with 2 and 3 VVG-InfoV
For life insurance, disability income benefit, accident insurance with return of premium and health insurance the insurer has to give additional information, such as
the distribution of expenses and the paid up values. The background to this is that
the above types of insurance are particularly difficult for the policyholder to understand and that they are long-term contracts.
3.5.4.6 Timely supply of information
The information indicated above must be made available to the policyholder in
good time before he concludes his policy declaration. This formulation is derived
from the condition for distant selling contracts in accordance with 312c Code of Civil Law (BGB), since the legislator wants to make sure, regardless of the sales channel (distant or personal), that the policyholder already has the information when he
makes his policy declaration.
It is unclear what timely before the submission of the policy declaration means.
The term is not defined in the law and a minimum period of time is not given. The
choice of words makes it clear, however, that it is certainly not sufficient to give the
policyholder the information practically at the same time as he submits his policy
declaration. He must have the chance to take note of this. This has implications for
the various ways in which an insurance contract can be concluded.
Policy model
Consequently, the so-called policy model has been dropped, according to which
until the VVG reform the insurer could send the information after the contract had
been concluded with the dispatch of the insurance policy.
Proposal model
In future the insurer will be restricted to the so-called proposal model, according to
which the policyholder, as described above, must have received the complete information before the submission of the proposal declaration.
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Invitation model
Furthermore, the invitation model is in discussion. It is assumed that the policyholders proposal is not yet a binding declaration of intent pursuant to 145 BGB, but
only a request to the insurer to make an offer. He does that by sending the policy documentation to the policyholder. The policyholders acceptance of the contractual
offer is made either explicitly or implicitly by the payment of the premium. Whether
and to what extent the policyholders policy declaration can be understood as a
simple request to submit an offer depends on each individual case.
Concluding the contract by telephone
If the insurance contract is concluded by telephone at the request of the policyholder or by the use of another means of communication which does not permit the
transfer of information in text form, the transfer of the information can exceptionally
be made immediately after the conclusion of the contract.
Waiver of duty to provide information
In accordance with 7 Para. 1 S. 3 VVG the policyholder can forego the right to receive information. Since this possibility would practically undermine the new consumer protection as a basic principle of the VVG, exactly how such a waiver declaration could be made is very controversial. It is clear, however, that an insurer may
not systematically persuade all its customers to this renouncement in order to avoid
the duty to provide information. In such a case the Federal Financial Supervisory
Authority (BaFin) could intervene.
Breach of the duty to provide information
The duty to provide information is breached if the information, contents and phrasing clearly required in law are not complied with or used. This does not apply if the
information is provided inaccurately.
Breach of the obligation to supply information can have various consequences:
The revocation period pursuant to 8 VVG does not commence, the policyholder
can thus revoke the insurance contract for an indefinite period of time and demand a return of premium. For the insurance company this is a matter of great
economic uncertainty.
If the insurer does not fulfil its obligations to supply information systematically,
the Federal Financial Supervisory Authority (BaFin) can in accordance with 81
Para. 2 Insurance Supervisory Act (VAG) insist on the fulfilment of the duties.
Competitors or consumer associations can take action against the company in
accordance with the regulations of the Unfair Competition Act (UWG).
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Example 1:
Insurer X on principle does not hand out product information sheets to its customers. In this way it is in breach of duty to provide information and is exposed to the
aforesaid consequences.
Example 2:
Insurer X does hand out a product information sheet to its customers, but it does not
mention the most important exclusion. There is no breach of duty to provide information that could lead to the legal consequences intended in the case of failure to
provide information. This dispute can only lead to liability to pay damages for a failure to comply with pre-contractual obligations.
3.6
Commencement, duration and termination

of the insurance contract
3.6.1
Commencement of the insurance contract
There are three types of insurance commencement: the formal, the material and the
technical insurance commencement.
3.6.2
Formal insurance commencement (Conclusion of the contract)
The formal insurance commencement is the time at which the contract is concluded:
that is, the signing of the agreement in the legal sense.
3.6.2.1 Material insurance commencement (Beginning of the insurance cover)
The material insurance commencement is the contractually agreed time from which
the insurance cover is in force: that is, when the insurers liability (assumption of
risk) begins. This point of time does not necessarily need to coincide with the formal
commencement of the insurance.
The material insurance commencement is regulated in 10 Insurance Contract Act
(VVG), which states that an insurance contract whose duration is determined in
days, weeks or months begins at the beginning of the day on which the contract was
concluded.
Example:
Mr Mller takes out a household insurance policy with X-Insurance on 10. 3. 2009 at
11:00 a.m. There is no special agreement as to the commencement of the insurance.
The contract is signed with the above date. The material insurance cover begins
according to 10 VVG already on 10. 3. 2009 at 0:00 a.m.
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Because of 10 VVG the so-called midday rule was abandoned, according to

which the insurance commencement was in principle fixed at 12 noon. Since even
during the period when the midday rule was in force many classes of insurance
chose to make the cover begin at 0 hours in order that there was no time gap in the
cover, the new general stipulation was made to fit in with these special regulations.
It is possible to diverge from 10 VVG, since it is only a rule of interpretation: individual agreements regarding the start of the insurance cover are possible.
Payment clause
In addition, until the VVG reform the so-called payment clause applied. A precondition for the commencement of the insurance cover was as a matter of principle the
payment of the first premium by the policyholder. After the VVG reform the payment clause in this form is no longer permitted, because since 1.1. 2008 already with
the late payment of the first premium fault has to be considered. A payment clause
that complies with the new law should thus include the default element, and could
read as follows:
The insurance cover begins at the earliest with the payment of the first premium,
unless the policyholder is not responsible for its not being paid.
If the policyholder is responsible for the non-payment of the first premium, the insurer is by law already free from its duty to pay insofar as it has drawn the policyholders attention to this effect in a specific message in text form or by means of a
noticeable warning in the policy document.
The policyholder is often granted insurance cover before the payment of the first
premium and thus has immediate cover. In this case the (legally standard) payment
clause is contractually waived. It is then substituted by the so-called extended payment clause, according to which the policyholder has insurance protection if the
premium is paid within an agreed period of time or immediately on receipt of the
invoice.
Waiting period
Furthermore, particularly in private health insurance waiting periods can be agreed.
In this case the insurance cover begins after they have finished.
There is a difference between a general waiting period and special waiting periods
for certain illnesses and benefits. The extent to which such waiting periods can be
agreed is regulated in 197 VVG. According to this the general waiting period must
last for a maximum of 3 months, special waiting periods especially for giving birth,
psychotherapy, dental treatment, dental prostheses and orthodontics maximally
8 months.
3.6.2.2 Technical Insurance commencement
The technical commencement of the insurance cover is the beginning of the period
for which a premium is required: that is, the period of time for which a premium is
calculated. The technical commencement of the insurance cover coincides regularly
with the material insurance commencement.
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The period for which a premium is required is broken down into insurance periods.
Each insurance period lasts one year insofar as the premium is not based on shorter
periods of time (12 Insurance Contract Act (VVG)).
Backdating
There is backdating if the technical but not also the material insurance commencement is set before the start of the formal insurance commencement. The period for
which a premium is due begins before the legal contractual conclusion, but the
insurance cover only begins with the start of the material insurance.
Backdating plays a role in life insurance if the proposer chooses a younger age of
entry in order get a lower premium rate or enjoy tax advantages for a previous
period of time, or in motor liability insurance in order to achieve a better grading in
the claims-free classes in the future.
Example:
January 1st
technical insurance
commencement
conclusion of the insurance and

material insurance commencement
February 1st
March 1st
Forward insurance and retroactive insurance

Forward insurance is the norm and means that the material insurance commencement coincides with the formal insurance commencement or occurs later: that is,
in the future.
Example 1:
Ms Meier leaves her parents home on 1. 2. 2009 for her own flat. She wants to take
out a household policy and have insurance cover as soon as possible. She meets
her insurance intermediary on the same day, therefore, and takes out the appropriate policy in which the insurance commencement is also dated 1. 2. 2009.
Example 2:
Family Gruber books a holiday trip to Mallorca which will take place in October. The
family takes out baggage insurance for the journey. The material insurance commencement is at the same time as the start of the journey.
There is retroactive insurance when the technical as well as the material commencement of the insurance is set before the formal insurance commencement.
The insurance cover should thus already begin before the conclusion of the contract.
According to 2 II VVG the insurer only has a right to the premium payment if it did
not know that the occurrence of the insured loss was excluded before it made the
contractual declaration. Vice versa, the insurer is released from its liability to make
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payment if the policyholder already knows that a claim had occurred when he submits the contractual declaration. If one of the two eventualities is the case, retroactive insurance is excluded.
Example:
January 1st
technical and material

insurance commencement
conclusion of the insurance

policy
February 1st
March 1st
3.6.2.3 Provisional cover

A contract for provisional cover is concluded if the policyholder needs insurance cover immediately, but the insurer would actually still need time to assess the policyholders risk thoroughly and determine the exact policy conditions.
Example:
Ms Schmidt buys a secondhand car and in order to obtain registration she needs
proof of compulsory liability insurance. Because she wants to obtain the licence on
the very day of the purchase she applies for provisional cover at Insurer X, since the
latter cannot make a final offer at such short notice.
The contract of provisional cover is an independent insurance policy for which the
regulations of the Insurance Contract Act (VVG) apply. Since this contract is usually
made under great time pressure, 49 to 52 VVG stipulate some exceptions which
facilitate its conclusion.
Consequently, in accordance with 49 I VVG it can be specially agreed that the
information from the insurer stipulated in 7 VVG need only be given if the policyholder requires it, at the latest with handover of the policy document. Because of the
strict requirements of the distance selling directive, this concession does not apply
to distance selling policies. Furthermore, the policyholder does not have a right of
revocation as defined in 8 VVG (which he has in the case of a distance selling
policy).
As a matter of principle, the material insurance cover of contracts with provisional
cover begins with the formal conclusion of the contract or the stipulated commencement. In contrast to the main policy, the payment clause must be explicitly agreed
in accordance with 51 VVG.
Depending on the wishes of the parties provisional cover should apply only to the
point of time at which the insurer has finished its risk assessment. There is no duty
to take out the main contract, compare 50 VVG. Thus in this case it is not a so-called preliminary agreement. The contract for provisional coverage thus terminates at
the latest when the main contract or a further contract for provisional cover was
concluded: namely, irrespective of which insurer ( 52 VVG).
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Example:
On 1. 2. 2009 Ms Schulz takes out a policy for provisional compulsory liability cover
with X-Insurance for her car. On 1. 3. 2009 she takes out the main compulsory liability policy with Y-Insurance. The policy for provisional cover with X-Insurance ends
automatically on 28. 2. 2009 at 24:00 hours.
Furthermore, the provisional cover ends provided there are instructions to this
effect if the policyholder fails to pay the initial premium.
3.6.3
Duration of the insurance policy
The duration of the insurance contract depends in the first instance on the agreement of the contractual partners. The insurance contract can be concluded for a
defined period or it can end automatically upon occurrence of a particular event.
Example 1:
A motor insurance policy is taken out for a year. Commencement of the insurance:
1. 1. 2009, 0:00 hours, Termination of the insurance: 31. 12. 2009, 24:00 hours. In this
case the policyholder must take action in order to take out a new insurance policy or
in order to renew the existing policy.
Example 2:
Mr Kunze has bought a piece of land and while his house is being built he needs a
principals liability insurance. This ends automatically on completion of the building.
An insurance policy can, furthermore, be taken out for an indefinite period. There
are two ways of doing this in practice: either the termination of the insurance policy
is deliberately not stated and defined as open, or the agreement states that the
insurance duration is one year and is renewed automatically unless one of the parties to the policy has cancelled it. In both cases one of the parties to the contract
must take action in order to terminate the policy.
In accordance with 11 I VVG each renewal of the policy must be for maximally one
year.
3.6.4
Termination of the insurance contract
Insurance policies can be terminated in different ways or they can end automatically. The most important are duration, occurrence of a particular event, mutually
agreed nullification, withdrawal or cancellation.
3.6.4.1 Expiry
An insurance contract can be taken out for a certain period and end automatically at
the date stipulated. To avoid undermining the policyholders right of revocation,
which could be the case if contracts with extremely long durations were taken out,
the legislator in 11 Para. 4 Insurance Contract Law (VVG) has laid down that for
contracts that last for longer than 3 years the policyholder should have a right of
revocation from the end of the third year. It should be noted that only the policyholder has this right of revocation, not the insurer.
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Example:
Mr Huber takes out a personal liability policy. In order to get particularly good conditions, he takes out the contract for five years.
Version a:
The contract ends automatically without the parties needing to take action after the
agreed 5 years.
Version b:
Mr Huber wants to change the insurer after 4 years and gives notice of cancellation
as of the end of the 4th insurance year, because he has a special cancellation privilege in accordance with 11 Para. 4 VVG.
Also in the case of a temporary contract there can be ways of cancelling it during the
agreed duration. But a precondition in this case are special events that would justify
an extraordinary cancellation. Cancellation by agreement with the contractual partner is also always possible.
3.6.4.2 Occurrence of particular events
If it is agreed that the contract should be terminated on the occurrence of a particular event, the insurance contract ends when this event occurs without the parties to
the contract needing to take further action. This is always appropriate if the occurrence of the event cannot (yet) be fixed for a particular date. Examples of such
events are transports or exhibitions.
As with an insurance contract for a limited period of time, the contract can only be
cancelled during its defined duration for special reasons or by mutual consent.
3.6.4.3 Withdrawal of the contract
The cases in which one of the contractual partners can give notice of withdrawal are
regulated in the Insurance Contract Act (VVG).
Notice of withdrawal is a unilateral declaration of intent which requires acknowledgement of receipt in the sense of 116 ff Code of Civil Law (BGB). In contrast to the
general law of obligations, withdrawal from an insurance contract does not lead to
the contract being rescinded, because as a continuing obligation it was already
partly fulfilled (usually by the insurer carrying the risk for a particular period of
time). Thus the consequences of the withdrawal are regulated in the VVG in each
case, where the basic principle for the right of withdrawal is also found.
Withdrawal because of breach of the duty of disclosure prior to contract,
19 ff VVG
In accordance with 19 VVG the insurer can question the policyholder about the present risk features before the contract is concluded. This serves the purpose of
giving the insurer the chance to make a proper calculation and to consider whether
or not it wants to insure a particular risk.
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Other than before the reform of the VVG the policyholder needs only disclose significant risk elements
which the insurer has inquired about in written form and
which exist before he submits his contractual declaration
The insurer must consider carefully which circumstances are important for him and
which questions he would like to ask. Furthermore, he can only ask questions which
are of significance for his risk assessment and not further questions which would
enable him to offer other insurance policies, for example.
Example 1:
Mr Mller wants to take out private health insurance and submits a proposal to X-Insurance. Following this he receives a questionnaire in which he is asked specifically
about previous diseases, operations and dental treatment. The insurer needs this
information in order to calculate a premium.
Example 2:
Ms Meier wants to take out household insurance. The insurer asks Ms Meier about
her income, because at the same time he sees a chance of offering her an annuity.
This new regulation has the advantage for the policyholder that as long as he answers all the insurers questions truthfully he no longer bears the risk of jeopardizing
the insurance cover. If the insurer does not ask a question whose answer is relevant
for the risk assessment, this is to the disadvantage of the insurer. In contrast before
the VVG reform, the policyholder had to decide which facts were relevant for the risk
assessment.
Furthermore, the policyholder need only point out circumstances which he is aware
of until he submits his policy declaration. As a rule this is the proposal for taking out
the policy. If the insurer now needs more time for its risk assessment, and should
additional dangerous circumstances be known to the policyholder between his policy declaration and the acceptance of the insurer, he is only obliged to report these
if the insurer explicitly asks him after his policy declaration. Before the VVG reform
the policyholder was obliged to report any circumstances that could negatively
influence the risk that occurred after the contract declaration, without the insurer
needing to inquire specifically.
If the policyholder breaches his duty of disclosure, 19 ll VVG gives the insurer the
right to withdraw from the insurance contract, unless the breach was due to simple
negligence. In this case the insurer only has the right of cancellation, compare 19 lll
VVG.
Insofar as the right to withdraw exists because of a grossly negligent or intentional
violation of the duty to disclose, it is nevertheless excluded if the insurer would have
concluded the contract to other conditions.
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Example:
Ms Gruber wants to take out private health insurance, but forgets to declare a chronically asthmatic condition, although the insurer had asked about such conditions.
Although Ms Gruber has not complied with her duty to disclose, the insurer is not
permitted to withdraw from the contract, because it usually insures asthma sufferers with an extra premium of 5 %, however. Ms Gruber thus has insurance cover,
but she must pay the higher premium (with retrospective effect). If Ms Gruber had
not declared the disease deliberately, the insurer would not be obliged to make the
contractual adjustment, 19 IV VVG.
If because of this the premium is raised by more than 10 percent or if the insurer excludes the risk that was not reported, the policyholder can withdraw from the insurance contract by cancelling it, compare 19 Para. VI VVG.
Furthermore, the insurer can only exercise its right to withdrawal if it has informed
the policyholder accordingly by means of a separate note in written form and if it
had no knowledge that the information was incorrect. The insurer should, therefore,
enclose a further sheet with the proposal form, in which the consequences of supplying false information are spelt out.
If the insurer announces the withdrawal, in accordance with 39 Para. 1 Sentence 2
VVG it can demand the pro rata premium which it is entitled to until the withdrawal
announcement is effective. Until the reform of the VVG the principle of the indivisibility of the premium prevailed. The insurer was entitled to the entire premium due
until the expiry of the insurance period. This principle of the indivisibility of the premium was suspended, however, in the new VVG, so that pro rata premium payments are possible.
This is nevertheless fair, because the insurer is liable to pay for a claim before the
submission of the withdrawal announcement if neither the occurrence nor the
extent of the insurance claim is due to the breach of the duty of disclosure.
Withdrawal due to non payment of the first or single premium
In the event of late or non payment of the first or single premium, the law also gives
the insurer the right to withdraw from the contract. The preconditions for this will be
dealt with in the next chapter, Premium payment duty.
The consequence of a withdrawal in accordance with 37 VVG is that benefits
already received (e.g. premium or an insurance benefit because of a claim) must be
returned. This is a result of the general withdrawal regulations of the Code of Civil
Law (BGB). However, in 39 Para.1 Sentence 3 VVG there is a special regulation that
the insurer can demand a reasonable expense charge.
3.6.4.4 Cancellation of the insurance contract
The cancellation as also the notice of cancellation is a unilateral declaration of
intent which requires acknowledgement of receipt. Other than the withdrawal,
which is aimed at ending a contract retroactively, the purpose of cancellation is to
end the insurance contract for the future.
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Whether the cancellation needs a particular form can either be established in law or
in the insurers General Insurance Conditions (AVB).
It is important to distinguish between contractual notice of termination and extraordinary notice of cancellation.
Contractual notice of termination
Contractual notice of termination can be given with effect from a specific time of
cancellation, but in doing so the period of notice must be observed. It is not necessary to state the reason for cancellation.
The contractual notice of termination is mainly regulated in 11 Insurance Contract
Law (VVG). As already described above, the following can be given contractual
notice of cancellation:
Insurance contracts with a renewal clause
Insurance contracts with a duration of more than three years, at the earliest to the
end of the third year
Open-ended insurance contracts
In the case of the last named, the right of cancellation can be waived for a maximum
of two years.
The period of notice must be from one to three months and be the same for both
parties to the contract. In this respect 11 may not be varied to the disadvantage of
the policyholder.
The legislator has standardized exceptions to these regulations for different types of
insurance, insofar as particular interests require this.
The insurer cannot give contractual notice of cancellation, for example, for sickness
benefit, daily benefit or long-term care insurance that replace the statutory benefits.
The background to this ruling is the need to protect the policyholder, who because
of medical underwriting is put into a certain tariff and after falling sick would only
obtain insurance cover again to considerably worse conditions. The intention of
substitutional health insurance is, namely, to provide lifelong insurance cover that is
able to replace statutory schemes. The policyholder, on the other hand, is granted
the right to give contractual notice of cancellation.
There are further exceptions in life and disability income benefit insurance. In motor
third party liability contractual notice of cancellation is also stipulated explicitly.
Extraordinary notice of cancellation
Extraordinary notice of cancellation is possible for temporary as well as for openended insurance contracts and can be effected during the year. There must always
be a reason for this (cause of notice of cancellation).
The principles on which an extraordinary notice of cancellation may be issued in
favour of the policyholder and / or the insurers can be found in various places of the
VVG.
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Important examples of this are:

The insurers right of cancellation because of a simple negligent breach of the precontractual duty of disclosure
The insurers right of cancellation because of an increase in the risk while the
policy is in force
The insurers right of cancellation because of a breach of obligation before a loss
occurs
The insurers right of cancellation because of persistent failure of the policyholder
to pay the renewal premium
The policyholders right of cancellation because of an increase in the premium
The right of cancellation of both parties because of a claim in non-life insurance
Extraordinary notice of cancellation does not necessarily mean cancellation with
immediate effect. Rather, the law often fixes periods within which and at which
point of time extraordinary notice of cancellation may be given. This serves to protect the policyholder, who should have time to look for new insurance cover.
The law provides for cancellation with immediate effect only in a very few cases, if a
particularly serious breach by one party justifies this.
As well as the usual reasons for an extraordinary notice of cancellation as regulated
in the VVG, there are two other justifications for an extraordinary notice of cancellation.
This is, on the one hand, possible with a contractual agreement, especially in the
General Insurance Conditions (AVB). However, the AVB often simply repeat the
rights which are already available by law. If an insurer tries to justify extraordinary
notice of cancellation in its AVB on grounds that the law is not familiar with, it will be
necessary to check very carefully whether this is consistent with the relevant basic
principles of the VVG.
A further right to extraordinary notice of cancellation can result from 314 Code of
Civil Law (BGB) (cancellation of a continuing obligation for an important reason) if
one party after consideration of the mutual interests cannot be expected to continue the contractual relationship.
This very broadly expressed right of cancellation can naturally only apply if there
was not already an ultimate rule for each violation in the VVG.
Excursus: Death of the policyholder
The death of the policyholder does not in principle end the insurance relationship,
but this is transferred to his heirs, since the insured risk basically remains (Example:
motor liability insurance). Extraordinary notice of cancellation is thus not justified. If
the risk depends only on the person, however (for example, health or accident insurance) there is no longer insurable interest, so that the insurance contract can be terminated in accordance with 80 VVG. For life and accident insurance the death does
not only mean the cessation of the risk but also the claim event, which triggers the
claim to the insurance benefit.
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3.7
Duty to pay the premium
With the insurance contract the policyholder undertakes to pay the premium that
has been agreed.
The premium is the policyholders payment for the risk that the insurance carries. It
is, therefore, the price for the insurance cover. The premium is called contribution
by mutual insurance companies (compare 24 Insurance Contract Law (VVG)).
Nevertheless, the legal regulations, which only refer to the premium, apply also to
the contributions.
The contractual partners are free in principle to agree the premium level. Where
the insurer has mass business, however, there will naturally be no individual negotiations about the premium. Rather, the insurer refers instead to its precalculated
tariff tables, which reflect different risk groups.
Although price control by the supervisory authority was stopped in 1994, for the
classes of insurance of sociopolitical relevance life insurance, accident insurance
with return of premium and the form of health insurance that replaces statutory
cover there are still standard rules from in the Insurance Supervisory Act (VAG)
about the principles of calculation and later premium adjustment.
3.7.1
Types of premium
There are different types of premium

Premium
single premium
regular premium
initial premium
renewal premium
A single premium is one which the policyholder has to pay on conclusion of the
insurance contract and then no further premiums are due. Single premiums pay a
role especially for policies of shorter duration (e.g. travel cancellation insurance).
For all policies with regular premiums the premium is generally paid per year,
unless shorter periods of time were fixed by the insurer (compare 12 Insurance
Contract Law (VVG)).
For policies with regular premiums a distinction is made between the first premium
that has to be paid (first premium) and the other premiums (renewal premiums).
This distinction reflects the fact that a policyholder who has not paid the first premium (promptly) must reckon with more serious consequences than a policyholder
who does this in the course of a long contractual relationship.
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On the other hand, in law the single premium and the first premium are treated
equally.
It is necessary to distinguish between a shortened insurance duration for which a
particular premium is payable and a longer insurance period with agreed instalments. The latter case constitutes only a contractual agreement about payments.
The reduction of the insurance duration, however, would affect the right of contractual notice of cancellation
Example 1:
Insurer X writes in its policy conditions:
The insurance policy is taken out for 6 months and is automatically renewable by 6
months if one of the contractual partners does not submit notice of cancellation at
least one month before expiration. In this case a duration of only 6 months has been
agreed and for this period a premium has to be paid. If the policy is renewed, the
premium for the next 6 months becomes due. Contractual notice of cancellation can
always be given to the end of the insurance periods.
Example 2:
Insurer Z writes in its policy conditions:
The duration of the contract is one year. The premium is always due quarterly,
always at the beginning of the new quarter. In this case the insurance duration is
one year. The premium is payable in instalments. Contractual notice of cancellation
can only be submitted to the end of the insurance year.
3.7.2
Premium due dates
The due date is the point of time when the creditor can request the benefit and when
the debtor must deliver. First premiums, single premiums and renewal premiums
have different due dates.
First and single premium
In accordance with 33 Para. 1 Insurance Contract Law (VVG) the first and single
premium are payable immediately after the expiry of two weeks after receipt of the
insurance policy. In the old version of the VVG there was not yet this two week shift
of the payment date. With this change the legislator expresses its clear intention
that payment should only be made when the revocation period has run out and the
insurance policy is in force.
It is, therefore, questionable whether 33 Para. 1 VVG from which deviations are
also possible to the detriment of the policyholder, can be changed by means of the
General Insurance Conditions to such effect that the premium is immediately payable on receipt of the insurance policy. Such a clause could be invalid according to
307 Code of Civil Law (control of content), because it is not consistent with important basic principles of the legal regulation, which is being deviated from.
This would be the case if the two week payment period fitted in with the general
principles of the new VVG and its basic concepts.
83
For those insurance contracts for which there is no right of revocation (e.g. policies
with a duration of less than a month), the agreement of the immediate due date of
the first and single premium is certainly possible, because the principles outlined
above are not relevant in this case and the policyholder does not have justifiable
interest in making a later payment.
For all other insurance policies both opinions could be pleaded for. Many factors
indicate that the legislator did not want to link the duty to pay the premium to the
duration of the right of revocation because otherwise the premium period would be
further extended if the right of revocation began to run belatedly, for example, because of inadequate information.
Renewal premium
The due date of the renewal premium depends on the period insured, since the premium is calculated according to the duration of the insurance period. With the beginning of the new insurance periods the renewal premium is due. Special payment
modalities can naturally be agreed with the policyholder (e.g. payment within 4
weeks of the commencement of the new insurance period or only after the receipt of
an invoice, etc.).
3.7.3
Debtor of the insurance premium
The only main duty of the policyholder is to pay the premium. Also for a contract for
the account of a third party or if another person pays the premium, the policyholder
alone remains the one who owes the premium.
3.7.4
Late premium payment
As already mentioned, the first premium and renewal premium are due at different
times. The legal implications if the duty to pay the premium is not met are also different.
3.7.4.1 Non payment / Late premium payment
37 Insurance Contract Act (VVG) regulates the consequences of a late payment of
the first or single premium.
Right of withdrawal
If the policyholder does not pay the first or the single premium although it is due,
the insurer is justified in withdrawing from the contract as long as the payment has
not been made. In other words an existing right of withdrawal expires at the latest
with the payment of the first premium.
The fiction of the law before the VVG reform of 1.1. 2008, according to which it counted as withdrawal if the premium could not be legally ascertained within 3 months,
no longer applies. Today the insurer must take action in order to withdraw from a
contract in force.
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A precondition for the right to withdraw continues to be that the policyholder has to
take responsibility for the non payment, that is, he is culpable for not paying the premium.
Example:
Ms Mller has taken out an insurance policy and the premium is due on 1. 6. 2008. In
the week before Ms Mller has appendicitis and must go immediately to hospital
from which she is only released on 3. 6. 2009. On 4. 6. 2009 Ms Mller transfers the
money. In this case there would be no fault, and the insurer would not be justified in
withdrawing from the contract.
If the insurer declares withdrawal justifiably, the parties must return their benefits
insofar as they have received any. A claim for premium payment also pro rata no
longer exists. The insurer can only demand a reasonable administration fee, since it
had administration costs due to the issue of the policy and the policyholder did not
behave fairly.
The insurer naturally has the right to hold on to the policy in force and sue for the
payment of the premium.
Release from obligation to perform
If the policyholder does not pay the first or single premium because of his own fault,
the insurer is released from its obligation to pay quite apart from a declaration of
withdrawal if a claim occurs before the premium has been paid.
Beside the precondition of fault, to invoke release of liability the insurer is obliged
to make the policyholder aware of the legal consequences by means of a specific
message in text form or a noticeable indication in the policy document.
Example:
On 1. 4. 2009 Mr Huber takes out a baggage insurance policy. Failing an agreement
to the contrary he must pay the single premium only two weeks after receipt of the
insurance policy. It is agreed, however, that the insurance should be immediately in
force if he pays the premium punctually at the end of these two weeks. There is no
further information about this matter.
On 2. 4. 2009 Mr Huber has a baggage loss and reports this to his insurance company, which on 6. 4. 2009 already deals with the claim amounting to 500,. Mr Huber forgets to pay the premium.
The insurer cannot claim release from the obligation to perform, because it did not
issue the noticeable information that was needed.
3.7.4.2 Non payment / Payment default with the renewal premium
38 Insurance Contract Act (VVG) regulates the results of a payment default of the
renewal premium.
In the case of non payment of the renewal premium the policyholder had already
paid the first premium and so obtained insurance cover. He obviously owes the
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insurer the renewal premium, but he should not easily lose the insurance protection. For this reason the insurer must request the policyholder to pay the premium
(qualified reminder in accordance with 38 Para. 1 VVG) with two weeks notice
before there can be legal consequences. In this payment demand the insurer has to
state the consequences of non payment.
Only if the policyholder is still in default with the renewal premium after this period
of notice is over,
is the insurer released from the duty to pay if the insured loss event occurs after
expiry of the notice period but before the premium has been paid.
can the insurer cancel the policy without observing a period of notice. The cancellation becomes ineffective, however, if the renewal premium is nevertheless
paid within a month of the receipt of notice of cancellation. According to the new
VVG it does not matter in this connection as to whether an insured loss has
occurred in the meanwhile. For the insured loss that occurred between the end of
the notice and the payment there is in any case no insurance cover.
Example:
Ms Huber has comprehensive insurance for her car. She does not pay the renewal
premium, which is due on 1. 1. 2009. Thereupon her insurer Z sends her a reminder
on 5. 2. 2009, in which it states that she must pay the premium by 24. 2. 2009. The reminder states that after the expiry of the term the contract is deemed to be cancelled
with immediate effect. Z points out to Ms Huber in due form what the legal consequences will be. On 28. 2. 2009 Ms Huber makes a claim and pays the premium on
3. 3. 2009.
The notice of cancellation was effective in law and can, as in the example, be connected with the qualified reminder. Although with the payment of the premium
within the month the effects of the cancellation cease to apply, there is no insurance
cover for the insured loss between the end of the period of notice and the payment
of the premium. Since Ms Huber is still in default with the renewal premium after
the period of notice has run out, Z is released from its liability to pay.
3.8
Obligations
As well as the payment of the premium the insurer is naturally interested in ways in
which the policyholder behaves, in order in the first place to be able to assess its risk
and during the policy that the risk does not become greater and in the event of a loss
so that the claim is as small as possible. To this end the insurer has the instrument
of warranties at hand.
An obligation is not a statutory duty, however, because the insurer cannot bring an
action for it or claim damages (compare Wandt, l.c., marginal 522, 532). Compliance
with the rules of behaviour is only in the interests of the policyholder in order to
maintain his right to cover.
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3.8.1
Esther Grafwallner
Legal and contractual obligations
The legislator distinguishes between legal obligations, which are already compulsory in law for the policyholder, and contractual obligations, which the insurer generally makes an element of the insurance policy by means of the General Insurance
Conditions (AVB).
The legal obligations are found in the Insurance Contract Act (VVG) irrespective of
when they should be observed or whether they apply to the insurance of indemnity
or the insurance for a specified amount.
There are legal obligations before the contract is concluded (duty of disclosure in
accordance with 19 ff VVG), during the term of the contract (avoidance and disclosure of an increase in risk, 23 ff VVG) and after the occurrence of a loss (duty to
notify and give information, 30, 31 VVG). In indemnity insurance the obligation to
reduce the claim in accordance with 82 VVG is certainly one of the most important legal duties.
Legal obligations often have additional regulations which describe the legal consequences of breaching them. If an insurer incorporates a legal obligation unchanged
into its AVB, the obligation remains, nevertheless, a legal one. If the insurer, however, modifies the facts of the case or the legal consequence, the legal obligation becomes a contractual one. The same applies for legal obligations for which the legislator has not stipulated any legal consequences if they are breached. If the insurer
incorporates such an obligation into its AVB, and couples its breach with legal
consequences, the obligation becomes a contractual one.
Since there are special requirements for contractual obligations, it is important that
obligations should be recognizable as such. It may be problematical to distinguish
them from exclusions. Since whereas compliance with an obligation can be influenced by the policyholder so that it is the insurers concern to encourage the policyholder to behave in a desired way, in the case of a risk exclusion the insurer wants to
remove part of the cover irrespective of whether or not the policyholder can influence it.
In this respect according to the consistent judgments of the Federal Court of Justice
(BGH) it does not depend on the phrasing of the clause or its status in the AVB, but
only on the material content (compare Wandt, l.c., marginal number 539).
Example:
Ms Mller has insured her expensive mountain bike. In the Exclusions/Limitations
there are the following clauses:
1. There is insurance cover only between 6:00 and 22:00 hours. Between 22:00 and
6:00 hours there is insurance cover if the bicycle is secured with a lock.
2. There is no insurance cover as long as the bicycle is being used for the purpose
for which it was intended.
The first clause is a so-called implicit obligation, because the insurer wants to
encourage the policyholder to secure it with a lock. The second is a real exclusion,
because the insurer definitely does not want to assume risks when the bicycle is
being used, although Ms Mller could naturally also not use the bicycle.
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As the example has already shown, the distinction can be very difficult in the particular case.
In laws which apply to compulsory forms of insurance, there are often further requirements for obligations in order to maintain a minimal standard of insurance cover
for the protected third party.
3.8.2
Breach of obligations
The legal consequences of breaching a legal obligation are regulated (variably) by

the particular stipulation in the law.
The legal consequences of breaching a contractual obligation are, on the contrary,
fixed in 28 Insurance Contract Act (VVG). A distinction is made between contractual obligations after taking out the insurance policy but before the occurrence of a
loss and obligations after the loss occurrence. The regulation is half mandatory, so
that it may not be modified to the detriment of the policyholder.
obligations
legal
contractual
before the occurrence

of the insured loss
after the occurrence

of the insured loss
Legal consequences for breach of obligation before the occurrence of the

insured loss
If the policyholder breaches an obligation before the occurrence of an insured loss,
the insurer can cancel the insurance contract without observing a period of notice.
This severe legal consequence shall only apply, however, if the breach is intentional
or at least grossly negligent. There is no right of withdrawal, however, and it also
cannot be contractually agreed.
Note: the insurer only has the right to cancel if the policyholder has breached an
obligation before the loss occurrence. If the breach of obligation occurs after the
occurrence of the insured loss, this possibility does not exist.
After the occurrence of the insured loss, however, the insurer as well as the policyholder have the right of cancellation, 92, 111 VVG.
Legal consequences for breach of obligation before or after the occurrence of the
insured loss
If the policyholder breaches a contractual obligation, the insurer can be released
wholly or partly from the liability to make payment. In this case the legislator no longer makes a distinction between the times of the violation (before or after the occurrence of the insured event).
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Esther Grafwallner
Before the reform of the VVG of 1. 1. 2008 the so-called all or nothing principle
applied. According to this the insurer was either completely liable (the policyholder
then received everything) or completely free of liability (the policyholder received
nothing) if an obligation had been breached.
Since the border between negligence and gross negligence is blurred, but the
consequences are very different, the legislator has abandoned this principle and
replaced it by the more or less principle.
In accordance with 28 VVG the insurer is thus only released from liability if the
policyholder acted intentionally. If the policyholder acted with gross negligence, the
insurer only has the right to reduce its benefit in accordance with the degree of
responsibility. In the case of simple negligence the insurer is completely liable.
breach of a
contractual obligation
simply negligent
grossly negligent
intentional
full benefit
partial benefit
no benefit
A further precondition for a reduction or rejection of the duty to provide indemnification is that the breach of obligation was the cause of the loss occurrence or the
loss manifestation. This only does not apply if the policyholder has acted fraudulently.
Furthermore, the insurer can only claim (partial) release from the obligation to perform if it has previously pointed out to the policyholder the consequences of a
breach of obligation. This applies only to informational and explanatory obligations
after the occurrence of an insured loss, however, because the policyholder has
already fulfilled or breached its obligations when the insurer learns of the insured
loss and cannot thus inform the policyholder of the effects of a breach in good time.
Example:
Mr Mller has taken out baggage insurance. His case is stolen from his hotel room.
It states in the insurance conditions that in the case of theft the policyholder has to
report the loss at the next police station immediately. Mr Mller does not want to
spoil his holiday and reports the loss 10 days later when he returns home. Since Mr
Mller is in deliberate breach of obligation, the insurer is released of any liability.
The breach also affects the possibility of establishing whether the loss occurred and
if it did, its extent, because the local police only have a good chance of catching the
thief and finding the booty immediately after the theft. The insurer could not inform
the policyholder of the effects of the breach of duty because duty of disclosure
occurred immediately and the insurer only learnt later of the loss.
3.9
89
The insurers duties
The insurers main contractual duty is to carry the risk on behalf of the policyholder
and to provide the agreed benefit if the risk should occur.
As a rule, the insurer will have to provide a financial benefit in the event of an insured loss, although other benefits can also be agreed, such as in liability insurance
the rejection of unjustified claims, or certain assistance services such as the organization of patient transport in the case of travel health insurance.
Just what benefits are to be provided depends in the first instance on the contractual agreement.
3.9.1
Insurance for a specified amount
With insurance for a specified amount the agreed sum (the sum insured) must be
paid if the insured loss occurs, quite independently of what damage the insured loss
actually caused. Thus the insurance for a specific amount has no insurable value. It
is fixed by the policyholder according to the principle of the abstract need for cover.
The payment of the sum insured can take the form of a lump sum payment or an
annuity.
3.9.2
Indemnity insurance
With indemnity insurance, on the other hand, the specific loss that the policyholder
has suffered must be replaced. The insurers liability is limited to the level of the loss
that actually occurred.
Insured value
Because the possible loss level is directly connected to the value of the insurable
interest (insurance value as in the legal definition of 74 Insurance Contract Act
(VVG)), finding what it is is relevant for the risk assessment. Already at the proposal
stage the insurer will inquire about the value of the insurable interest, in order to calculate its risk on the basis of this figure. The higher the insurance value, the higher
can be the obligation to pay in the event of a claim.
In indemnity insurance the figure counts as the insurance value that the policyholder has to pay at the time of the insured loss for the replacement of the object as
new after subtraction of the difference between old and new. The regulation of 88
VVG is flexible, however, and the parties to the contract can agree other arrangements, which makes particularly good sense if the insurance value cannot be established without a great deal of effort. For example, the reinstatement value of an
object can also be insured.
Sum insured
In indemnity insurance the sum insured is the limit of the replacement benefit. The
insurer never has to provide more than the amount of the actual loss, however, even
if the sum insured is higher.
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Esther Grafwallner
Insurance at full value

There is full cover insurance if the agreed sum insured is the same as the insurance
value. Only in this case is there sufficient insurance cover.
Over-insurance
There is over-insurance according to 74 VVG if the sum insured is significantly
higher than the insurable value. Each contractual partner can request that the overinsurance should be corrected with immediate effect by lowering the sum insured
and the premium respectively so that there is full cover insurance.
If the policyholder has stated a sum insured that is too high in order to enrich himself fraudulently, the insurance contract is nullified. In this case the insurer can
demand the premium up to the time when it learnt of the nullification.
Underinsurance
There is underinsurance if the sum insured is significantly lower than the insurable
value at the time when the insured loss occurs, compare 75 VVG.
In this case the insurer only needs to provide its benefit in the relation of the sum
insured to the insurable value.
compensation
sum insured x loss

insurable value
Example:
Mr Braun has taken out a household contents insurance policy and he stated that
the insurable value is 50,000. The value of the household contents is actually
100,000, however. There is now an insured loss of 25,000.
The insurer need pay only 12,500 in this case.
First loss insurance
There is first loss insurance if the insurer, other than in 75 VVG, pays the claim up
to the level of the sum insured, although the insurable value is higher than the sum
insured and ignores underinsurance.
Example:
Ms Koch has taken out a household contents insurance policy and the insurable
value is stated as being 50,000. The actual value is 100,000, however. In her
insurance conditions the following is stated: The insurer will not subtract any
amount for underinsurance. There is now an insured loss of 25,000. The insurer
must pay the full claim of 25,000.
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Partial insurance
There is partial insurance if not the whole insurable value but only a fraction of it,
that is a certain part of it is insured on a value basis. Partial insurance makes sense
if it is very unlikely that the occurrence of the insured event could affect all the
insured objects.
Example 1:
Company X has a furniture store. The complete value is 1,000,000. Since X wants
to save premium and it is unlikely that all the furniture could be stolen at once,
it takes out partial insurance against burglary. A 10 % share is insured that is,
100,000.
Example 2:
Company A has a furniture store. The complete value is 2,000,000. However, A reports the total value as being 1,000,000, because he estimates this as being much
lower and then takes out partial insurance with a share of 10%. Furniture worth
80,000 is lost in a burglary. In this case the insurance company need pay only
40,000, because there was underinsurance.
Multiple insurance
One and the same risk may be insured against the same peril by several insurers
and the total of the sums insured may be greater than the insurable value. In accordance with 78 VVG the insurers are liable as joint debtors for the contractual agreement, at the most, however, for the amount of the claim. Internally, the insurers
payments are apportioned according to the indemnification which each insurer
would have had to pay according to its policy.
Example:
Ms Schneider is covered for health insurance abroad by her private health insurer X.
X pays 80 % of the costs of treatment according to the General Insurance Conditions
(AVB). There is also foreign travel health insurance of the insurer Y in her credit card
with which she paid for the journey. The share of the costs in this case is 100 %. In
the USA Ms Schneider has an accident and must be treated in hospital. The costs of
treatment amount to 100,000. Ms Schneider reports the damage to Y, which must
also pay the claim in full. By way of recourse it can claim 40,000 from X, however.
Retentions
The insurers liability can, furthermore, be limited by retentions. There are various
forms of retention. They can be agreed as fixed amounts, which have to be paid
for each claim (e.g. a retention in comprehensive motor insurance of 300 each
insured loss), as a percentage (e.g. 80 % of the cancellation costs in travel cancellation insurance will be paid for) or as a franchise, whereby the claim up to certain
amount is not paid for at all, but claims that exceed this amount are paid for completely (compare Wandt, l.c., marginal 743).
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3.9.3
Esther Grafwallner
Performance
The insurers benefit is provided after the insured loss has been reported, information has been supplied on request and documents have been provided.
Due date
The insurers payment is due on the conclusion of the investigation needed to establish the insured loss and the amount to be paid by the insurer, see 124 Insurance
Contract Act (VVG). This legal regulation is not mandatory. For this reason many
insurers have a clause stipulating that there must be indemnification within two
weeks after admission of the insurers liability and agreement as to the amount.
If investigations have not been completed by the end of the month after the reporting of the claim, the policyholder can request a part payment as high as the minimum amount that the insurer probably has to pay as things stand. This regulation
must be to the advantage of the policyholder. The deadline is, however, suspended
if it is the policyholders fault that the conclusion of the investigation is hindered,
such as when the policyholder fails to bring documents requested by the insurer.
Limitation of actions
Other as before the reform of the VVG claims from insurance policies are no longer
subject to a special limitation of actions. The general statutes of limitations apply
in accordance with 194 ff Code of Civil Law (BGB). This means that also these
claims are usually limited to three years, whereby the limitation of actions begins
with the end of the year in which the policyholder knew of the claim against the
insurer or must have known it.
There is still a special regulation for insurance policies in 15 VVG, however, according to which the limitation of action is suspended during the period between the
reporting of the claim to the insurer and the receipt of the insurers decision by the
policyholder.
A further deadline up to which the legal action must be taken is no longer provided
for in the reformed VVG, since this leads to a de facto reduction of the period of the
limitation.
3.10 Possibilities for the policyholders complaints

and asserting his will
3.10.1 Complaints to BaFin
If customers are dissatisfied with the proposal procedure, actions during the policy
duration or the claims handling, they complain to, for example, the Management or
the Supervisory Board of the insurer.
Furthermore, customers of insurance companies can complain to BaFin about insurance companies on the basis of Art. 17. Basic Constitutional Law (GG) in connection
with 81 Insurance Supervisory Act (VAG). Legally this complaint is classified as a
93
petition, since the verdict of the supervisory authority does not have any effect in
civil law. It cannot help the complainant to achieve an enforceable claim. As a rule,
however, an insurance company will follow the view of BaFin.
The basis of BaFins authority for claims stems from 81 VAG. According to this it is
the task of the supervisory authority to see that the interests of the insured are adequately safeguarded (compare Kollhosser in Prlss Insurance Supervisory Law,
C. H. Beck, 12th edition 2005, 81 marginal 57).
3.10.2 Insurance ombudsman procedure

The insurance industry has created the so-called insurance ombudsman as a neutral
mediation body. This procedure is based on the regulations of the code of procedure of the insurance ombudsman. The customers of an insurance company can
only make a complaint to the insurance ombudsman if the insurance company has
joined the Association of Insurance Ombudsman e.V.
The insurance ombudsman is allowed to decide about disputes up to 5,000. This
decision is binding for the insurance company, but not for the complainant. For
higher dispute values the ombudsman can only make a non-binding recommendation.
Private health insurers do not take part in the insurance ombudsman procedure, because they have appointed their own private health insurance (PKV) ombudsman.
3.10.3 Dispute procedure

As for all civil claims the policyholder can bring an action against an insurer in a
civil court and win a writ of execution. As long as a claim is being examined by the
ombudsman procedure, limitation of action is suspended.
Insurance practice
and statistics
by
Dr. Georg Erdmann
Insurance practice and statistics
4.1
95
Insurance risk
Insurance business is based on the idea that in accordance with the principle of
equivalence an insurance company receives premiums, on the one hand, and pays
insurance benefits and expenses, on the other, thus making a spread of risks possible. Although the premium computation (premium calculation) is based on statistical documentation, an exact calculation of the risk premium is a priori not possible.
The actual development of claims and expenses can deviate quite considerably
from the results as calculated.
The basic problem in offering insurance protection is thus that a premium is required and calculated before the insurer knows whether or when it must pay and how
high the benefit will be. The insurer promises to pay a benefit, and this is a future
and compensatory benefit that depends on chance. It requires an adequate premium for this, but can only estimate how high this should be. This estimate is based
on data from the past. The insurance risk arises from this situation.
The insurance risk is the danger that in a given period the total losses of the insured
portfolio will exceed the sum of the share of the total premium available to cover the
risk as well as the available capital. This risk is a specifically insurance risk, because
it depends on the kind of business conducted (acceptance of risks in return for a premium). The insurance risk has various origins/components.
Origins/components of the insurance risk:
4.1.1. Risk of random loss

Variations in expected claims are called the risk of random loss. These occur as a
result of the random development of the number and size of the incurred losses,
e.g.:
Accumulation risk: an event causes a great number of losses at the same time
Risk of infection: an event causes a succession of many insurance losses or claims
by the first risk infecting further risks.
Catastrophe risk or risk of a major loss
The expected loss is thus subject to random fluctuations. It is uncertain as to the level and number of claims. Using historical data it is possible to calculate stochastic
regularities which indicate the losses the insurer can expect. Fortuity itself cannot be
calculated, since these values are subject to random fluctuation.
Measures to counteract the risk of random loss are, for example:
Safety loadings
Fluctuation reserves
Increasing the portfolio size
Risk reduction (objectively/spacially)
Reinsurance and coinsurance
Balance over time (long-term contracts)
Sufficient owners equity
Claims statistics for many years
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4.1.2
Dr. Georg Erdmann
Risk of error
= Error in the stochastic regularities. This error results in erroneous calculations of

the expected loss and consequently leads to wrong premium requirements. An
error can occur if a mistake is made in analyzing historical data, as a result of which
erroneous assumptions are made. The risk of error is thus a result of the analysis
and projection risk, whereby the analysis risk aggregates the available statistical
data incorrectly and the projection risk interprets the statistical aggregation incorrectly.
Measures to counteract the risk of error are, for example:
Loss statistics that are interpretable (Consideration of the law of large numbers;
statistics over a long period of time)
Appropriate risk features
Adjustment of the risk features to changed circumstances
Suitable statistical estimate procedures
4.1.3
Risk of change
The risk of change is, in contrast to the risk of random loss, impossible or very difficult to calculate. The divergence of the actual from the expected loss experience is
in this case not the result of random fluctuations against the background of a constant risk environment, but the result of a change in the risk situation itself. The
changes can scarcely be quantified in advance, because many factors can exert an
influence over time, the development of which is unforeseeable. Unforeseeable
changes occur in the insurers environment, which mean that the forecasts of expected claims are no longer true. The insurance risk is not only dependent on random events, but also on changes in the insured risks themselves and on the basic
conditions. Such areas of change occur in the basic conditions of
the economy (fluctuations and changes in economic activity)
society (shifts in values)
the state (changes of law)
ecological environment (climatic changes)
technical environment.
Measures against the risk of change are, for example:
Safety loadings
Fluctuation reserves
Restriction to short-term benefit promises (short-term contracts)
Adjustment clauses (premium and benefit)
Reinsurance and coinsurance
Mix of risks (objectively/geographically)
Sufficient owners capital
4.2
Basic principles of the premium calculation
4.2.1
Purposes and Targets
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The purpose of the premium calculation is to fix a price that matches the risk. The
premium must conform to the principle of equivalence. A distinction is made between the individual and the collective principle of equivalence:
Individual principle of equivalence: for each individual insured risk the policyholders premium and the benefits of the insurance company should match.
Collective principle of equivalence: even if the whole population is observed, premiums and benefits should match.
4.2.2
Risk factors and premium differentiation
A distinction is made between objective and subjective risk features.

Objective risk factors: These risk/influencing factors do not depend on the behaviour of the policyholder and can be determined beforehand.
Subjective risk factors: These risk/influencing factors are person related and the
policyholder can influence them. They cannot be determined beforehand.
Moral risk (moral hazard): By this is meant the psychological phenomenon that
some policyholders change their behaviour after taking out an insurance policy.
Differentiating premiums
Primary premium differentiation: the premium for the insurance protection is
fixed in advance: that is, on taking out the policy. However, in reality only the
objective features are known at the outset. That is, before the insurance policy is
taken out and before knowing the policyholders risk behaviour, it is only possible
to classify a risk as belonging to a particular premium class if features are used as
criteria that are already known in advance from the objective population data.
Subjective features can only be brought into the process of differentiating premiums if the individual claims experience of a risk is known at the end of the period.
The differentiation of premiums on the basis of subjective features is called
secondary premium differentiation or experience rating, since it is based on experience with the individual loss experience/behaviour of the policyholder. The
subjective features are thereby gradually brought into the rating later.
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Dr. Georg Erdmann
Basic formula of the premium calculation

Net risk premium
Safety loading
Risk premium (Net premium, gross risk premium)
Extra for operating expenses
Cash flow underwriting (Profits taken out of the investments are factored into
the premium in order to lower it for competitive reasons)]
+ Profit extra
/+ Discounts/Extras
+ Extra for premium payment more frequent than annually
= Gross premium
+ Insurance tax
= Total premium
+
=
+
[
Structure of the premium rate in insurance companies

The insurance premium or the insurance contribution is the policyholders financial
contribution to the insurance company for carrying the risk or for providing indemnification.
The policyholders premium must not only cover the operating expenses or the administration costs (e.g. salaries, commissions, rents, depreciations) and the profit,
but also the risk and claims expenses of the insurance company.
The following overview shows the components of the gross or premium rate of
household insurance.
Basis of calculation
Structure
Use
Claims statistics
Net risk premium
Insurance benefit
safety loading
Balance of the
insurance risk
Book-keeping
Cost accounting
= Risk premium
(Net premium)
+ Loading for operating
expenses
+ Loading for profit
Acquisition
and administration
expenses
= Gross or premium rate

Risk contribution
ca. 58 %
Operating expenses ca. 36 40 %
Profit
ca. 2 6 %
The above percentages for the operating expenses only serve as an example. They
depend on the expenses of the individual insurance companies especially on the
sales system (direct selling or sales by agents) and from the class of insurance sold
(risk premium). The operating expenses and under certain circumstances the profit
are usually added as a percentage extra onto the risk premium.
99
For each risk group the claims frequency (claims probability) and the average claim
is calculated:
Claims frequency
Number of claims
Number of risks (policies)
Average claim
Sum of claims
Number of claims
The risk premium is a product of:

Risk premium = Loss frequency * average size of claim
Example:
The claims experience for a household insurance in Tariff Zone III is such that
for every 100,000 contracts there are 8,000 claims. The total sum of claims is
10,400,000, the average sum insured is 70,000
What is the risk premium rate?
Solution:
Risk premium = Loss frequency * average size of claim
8,000
10,400,000
Risk premium = ________ * __________ = 104
100,000
8,000
A risk premium of 104 per policy is needed.
4.3
Emergence and distribution of surpluses
4.3.1
Reasons for the emergence of surpluses
4.3.1.1 Emergence of surpluses in all classes of insurance

Cost overrun
Due to rationalization measures and economical administration the actual acquisition and administration expenses can be less than the calculated costs.
Example life insurance:
The acquisition and administration expenses calculated into the premium
actual acquisition and administration expenses
= profit on expenses
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Dr. Georg Erdmann
The profit on expenses is expressed as a percentage of the premium or as a per

mille rate of the sum insured.
Example:
With premium income of 66,443,750 the actual expenses for acquisition and administration were 12,436,900 whereas 13,500,000 had been calculated.
How high was the profit on expenses expressed as a percentage?
Solution:
Calculated share of expenses: 13,500,000
Actual expenses:
12,436,900
= Profit on expenses:
1,063,100
Profit on expenses as a percentage of the premium: 66,443,750 = 100 %

1,063,100 = x %
x = 1,063,100 x 100
x = 1,066,443,750
x = 1.6 %
Surplus by the release of hidden reserves

These result, for example, from the sale of buildings that have been written off or
from the sale of bonds that have been valued according to the strict principle of the
lower of cost or market value. The selling price is then higher than the book value.
Technical surplus
The actual claims payments are less than the calculated ones.
Surplus from reinsurance business
A surplus exists if the reinsurance commission for the direct insurer is greater than
its proportional share of the administration expenses
4.3.1.2 Emergence of surplus in life insurance
Risk surplus (mortality profit)
The actual mortality is more favourable than had been calculated, because of positive selection and outdated mortality tables, for example.
Evaluating the mortality profit
All risk premiums (premiums for pure term insurance and the share of risk premiums from policies with a savings component) accumulate during the business
101
year. From these the death benefits are paid for term insurance policies and the sum
at risk for the death benefit of policies with a savings component (sum insured
minus mathematical reserve).
The annual surplus is the mortality profit.
Calculated risk premiums
Death benefits of the term insurance
(Death benefits mathematical reserve) in life policies with a savings component
= Mortality profit
Mortality profit is expressed as a percentage of the premium or as a per mille rate of
the sum insured.
Example:
An insurer has paid out 529,890,000 in claims for policies with a savings
component. This amount contains savings components amounting to a total of
212,760,000. For the corresponding insurance policies the life insurer has received
risk premiums of 384,600,000.
Calculate the mortality profit in .
Solution:
Calculated risk premiums:
384,600,700
(actual benefits mathematical reserve paid out)
= 529,890,000 212,760,000 =
317,130,000
= Mortality profit:
67,470,700
Interest surplus (extra interest)

The profit from investments is higher than the technical interest rate calculated into
the premium. The technical interest rate is, for example, 2.5 %, but the insurer earns
an average rate of interest of 4.5 % on the investments.
Calculation of the interest profit
If due to a wise investment strategy a life insurance company makes profits from
investments which are higher than the calculated technical interest rate of 2.5 % p.a.,
the yield which exceeds the technical rate of interest is available to it as interest
profit for the profit participation.
Yield from investments
Technical interest rate (e.g. 2.5 %)
Expenses for asset management
= Interest profit
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Dr. Georg Erdmann
The interest profit is achieved by the investment of the mathematical reserve. For
this reason it is expressed as a percentage of the mathematical reserve.
Example:
A life insurance company achieves a total interest yield of 2,525,893 from a
mathematical reserve of 56,897,000. The technical interest rate is 2.5 %, the cost of
the asset management 284,485.
a) How high is the interest profit in ?
b) How high is the interest profit as a percentage of the mathematical reserve?
Solution a):
Interest total:
Technical interest rate = 2.5 % of 56,897,000:
Cost of the asset management:
2,525,893
1,422,425
284,485
= Interest profit:
818,983
Solution b)
Profit on expenses as a percentage of the premium: 56,897,000 = 100 %
818,983 = x %
x = 818,983 x 100
x =
56,897,000
x = 1.4 %
Surrender surplus
If the policyholder cancels the life insurance policy before maturity, the insurer can
charge a cancellation fee if this had been agreed with the policyholder and the
amount of the reduction is reasonable. The cancellation fee is calculated as a percentage of the capital at risk. The percentage depends on the age of entry and the
duration of the policy. If the cancellation fee is higher than the actual expenses, then
the insurer earns a surplus.
The surrender value corresponds to the current value reduced by the cancellation
fee. The cancellation fee is, however, only permissible if it was agreed in the conditions.
The surrender value of a life insurance policy is basically calculated as follows:
Savings components with compound interest
unamortized acquisition costs
= zillmerized mathematical reserve
credited and earned surpluses
= current value, however, at least the current value for the
guaranteed insurance benefit with waiver of premium
surrender fee (insofar as agreed)
= surrender value
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Example:
For an endowment policy of 30,000 a mathematical reserve of 2,040 was accumulated over a period of 27 months.
According to the insurers documentation 90 % of the acquisition costs (40 %o of the
sum insured) are not amortized. Surpluses (credited and earned) of 120 have to be
taken into account.
Calculate the surrender value of this policy if a cancellation fee amounting to 1% of
the sum at risk had been agreed.
Solution:
Savings components:
2,040
Unamortized acquisition costs

40%o of 30,000 = 1,200, of which 90%:
1,080
Surpluses (credited and earned)

Cancellation fee
1% of 30,000 - 2,040 = 1% of 27,960:
+ 120
279.60
= calculated surrender value:
4.3.2
800.40
Distribution of surpluses
4.3.2.1 Distribution of surpluses in non-life insurance

Premium refund (depending on success)
If there is a surplus in the class of business (e.g. household insurance), part of it is
returned to the policyholder.
4.3.2.2 Distribution of surpluses in life insurance
For the shares of surplus that are allocated to the individual insurance policy there
are the following distribution possibilities:
Cash payment
A cash payment of the surpluses to the policyholder is seldom used for tax reasons.
Premium offset
Especially in the case of term insurance policies the surplus is set off against the premiums. In this way the policyholder has to pay a lower premium for an unchanged
sum insured. This procedure is tax neutral.
Accumulation of interest
The surplus shares accumulate for the policyholder and are invested with interest.
On the due date the sum thus saved is paid out with the sum insured. Due to compound interest the interest on the amount saved grows slowly at first, but towards
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Dr. Georg Erdmann
the end of the contract duration strongly, so that the system of profit distribution is
particularly favourable for those customers who continue their contract to maturity
and want the highest possible maturity benefit.
Reversionary bonus system (bonus system)
The annual share of the surplus is regarded as a single premium payment and is
used for the calculation of an additional sum insured. By means of the annually
increasing sum insured the risk protection provided by the policy is considerably
improved. This form of surplus sharing leads to a higher benefit in the event of early
death than with the accumulation of interest, since the single premium payment results in a higher sum insured than the sum of the share of the surplus plus interest.
Example of a surplus statement for a life insurance policy. (Other bases of assessment could also be agreed, and the rates are only examples. They differ from
insurer to insurer and also from year to year.):
1.5 % of the mathematical reserve, and it is contractually agreed how this mathematical reserve is to be determined at the policy anniversary before the distribution: for example, in accordance with the actuarial basis of the premium calculation on renewal:
20 % of the risk premium
2 % of the premium
0.1% of the sum insured
Relative importance of the types of profit distribution for the market
All the types of profit distribution shown are offered in the market. A number of life
insurance companies do not let their policyholders choose between different types
of profit distribution and it is agreed especially in the case of life insurance policies
with a savings component that the bonus system should be the basic form of profit distribution.
Should insurance companies plan to offer different types of profit distribution, a
number of life insurance companies often combine some of them. It can thus be
agreed that part of the surplus be used for an increase in the sum insured and that
the rest should be invested at a rate of interest. If there is an additional benefit to the
main cover, the profit share from the additional benefit is often used to lower the
premium (immediate offset), whilst the surplus from the main policy is used for the
accumulation of interest or to increase the sum insured.
4.4
Insurance accounting
Purposes of the annual financial statement

The first duty is to provide information about the company or, with the assistance
of the accounting department, to report about the deployment of the available
resources
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The second duty is the distribution of income or the measure of assets

The third function is that of protection. Company stakeholders (staff, creditors,
suppliers, customers) should be protected, but also the company itself by means
of the enforcement of self information.
Receivers of financial accounting
Employees and salaried insurance agents
Supervisory authority
Owners
Investors
Interested public
Associations and unions
State
BAV
Customers and policyholders
Potential staff
Injured third parties
Direct and reinsurance companies
Sections of the annual financial statement
Balance sheet 246 l HGB
Profit and loss account 246 l HGB
Schedule 264 I HGB
Management report 264 I HGB
Cashflow statement 297 I 2 HGB
Segment report 297 I 2 HGB
Description of the balance sheet of an insurance company
Insurance companies have to prepare the balance sheet in contradiction to 266
HGB in accordance with a form ( 2 RechVersV). The organization in accordance
with 266 HGB thus does not apply to insurance companies. The differences are
particularly clear on the assets side of the balance sheet: 266 HGB subdivides the
asset side into fixed and liquid assets. This arrangement mainly depends on the
degree of liquidity of the assets. Such a distinction is not possible in an insurance
balance sheet.
Reasons for the deviation from the commercial balance sheet
The following reasons can be given for the deviation of an insurance balance sheet
from a normal commercial balance sheet:
The intangible nature of the insurance product means that there are no identification problems for products and also no evaluation process.
106
Dr. Georg Erdmann
The time relationship of the insurance policies causes delineation problems for a
one period overview such as that given in the balance sheet. This is clear, for
example, with the mathematical reserve or the fluctuation reserve, which contain
long-term assumptions.
The random nature of insurance business leads to an extension of the principles
of creditor protection to the policyholders. This is particularly obvious in the duty
to set up further insurance specific reserves. In so doing due to its legal nature
(uncertainty as to existence, point of time and the amount of the obligation) a
reserve can adequately replicate the features of the insurance product that also
has an uncertain duty to pay with regard to existence and amount.
The general evaluation rules of 252 to 256 HGB apply to the drawing up of the
insurance companys balance sheet. They are complemented by the regulations for
large limited liability companies in 273 to 283 HGV as well as the specifically
insurance regulations of 341 ff. HGB, which the insurance company has to apply.
Furthermore, the insurers must continue to observe the complementary regulations
of RechVersV.
Asset side of an insurance companys balance sheet
A. Outstanding assets of the share capital
B. Intangible assets
C. Investments
I.
Land, land rights and buildings
II.
Investments in affiliated companies and holdings

1. Shares in affiliated companies
2. Lending to affiliated companies
3. Holdings
4. Lending to companies with which there is a holding relationship
III.
Miscellaneous investments
1. Shares, investment shares, and other fixed interest bonds
2. Coupon bonds and other fixed interest bonds
3. Mortgages, land charges and rent charges
4. Miscellaneous lending
5. Outstanding credit contributions with credit institutions
6. Other investments
IV.
Deposit receivables from reinsured business
D. Investments for the account of and risk of holders of life insurance policies
(14 RechVersV)
In unit-linked life insurance the insurance company does not carry the investment risk, but the policyholder, since he determines the kind of investment. In
this case the information about amount of capital invested for the unit-linked life
insurance is in terms of the current value.
E.
F.
107
Requirements
I.
Requirements arising from the insurance business with

1. policyholders
2. insurance intermediaries
3. members and carriers
II.
Accounting requirements arising from reinsurance business
III.
Miscellaneous requirements
Miscellaneous assets
I.
Tangible assets
II.
Cash with banks, cheques and cash in hand
III.
Treasury stock
IV.
Other assets
G. Accrued and deferred items

H. Deficit not covered by owners equity
J.
Settlement amount
Liabilities side of an insurance companys balance sheet

A. Owners equity
I.
Share capital or similar items
II.
Additional paid-in capital
III.
Profit reserves
IV.
Balance sheet profit
B. Participation rights capital

C. Subordinated liability
D. Extraordinary items with reserve funds ( 273 S.1 i.V. m. 247 III S.1 HGB)
E.
Provisions for own account

In accordance with 341e I HGB reserves must be set up in excess of what is
allowed by 249 HGB, in order to guarantee permanently the commitments
from the insurance policies (especially the insurance industrys principle of prudence). Because of the temporal difference between the premium payment and
the uncertain claims payment they serve the purpose of allocating the profits
and expenditure to the year in which the premiums had been earned and in
which the claims had occurred.
For a life insurance company they amount to ca. 90 %, in the case of a property /
accident insurer ca. 60 %, of the total assets on the balance sheet, i.e. they are on
the liabilities side the largest and most important item.
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Dr. Georg Erdmann
I.
Unearned premium reserves ( 341e II No. 1)

They must be set up for the part of the premiums, which represents the
profit over a certain time after the balance sheet date. Unearned premium
reserves actually constitute a passive accrued and deferred item. They constitute the part of the booked gross premiums which are to be accounted to
the following year as profit for a time after the balance sheet date.
II.
Mathematical reserve ( 341f HGB)

The mathematical reserve in life insurance business constitutes about 80 %
of the total assets on the balance sheet. It serves the purpose of covering
the liabilities as they occur from the life insurance business and from the
business that is conducted like life insurance.
Why does the insurer have commitments towards the policyholder for
which it has to set up a mathematical reserve?
1. The risk component of the premium is constant over the whole duration. It follows from this that in the first policy years the risk premium
is too high and in the last years it is too low. Consequently, in the first
years provision (as a sort of reserve) is set up, which in the last years is
released, so that the risk premium is correctly apportioned.
2. The insurer receives a savings component from the policyholder, which
has to be paid back with interest. Here, too, the insurer is liable to the
policyholder, with the result that provision must be made, since the
level and timing of the repayment is uncertain.
According to 25 I S.2 RechVersV the insurance company can choose to
take account of one off acquisition costs in the mathematical reserve (Zillmerung). Already in the first business year the insurer is allowed to charge
the policyholder for the paid acquisition costs. If the acquisition costs are
higher than the first year premium, there is a negative balance for the liability of the insurer towards the policyholder: that is, the policyholder would
actually be liable to the insurance company.
The mathematical reserve is called an ageing reserve in health insurance.
III.
Provision for outstanding claims ( 341b HGB)

This reserve is generally referred to as a loss reserve. It contains especially
Reserve for the indemnification of claims that have occurred and are
known to the insurer but which have not yet been regulated.
Late loss reserve for claims that have occurred but which the insurer
does not yet know about. The technical term for this is also IBNR claims
(incurred but not reported).
IV.
Reserve for premium refunds dependent on success or not dependent on

success ( 341e II No. 2 HGB)
V.
Equalization reserve and similar reserves ( 341h HGB)

It has an equalization function: that is, it serves the purpose of smoothing out fluctuations in the annual claims expenditure that the insurance
company has to carry itself.
Related to this is the security function as a measure against fluctuations
in particular classes of insurance. In this way there is a safeguard
against future major losses.
109
How does the equalization reserve fulfil its security and smothing function?
1. Case: Low claims year: that is, fewer claims than average. In this case
the equalization reserve is increased. That is, there is an allocation, by
which the expenditure increases and less profit is declared.
2. Case: High claims year: that is, more claims than average. In this case
the equalization reserve is released affecting net income, by which the
loss is reduced.
By allocation or release the claims expenditure is smoothed out over the
years. At the same time, the equalization reserve that has already accumulated serves as a safety cushion.
VI. Miscellaneous technical insurance reserves
In this mixed item five single technical insurance reserves are summarized,
of which only the 1st and 2nd have special importance:
1. Reserve for anticipated lapses
2. Reserve for threatened losses out of the insurance business ( 341e II
No. 3 HGB, vgl. also 249 I 1 HGB)
For a better understanding: a delineation from other technical insurance
reserves:
F.
Unearned premium reserves are collected premiums which do not contribute to the profit of the business year, whereas the reserve for contingent losses results from the mismatch of benefit and consideration.
In the case of the loss reserve the focus is on claims that have already
occurred or have been caused, whilst with the reserve for contingent
losses future claims that occur after the cut-off date are taken into
account.
The equalization reserve smooths out fluctuations in claims expenditure

which is under control, whereas in the case of the reserve for contingent
losses a loss is seriously suspected: that is, the premiums are actually
insufficient.
Technical reserves in life insurance, insofar as the investment risk is carried by

the policyholders ( 32 RechVersV).
Technical reserves must be set up for commitments from life insurance policies
whose value or profit is determined by the investments for which the policyholder carries the risk or by which the benefit is index linked.
G. Other reserves
H. Deposits received from reinsured insurance business
I.
Other liabilities
I.
Other liabilities from insurance policies underwritten by the company itself

1. Policyholders
2. Insurance intermediates
3. Affiliated companies and pension fund carriers
110
Dr. Georg Erdmann
II.
Accounting liabilities from reinsurance business
III.
Bonds
IV.
Liabilities towards credit institutions
K. Passive accruals and deferrals

L.
Settlement amount
Construction of the Profit and Loss Account

The Profit and Loss Account is divided into an insurance related and a non insurance
related account. It is constructed as follows:
Insurance related business (including or excluding investment profitability)
+/
=
+/
=
+/
+/
+/
=
Change of the fluctuation reserve (not for life insurers)

Real technical insurance result
Insurance related business (excluding or including investment profitability)
Result of the normal business activity
Extraordinary profit/loss
Tax
Transfer of losses/Transfer of profits
Surplus for the year/Deficit for the year
Insurance profits and expenditure according to Form 2

1. Earned premiums
Written premiums
Reinsurance premiums paid
+/ Change in the gross premium transfer
+/ Change in the share of the reinsurance in the gross premium transfer
= Earned premiums for own account
2. Technical interest earnings
3. Miscellaneous technical insurance profit
4. Expenditure for claims
a) Claims settlements
b) Change of the reserve for claims not yet settled
5. Change of the other technical insurance net reserves
a) Net mathematical reserve
b) Miscellaneous technical insurance net reserves
6. Expenditure for premium refunds that depend and do not depend on profitability
7. Expenditure for the insurance business
1. Claims regulation: internal and external, direct and indirect claims handling
expenditure
2. Acquisition of insurance policies: commission, brokerage, expenditure for
issuing policies
3. Administration of insurance policies: premium collection, claims prevention
and containment
111
8. Miscellaneous technical insurance expenditure

9. Change in the equalization reserve
10. Underwriting result
Non insurance related profits and expenditure
1. Investment yield
These are only for property and accident insurers and reinsurers in the non
insurance related account. For life insurers they are a part of the insurance
related account.
a) Profits from holdings
b) Yields from other investments
c) Profits from appreciations
d) Profits from the outflow of investments
e) Profits from profit pools and transfer of profits contracts
f) Profits from the release of extraordinary items with reserve funds
2. Expenditure on investments
a) Expenditure for the administration of investments
b) Depreciation of investments
c) Losses from the outflow of investments
d) Expenses from transfer of losses
e) Adjustments in the extraordinary items with reserve funds
3. Technical interest yield
4. Miscellaneous profits
5. Miscellaneous expenditure
6. Result of the normal business activity
7. Extraordinary profits
8. Extraordinary expenditure
9. Tax from income and profit
10. Miscellaneous taxes
11. Profits from transfer of losses
12. Transferred profits
13. Surplus for the year/Deficit for the year
The following offset generally follows, which is decided by the management and
provides room for manoeuvre:
+/
+
+
Surplus for the year/Deficit for the year

Profit/Loss carried forward from the previous year
Withdrawal from retained earnings/additional paid in capital
Withdrawal from the participation rights capital
Adjustment in the retained earnings/additional paid in capital
Replenishment of the participation rights capital
Balance sheet profit / loss
112
Dr. Georg Erdmann
Functions of the Schedule

1. Release function: the schedule releases the balance sheet and the profit and loss
account from too much information.
2. Explanation function: the methods of drawing up a balance sheet and evaluation
must be supplied.
3. Supplementary function: there is additional information in the schedule, which is
not given in the balance sheet and the profit and loss account.
4. Correction function: if because of special circumstances the balance sheet and
the profit and loss account do not succeed in communicating a picture of the
assets, finances and the profits of the company that reflects the reality, it is
necessary to provide additional information in the schedule. ( 264ii S. 2 HGB).
5. In the schedule of insurance companies the current values of investments must
be given ( 5456 RechVersV). Since 1997 all investments except land must be
valued according to current value. Since 1999 this also applies to land.
Functions and content of the management report
The management report also has only one information function. In detail, the
following should be shown:
1. Course of business until the balance sheet date (historical view)
2. Company situation (cut off day view)
3. Extraordinary events between the end of the business year and preparation of the
balance sheet (View of the period of time of the most recent past)
4. Future development of company
5. Risk report
4.5
Insurance mathematics and actuarial science
Insurance mathematics is a part of mathematics. It is chiefly concerned with mathematical modelling and also with the statistical estimates of insured risks (especially
personal injury or property damage), the calculation of the price needed for taking
over such risks (premium calculation), the calculation of insurance reserves or the
necessary equity capital resources, controlling including the reporting system, risk
management and asset liability management. Insurance mathematics belongs to
applied mathematics and is an important field of application for the theory of probabilities and statistics. To show the financial risks which are also in insurance contracts, methods of financial mathematics are also used. These can be subdivided as
follows:
Life insurance mathematics
Health insurance mathematics
Pension insurance mathematics
Non-life insurance mathematics
113
Because of the comprehensive application of insurance mathematics to all types of

risk, financial mathematics can also be understood as a special case of insurance
mathematics that focusses on financial risks.
Statistics
Tasks, working steps and statistical procedures
In order to be able to calculate premiums that fairly reflect risk and to regulate at
any time all claims that have to be indemnified, insurance companies need in motor third party liability, for example, information about claims frequency and the
average level of losses of the various types of car.
In order to keep market share, insurance companies need among other things
information about the demand for products of households and companies, premium developments in the individual classes of insurance, the disposable income
of the various groups of households and the price inflation rate for a wide variety
of goods and services.
For adequate personnel planning insurance companies need, for example, information about the average age and gross income of staff, broken down among
other things into internal and external activities, gender, possible fields of employment internally and staff qualifications.
Statistics includes the methods and procedures with which information about observable mass phenomena can be captured, prepared and analyzed
The aim of the statistics is in the first instance to describe the current situation in
order serve as a basis for the explanation of causal relationships and to assist in
decision making.
Course of statistical examinations

1
Questions are
formulated to fit
the particular
purpose
2
Data capture
Data preparation
Data analysis
Decisions on the
basis of the
data analysis
A precondition for the use of statistical procedures is that the events and the circumstances to be examined should be described exactly and be quantifiable. Statistics is not concerned with the individual case but always with a plurality of similar
single phenomena.
By the term statistics is understood the method by which events and circumstances
are examined as well as the tables and figures by which the events of an examination are presented clearly.
114
Dr. Georg Erdmann
In descriptive statistics the data needed are collected by a full inventory count: that
is, by capturing all cases. In inferential or inductive statistics on the basis of a random sample, that should be as representative as possible, the recurring features of
a population are established.
Example: Population statistics
Descriptive
Inductive
Size of the survey
Census = the data of

the whole population
living in a certain area
are captured
Micro-census = the data

of ca. 1 % of the population
living in a certain
area are captured
Statistics as a
procedure
Preparation of the data

from all households
Preparation of the data

from the random
sample and extrapolation
of the data for all
households
Statistics as a result
Tables and graphs to describe the structure

of the population of the German Federal Republic
The occupational description of an expert in insurance mathematics is insurance

mathematician. They can also be called actuaries, especially if they have extensive
knowledge of insurance that is beyond pure insurance mathematics.
The aim of actuarial activity is to estimate and evaluate risks such as insurance risks,
investment risks and liquidity risks. Expressed broadly, an actuary is concerned with
economic processes in which mathematical or statistical methods are used.
Actuaries work particularly in insurance companies, but also in public authorities,
consulting companies, surveyors or trustees. The department where they work is
called an actuarial department.
In German speaking countries there is no single job description of an actuary or training requirements. The professional name is also not protected. In other countries
some occupational activities can only be carried out by actuaries with a special
training. In other countries the membership of a professional organization is also
required.
For certain insurers because of legal requirements the Appointed Actuary is a required person, who has special legal duties in securing the financial integrity of the
insurer and protecting the interests of the policyholders. This person must have the
professional qualification of actuary and thus be a specialized and experienced
insurance mathematician.
In Germany the Insurance Supervisory Law (VAG) requires insurances of the person
as well as non-life and accident insurers which have mathematical reserves deriving
from liability and accident insurance to employ an appointed actuary. He has the
115
duties of guaranteeing the correct calculation of the mathematical reserve and the
calculation of adequate insurance premiums. Moreover, in life insurance he makes
proposals to the board of management regarding the distribution of the policyholders surplus.
The institution of the appointed actuary is enshrined in the Insurance Supervisory
Law (VAG, 11a). The following insurers must employ an appointed actuary:
Life insurers (including pension schemes and burial funds)
Accident insurers that offer accident insurance with return of premium
Non-life / Accident insurers with annuity benefits from accident and liability insurances.
Health insurers which provide comprehensive tariffs that replace statutory health
insurance
The appointed actuary must be reliable and have adequate knowledge of insurance
mathematics and business experience. The appointed actuary is appointed or dismissed by the supervisory board, and if there is none, by a suitably high authority
and must be nominated by the supervisory authority. The supervisory authority can
demand that another appointed actuary be employed.
Tasks of the actuary
The appointed actuary has to guarantee that in the calculation of the premiums and
the mathematical reserves the relevant legal regulations have been kept. This does
not apply to burial funds and pension schemes, for which a statement according to
156a Abs. 3 Satz 5 VAG was not issued (regulated pension schemes), since in
these cases the calculation is done according to the approved business plan.
He has to examine the insurance companys financial situation, whether the liabilities for the insurance policies can be fulfilled on a sustainable basis, and whether
adequate equity capital is available at the level of the solvency margin.
He has to confirm that the mathematical reserve in the balance sheet has been set
up in accordance with the relevant legal regulations (insurance mathematical confirmation). (Exception: smaller associations in accordance with 53 VAG). For burial
funds and regulated pension schemes confirmation is required that the mathematical reserve is in line with the business plan.
The appointed actuary has to explain in a report to the board of management
(Actuarial Report) what the approach and assumptions are that underlie this confirmation. This does not apply to health insurers and regulated pension schemes
and burial funds. In these companies the appointed actuary cannot freely determine the basis of calculation. In health insurance the fundamentals of the calculation of the mathematical reserve is based on legal regulations. The calculation of
regulated pension schemes and burial funds is fixed by the business plan.
Should the appointed actuary find that he is unable to confirm, or only in a qualified
form, he has in this case to inform the board of management and under certain circumstances also the supervisory authority. This also applies to circumstances which
could prejudice or endanger the development or the portfolio of the company.
116
Dr. Georg Erdmann
The appointed actuary has to suggest a reasonable distribution of surplus to the

board of management for the policies that are entitled to a distribution of surplus.
This does not apply to health insurance.
In the case of larger insurance companies the appointed actuary is generally either
a member of the board of management or the head of the insurance mathematical
department (actuarial department).
Small insurers, e.g. many company pension schemes, do not have their own actuarial department. In this situation as a rule the consultant that works for the insurer
provides the appointed actuary.
4.6
Fundamentals of claims handling
The expression claims management refers to the organized control of claims by

insurance companies. Two meanings have to be distinguished:
Claims management as a company controlling task; in insurance companies this
term is popular as a name for the organizational unit (department, team), which
establishes the work processes of the claims department.
Claims handling in the individual case. By claims handling the insurance industry
understands all activities in connection with the handling and settlement of claims
(claims regulation). Claims management belongs to the business benefit processes and is an important part of the insurance production. It includes all business processes from the entry of the claim over each stage of the handling to the
settlement or replacement.
Process of claims management
1. Recording the claim
Exclusion of double records
Acceptance of the claim notification
Opening a claim file
Checking of the insurance cover
2. Dealing with the claim
Obtaining statements from the policyholder, the injured third party, witnesses,
etc.
Under certain circumstances obtaining reports from experts, doctors, etc.
Checking for fraud
Appraisal of the claim by a clerk
3. Claims regulation/Settlement
Information of the policyholder about the result of the appraisal
Instruction to pay or replace
Recourse
Coinsurance
and reinsurance
by
Dr. Gerhard Mayr
118
5.1
Dr. Gerhard Mayr
Functions
To minimize risks direct insurers and reinsurers work together. Already in the field
of direct insurance a fragmentation of risks takes place in such a way that several insurance companies participate in a large risk, for example in the fire insurance of an
industrial company. This procedure is called coinsurance.
Reinsurance, on the other hand, is an insurance product for insurance companies.
That is, in this case an insurance company insures itself with another insurance
company. This can be a specialized professional reinsurance company as well as
another direct insurance company.
5.2
Coinsurance
Coinsurance is the agreed participation of several insurers on a risk in such a way

that each takes over a pro rata share of the sum insured or a certain amount. There
are as many contracts as there are insurers. In the insurance policy the individual
companies are listed by name with their shares. One insurance contract is thus concluded between the policyholder and each coinsurer for the respective share that is
covered: that is, as far as the policyholder is concerned, each insurance company is
regarded as a direct insurer. In the case of a claim the individual coinsurers are liable
to the extent of their share of the total sum insured.
Example:
A manufacturing company is insured with a sum insured of 100 MM. Using coinsurance five direct insurers take on the risk in such a way that one company participates with 40 %, two companies with each 20 % and two companies each of which
have 10 %.
To facilitate the settlement of claims the leading company, usually that insurer with
the largest share, conducts the negotiations in the name of the other participating
direct insurers. A so-called leaders clause is agreed, according to which the leading
insurance company in the relationship with the policyholder is authorized to submit
and receive notifications and declarations of intent. For its efforts the leading insurer
generally receives a lead office commission or an overrider.
The leadership clause or the trial conduct clause authorizes the leading insurer by
name to regulate contractual matters, to receive premiums, regulate claims and
under certain circumstances also to settle legal disputes with the policyholder on
behalf of the other coinsurers.
The lead office commission generally amounts to between 1 and 3 % of the other
coinsurers premium share.
The participation of the coinsurers on a risk is laid down in a schedule of distribution.
119
Coinsurance and reinsurance
Example:
The following direct insurers participate pro rata on an industry fire insurance contract with a sum insured of 16,500,000 at a rate of 1.4 : A 15 %, B 25 %, C (lead
office) 30 %, D 10 %, E 20 %.
a) Set up a schedule of distribution. Work out the individual coinsurers shares of
the total sum insured and the premium (with and without insurance tax notional tax rate 10 %).
b) The lead office C receives a lead office commission of 2 % of the premium shares
of the other coinsurers (without insurance tax). How much commission do the
individual coinsurers have to pay the lead office?
Solution of a):
The pro rata shares of the sums insured and the premium should be calculated from
the total sum insured and the total premium respectively, using the given percentage rates for the shares of the individual coinsurers.
Distribution plan
Coinsurers
share
Sum
insured
Premium without
insurance tax
Insurance
tax
Premium incl.
insurance tax
A 15 %
B 25 %
C 30 %
D 10 %
E 20 %
100 %
2,475,000
4,125,000
4,950,000
1,650,000
3,300,000
16,500,000
3,465
5,775
6,930
2,310
4,620
23,100
346.50
577.50
693.00
231.00
462.00
2,310.00
3,811.50
6,352.50
7,623.50
2,541.00
5,082.00
25,410.00
(All figures in . A fictive insurance tax of 10 % was assumed)

Solution of b):
The lead office C receives as leader:
from insurer
A
B
D
E
2 % of
2 % of
2 % of
2 % of
Premium share
without insurance tax
Share of the
lead office commission
3,465
5,775
2,310
4,620
69.30
115.50
46.20
92.40
Total lead office commission for Insurer C
323.40
120
Dr. Gerhard Mayr
5.3
Reinsurance
5.3.1
Overview
Reinsurance is a unique security measure between insurance companies. Insurance

business is based on the idea that in accordance with the principle of equivalence
premium income, on the one hand, and insurance benefits and expenses, on the
other, correspond so that a spread of risks is possible. Although the calculation is
based on statistical information, a correct evaluation of the risk premium is not
possible. The actual loss experience can depart considerably from the results as calculated. This possibility is called the underwriting risk. There are several reasons
for it.
Underwriting risk
Phenomena
Risk of
random loss
Risk of change
Accumulation or
catastrophe risk
Risk of error
The actual loss

experience differs
randomly from
the anticipated
trend. Moreover,
unwanted fluctuations can occur
because of the
insurance of high
risks.
For many risks the

direct insurer has
no or insufficient
information on
which to base a
calculation. This
inadequate basis
of calculation
makes it difficult to
foresee structural
changes in the risk
profile.
A loss accumulation (e. g. aircraft

crashes, natural
disasters)
endanger the
portfolio balance.
The premium
calculation or
the rating of the
risks is based
on erroneous
calculations or
estimates.
The purpose of reinsurance to reduce this insurance risk for the direct insurer. In this
way reinsurers contribute to the greater stability and security of the insurance business, since they spread the risk to several insurance companies. Consequently, this
enables a direct insurer to take over the cover for larger risks, too (industrial insurance or liability insurance for whole concerns). The direct insurer keeps only so
much of the risk it has taken over for its own account as it can in accordance with
insurance principles without putting its own portfolio at risk. Reinsurance is thus
one of the most important ways of release for the direct insurer.
The risk transfer takes place by concluding a reinsurance treaty. Its partners are
known as direct insurer (cedant) and reinsurer. The acceptance of risks is known as
active reinsurance or indirect business or business taken in reinsurance. In contrast,
the outward transfer of risks is known as passive reinsurance.
The original insurance relationship between the policyholder and the direct insurer
is not affected by the reinsurance treaty: that is, the direct insurer alone remains
responsible to the policyholder for payments against the insurance policy. In this
way reinsurance differs fundamentally from coinsurance. (There the policyholder
has a direct claim against each of the coinsurers).
121
Insurance companies which only carry out reinsurance business are known as professional reinsurers. Direct insurers can also act as reinsurers in the market, however. In contrast to direct insurance there are no regionally limited reinsurance markets, because the supply and demand for reinsurance protection are traditionally
internationally oriented and thus cross the borders of individual countries.
Reinsurance protection is required by both direct and reinsurance companies. Almost all direct insurers have to transfer part of their risks by means of reinsurance,
but also reinsurers cover risks by means of further reinsurance (so-called retrocession) with other direct insurers or reinsurers. In this way, a large number of insurance companies participate in the risks. At the same time this fact explains the international nature of reinsurance, which serves the purpose of spreading risk
worldwide (geographical diversification).
Important basic reinsurance terms
Tranche
Surplus
Capacity
Limit
Line
Deductible
Quota share
Cedant
Cession
Transferee
5.3.2
=
=
=
=
=
=
=
=
=
=
Extent of liability of a reinsurance treaty

Part of the sum insured that exceeds the retention
Retention + surplus
Extent of the reinsurers liability
Retention in the case of a surplus treaty
Share of the claim carried by the cedant
Pro rata relationship
Direct insurer
Share of risk transferred from the direct insurer
Reinsurer
Reinsurance forms
The various reinsurance forms are distinguished by the type of contract.

Facultative reinsurance relates to large single risks. The direct insurer that wants to
take on this kind of risk or that has already taken it on, offers the reinsurer a share of
it. The offer includes details of the policyholder, the type and size of the risk, the
insurance period, the premium as well as the retention of the direct insurer. The
term facultative means that the reinsurer is free to accept or reject the offer. Thus
facultative reinsurance involves case by case risk acceptance by the reinsurer, also
frequently after other possibilities of gaining cover have been exhausted.
Obligatory reinsurance constitutes the greatest volume of reinsurance business. It
results in a stronger and longer term commitment between the contractual partners.
In the case of obligatory reinsurance the insurance cover relates to the insurance
portfolio as described in the treaty. The direct insurer is obliged to transfer certain
risks to the reinsurer. In the same way the reinsurer promises to take over these
risks. Obligatory reinsurance mandatorily guarantees the direct insurer reinsurance
protection from the point of time that the insurance policy is concluded with the
policyholder.
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5.3.3
Dr. Gerhard Mayr
Types of reinsurance
5.3.3.1 Overview
The types of reinsurance have developed out of the direct insurers purpose in
taking reinsurance. It can happen that the direct insurer wants to avoid significant
variations in claims experience and so gives up high sums to make the portfolio
more well balanced. But it is also conceivable that the direct insurer only wants to
transfer the claims burden to the reinsurer after a certain level.
Reinsurance can be taken
on the basis
of the sum insured
on the basis
of the claims
Reinsurance based on the sum insured

(proportional reinsurance)
Claims based reinsurance

(non-proportional reinsurance)
The direct insurer invites the reinsurer

to participate in a certain proportion
of the reinsured portfolio:
i. e. premium, liability and claims are
split proportionately between direct
insurer and reinsurer.
The reinsurance benefit is defined

by the level of the claim only.
The reinsurers liability begins
when the direct insurers deductible
is exceeded. The reinsurance premium
is negotiable.
5.3.3.2 Proportional reinsurance (Reinsurance based on the sum insured)

With proportional reinsurance the reinsurers participation is based on the sum
insured, by the transfer of a quota share and/or the peaks of certain risks. This is
called reinsurance based on the sum insured or proportional reinsurance, because
the sum insured, premiums and claims are shared pro rata by direct insurer and
reinsurer.
In the case of a quota share treaty the reinsurer participates with an agreed constant percentage (quota share) of all the risks ceded to the treaty for its duration.
This quota share (e.g. 10 or 25 %) determines the distribution of the premiums and
the claims.
The purpose of a quota share reinsurance treaty is to reduce the fluctuations of the
cedants small and medium sized claims, and thus to reduce the size of an insurance
loss. The reinsurer participates with the same share on all risks in the insurance
portfolio.
With surplus reinsurance the reinsurer participates only on those risks whose sums
insured exceed a certain amount. The insurer decides on the highest amount that it
is prepared to accept as the retention.
123
This retention is called a line. Its level is fixed by the individual companies in line
tables. It depends on the capacity of the insurance company, the degree of danger of
the individual risk and the particular class of insurance.
That part of the sum insured that exceeds the retention and is ceded as reinsurance
is called the surplus. The reinsurers obligation to accept is usually limited in that it
takes over a certain number of lines (e.g. 10 lines). It follows from this that the direct
insurer can give ten times the amount it keeps for its own account to the reinsurer.
Surplus reinsurance serves the purpose of improving the balance of the insurance
portfolio if there is great variation in sums insured (e.g. in industrial fire insurance).
Example quota share treaty:
A liability insurer has a quota share treaty with a reinsurer: quota share 30 %, Limit
2 m: i.e. the reinsurer accepts the quota share of maximally 2 m, even if the
actual sum insured of the policy concerned is higher. The direct insurer can cover
this amount facultatively (= from case to case) with a further reinsurance.
Work out the reinsurers share of the premium and claim for the following treaties of
the direct insurer:
Sum insured
Premium
Claim
A) 600,000
B) 1,200,000
C) 2,500,000
390
810
1,240
84,000
360,000
1,600,000
Solution:
Share of premium
a) 30 % of 390
b) 30 % of 810
c) Reinsurer takes over up to a limit of 2 m
30 % of 4/5 of the premium (= 992)
117.00
243.00
297.60
657.60
Share of claims
a) 30 % of 84,000
b) 30 % of 360,000
c) 30 % of 4/5 of the claim (= 1,280,000)
25,200
108,000
384,000
517,200
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Dr. Gerhard Mayr
Example surplus treaty:

For a household insurer there is a surplus treaty with a retention of 100,000
(= 1 line). The reinsurer takes over 500,000 (= 5 lines). In the direct insurers portfolio there are i.a. the following insurance policies:
Sum insured
a)
b)
c)
d)
Premium
Claims
1,440
700
204
1,875
18,900
7,200
56,300
24,000
600,000
250,000
85,000
750,000
Work out for each policy the reinsurers share of the premium, liability and claims.
Solution:
There is a corresponding reinsurance quota share to work out for each single policy
Policy a):
Proportionality
Retention
Surplus
100,000
500,000
1
5
Distribution of premium, liability and claims between direct insurer and reinsurer
in proportion 1:5:
Direct insurer
Reinsurer
Proportionality
Premium
Liability
Claims
1
5
240
1,200
1,440
100,000
500,000
600,000
3,150
15,750
18,900
125
Policy b):
Proportionality
Retention
Surplus
100,000
150,000
2
3
in proportion 2:3:
Proportionality
Premium
Liability
Claims
1
5
280
420
700
100,000
150,000
250,000
2,880
4,320
7,200
Direct insurer
Reinsurer
Policy c):
Retention
Surplus
100.000
100.000 (no surplus, since sum insured < 100,000)
Direct insurer carries premium, liability and claims alone

Policy d):
Proportionality
Retention
Surplus
+ 100,000
1
+ 150,000 (the amount by which the treaty capacity is exceeded)
+ 500,000
2
in proportion 1:2:
Direct insurer
Reinsurer
Proportionality
Premium
Liability
Claims
1
2
625
1,250
1,875
250,000
500,000
750,000
8,000
16,000
24,000
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Dr. Gerhard Mayr
Example Quota share + surplus treaty (mixed form)

A direct insurer agrees in a quota share treaty a reinsurance share of 25 %, a retention from the quota share of 80,000 (= 1 line) and as surplus 3 lines.
Work out the reinsurers share of the premium and claims for an insurance policy of
240,000.
Solution:
Since the quota share surplus treaty is a combination of a quota share and surplus
reinsurance treaty, the calculation of the share of the premium and claims for the
insurance policy must be done in 2 steps:
Share of the
Share of the
Direct insurer
Reinsurer
1st step
(Quota share reinsurance treaty):
Splitting up of the sum insured of 240,000
pro rata for direct insurer and reinsurer:
Sum insured 240,000
(Direct insurer quota share: 75 % of 240,000

(EV-Quote: = 180,000
(Reinsurers
quota share 25 %)
of 240,000
= 60,000
2 nd step
(Surplus reinsurance treaty)
Division of the direct insurers quota share
into the agreed retention and surplus
(Retention)
80,000
Sum:
80,000
Direct insurers share: 80,000

Reinsurers share:
160,000
(Surplus)
100,000
160,000
Proportionality
1/3
2/3
For an insurance policy of 240,000 the reinsurer receives 2/3 of the premium
and pays 2/3 of the claims.
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5.3.3.3 Non-proportional reinsurance (Reinsurance based on claims)

In non-proportional reinsurance the reinsurers liability is determined exclusively by
the amount of the claim. There is thus no proportional distribution of the individual
risk and the premium required for that. Rather, a separately calculated premium is
agreed for the non-proportional cover.
In the case of excess of loss reinsurance the reinsurer pays that part of a claim that
exceeds a contractually fixed amount. This amount that the direct insurer carries for
its own account is called the deductible or priority. The reinsurance cover begins
from this deductible. The reinsurer is liable only if the deductible is exceeded.
Claims below this limit must be borne by the direct insurer alone: the reinsurer does
not participate in them.
The purpose of excess of loss reinsurance is thus to protect the direct insurer from
large claims. The degree to which the reinsurer participates in a particular claim
depends, therefore, on its size and is not already fixed as soon as the reinsurance
treaty has been agreed, as is the case with surplus reinsurance.
In the case of stop loss reinsurance the reinsurer does not cover the amount of a
particular single loss which exceeds the direct insurers deductible but all the claims
that exceed the direct insurers contractually agreed retention ratio. Consequently,
the reinsurer is liable only when the claims expenditure of the direct insurer exceeds
a certain loss ratio. A highest loss ratio is always fixed for the liability of the reinsurer.
This form of reinsurance is called stop loss, because it limits a direct insurers total
claims expenditure for the business year. It is especially important for classes of
insurance that are subject to annually fluctuating claims expenditure, such as hail
and storm insurance.
The premium for excess of loss reinsurance is generally fixed as a percentage of the
annual premium, which the direct insurer earns from the reinsured portfolio.
Example risk excess of loss:
For a risk excess of loss the following conditions apply:
Direct insurers deductible 5 MM; Reinsurer A takes over Layer 1 from the deductibe up to a limit of 15 m, Reinsurers B and C take over the Layer 2 from 15 m up
to a limit of 35 m with the same shares.
Work out each reinsurers share of the following claims:
a) 4 m, b) 13 m, c) 27 m
Solution:
Claims
a)
Claim amount
4,000,000
Direct insurers deductible
4,000,000
(Max 5 m per claim)
= Subtotal
Liability of Reinsurer A
(Max 10 m per claim)

= Liability of Reins. B & C (each 50 %)
(Total max. of 20 m per claim)
b)
c)
13,000,000
5,000,000
27,000,000
5,000,000
8,000,000
8,000,000
22,000,000
10,000,000
12,000,000
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Dr. Gerhard Mayr
Example stop loss:

A hail insurer has agreed a stop loss with the following conditions:
Retention 75 % of the annual premium for the portfolio;
Stop loss maximally 50 % of the annual premium income following the retention.
As agreed, at the end of the year the direct office reports to its reinsurer that the
annual premium amounted to 89,500,000.
The years expenditure for claims:
a) 78,670,800
b) 103,290,000
c) 124,358,000
What is the reinsurers contribution to the years claims expenditure in the cases of
a), b) or c)?
Solution a):
Claims expenditure for the year
Retention (75 % of 89,500,000)
78,670,800
67,125,000
= Stop loss
11,545,800
The reinsurer pays 11,545,800 of the claims expenditure for the year
Solution b):
Retention (75 % of 89,500,000 )
103,290,000
67,125,000
= Stop loss
36,165,000
The reinsurer pays 36,165,000 of the claims expenditure for the year.
Solution c):
Retention (75 % of 89,500,000)
124,358,000
67,125,000
=
Stop loss
max. 50 % of 89,500,000
57.233.000
44,750,000
= Share, which the direct insurer has to carry itself in addition
12,483,000
The reinsurer carries the maximum possible share of the stop loss payment of
44,750,000.
(The direct insurer in addition to its retention of 67,125,000 pays 12,483,000)
5.3.4
129
Other ways of atomizing risk
5.3.4.1 Insurance pools

An insurance pool is a joint venture for the atomization of risk in which several insurance companies (direct insurers and reinsurers) join together in order to carry
risks collectively. The pool members undertake to bring all risks into the pool that
meet certain criteria, in order to participate in all the business of the pool for their
previously agreed shares. Each member participates in the risks covered by the pool
only to the extent that its share has been previously laid down in the agreement.
Each pool member takes on this share not only of risks which it has underwritten,
but also of risks that have been brought into the pool by other pool members. Either
a corporate pool member or a pool administrator has the responsibility for managing a pool. Expenses are divided among the members.
Pool agreements serve above all the purpose of atomizing and collectively bearing
risks that are new, especially dangerous or unbalanced. Thus a financially strong
risk bearing community is created with large underwriting capacity.
In Germany the following insurance pools exist at present:
The German Atomic Insurance Pool (Atompool)
Provides liability and property cover against perils connected with the erection and
running of nuclear reactors and similar plants.
Pharma Reinsurance Pool (Pharmapool)
For the business of liability insurance of pharmaceutical companies in accordance
with the German Pharmaceuticals Act.
Until the end of 2003 there was in addition the German Aircraft Pool (for aviation
insurance).
5.3.4.2 Financial Reinsurance
Starting in the USA forms of reinsurance were developed that focus on annual
financial statements, supervisory regulations, fiscal and financial targets. In this
case the transfer of insurable risk is not in the forefront. Because the driving force
behind it is financial and economic success, this form of reinsurance is called financial reinsurance.
These types of reinsurance contract are constructed individually and generally
tailor made. Investment income is explicitly and as a matter of principle taken into
account in the price calculation, and as a rule over the duration of the contract,
which is usually long, a balance of interest is found that is unique to each agreement. For these contracts to be recognized as reinsurance in accounting, supervisory and fiscal law, there must nevertheless be a minimum amount of risk transfer.
A few examples of financial insurance are described below:
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Dr. Gerhard Mayr
Funded cover
The direct insurer sets up an interest bearing fund with the reinsurer, which is used
for the reinsurance share of future claims. The fund can take on a negative value in
the case of negative experience, so that the direct insurer has liabilities towards the
reinsurer.
Treaties that finance acquisition costs (especially in the field of life insurance)
At the beginning a direct insurer can incur heavy expenses in acquiring new business for an insurance portfolio. By means of treaties that finance acquisition costs at
this stage the reinsurance treaty is constructed in such a way that the direct insurer
achieves a payment surplus and profit, which in the ensuing period is then repaid
with interest to the reinsurer.
Spread loss contracts
With spread loss contracts the reinsurer provides up front financing of claims, which
in the ensuing period is amortized by the direct insurer paying regular instalments.
5.3.4.3 Alternative Risk Transfer
Parallel to classical reinsurance and financial reinsurance Alternative Risk Transfer
(ART) is considered to be a third type of reinsurance. By ART is understood the
financing of risks with non-traditional covers of the insurance companies. That is,
in this case the insurance cover is created outside the insurance market by capital
market investors acting as the insurers secondary risk carriers.
In this construction insurance risks are transferred into the capital market with original (Insurance Linked Bonds) or derivative financial titles (Loss derivates or insurance futures contracts). The repayment and/or the payment of interest of the particular financial instrument is made dependent on the development of a special loss
portfolio (indemnity trigger) or a parameter that is external to the company (index
trigger). These instruments are employed especially in the coverage of catastrophe
risks (e.g. CatBonds), since in this way the underwriting capacity of the classical
reinsurance market can be considerably increased.
Sources
Farny, Dieter: Versicherungsbetriebslehre. 4th Edition. Karlsruhe: VVW, 2006
Liebwein, Peter: Klassische und moderne Formen der Rckversicherung.
2nd Edition. Karlsruhe: Verlag Versicherungswirtschaft, 2009
Pfeiffer, Christoph: Einfhrung in die Rckversicherung: Das Standardwerk fr
Theorie und Praxis. 5th Edition. Wiesbaden: Gabler, 1999
Rockel, Werner; Helten, Elmar; Loy, Herbert; Ott, Peter; Sauer, Roman:
Versicherungsbilanzen: Rechnungslegung nach HGB, US-GAAP und IFRS.
2nd Edition. Stuttgart: Schffer-Poeschel Verlag, 2007
Cost accounting
and results accounts
by
Dr. Georg Erdmann
132
6.1
Dr. Georg Erdmann
Tasks and terms
Cost accounting is company internal accounting which serves the purpose of capturing and allocating periodic loss of value caused by the production of business. In
this connection only those costs are relevant that are actually directly related to
the companys business. External and extraordinary elements are not taken into
account in cost accounting.
In this way it serves the following purposes:
Control of the efficiency of the business process and identification of sources of
loss
Calculation of the risk premium (or fixing of the premium limit)
Cost accounting supplies information
for deciding on future plans
for checking decisions
for reviewing performance
on the liquidity status of the insurance company (together with the management)
for carrying out comparative calculations
Thus the information from the cost accounting constitutes an important controlling
instrument for the management.
In the case of results accounting the benefits are captured analogue to the cost
accounting and are delineated both temporally and according to type of business.
The accounting goal of results accounting is to calculate the benefits produced in
an accounting period or the revenues gained in the market, as well as the offsetting
of the benefits or revenues by the production of relationships to reference figures.
The insurance companys benefits are economic goods created by the employment
and combination of production factors, irrespective of how they are utilized. They
have a quantity component (volume of created benefit) and a price component
(valuation of the volume). The following types of benefit and revenues can be distinguished:
Benefits within the company
Revenues from sold insurance products
Revenues not derived from insurance products sold (especially investments)
By setting up the costs and benefits accounting parallel to each other, the business
success (profit) can be quantified by calculating the difference between costs and
benefits, This makes an important contribution to the decision-making process and
the achievement of plans.
The capture and evaluation of the relevant business events is divided into three subsections by the cost accounting:
133
In accordance with the criterion accounting way of the costs the following cost
accounting systems can be differentiated. Irrespective of the type of cost accounting
system, the accounting way of the costs is broken down into three subsections.
The cost-type accounting stands at the start of cost accounting and has the
function of capturing and breaking down all the types of cost that have been
incurred in the course of the particular accounting period. Question: Which costs
have been incurred?
In cost centre accounting the costs are allocated to the business areas (cost units)
in which they have been incurred. This distribution is made in the course of the
cost accounting and has a dual function: firstly, for cost control and to know what
has influenced the costs it is necessary to know where the costs were incurred,
and secondly exact unit product costing is only possible if the costs of those departments which deliver these benefits are allocated to the company products.
Question: Where have the costs been incurred?
The purpose of product cost accounting (cost accounting, unit product costing,
costing) is to calculate the unit costs of all goods and services created (unit costs).
Question: Why have the costs been incurred?
6.1.1
Cost-type accounting
In an insurance company we distinguish between the following costs:

Personnel costs (salaries, social costs, such as the employers contribution to
social security, company pensions, holiday pay, sickness benefit, Christmas bonus, among others). The costs of the sales force (travel expenses, salaries, commissions) are often broken down into these items.
Costs for intermediaries (all commissions to self-employed agents and brokers
including allowances of all kinds)
Costs of working capital, e.g.
Depreciation and amortization and repair costs
Running costs, e.g. costs of material and electricity
Rents for office space, data processing systems, motor and other working capital
Miscellaneous operating expenses, such as telephone costs, post, travel expenses, among other things
Taxes chargeable as expenses, e.g. for motor, fire brigades and value added tax.
Claims expenditure for own account (after subtracting the shares of the reinsurer).
Under this item payments and the loss reserves for the accounting period are
recorded.
Reinsurance costs: they arise from the reinsurance premiums paid minus the
reinsurance commission and profit shares.
A further important type of expense are imputed costs. These are costs for which
there has been no expenditure or another level of expenditure. Examples of imputed costs are imputed depreciation and amortization, imputed interest, imputed
rents and imputed risk costs.
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Dr. Georg Erdmann
Cost-accounting depreciation and amortization: for depreciation and amortization

criteria are often relevant that are irrelevant for a calculation of material requirements and control accounting, such as the principle of balance sheet continuity as
also fiscal criteria. Should a plant have been written off to a reminder value of 1,
for example, further book depreciations are not permissible, even if the plant is
still in use. The fact of further use means, however, that past depreciations were
too high and thus wrongly estimated. This can be corrected within the cost accounting, so that plants still in use can be accounted for, even if they have already
been completely written down in the financial accounts department.
Imputed interest: In the financial accounts department only effectively payable
interest is accounted. Thus interest is set off against borrowed capital only, and
interest on owners capital does not apply. In cost accounting, however, imputed
interest on the assets needed for the business and thus also the interest on the
owners equity is accounted. The owners equity admittedly does not produce an
effective interest payment, but due to the investment of the owners equity in the
business, the possibility of using it for another external capital investment has
been denied.
Imputed rents: If the insurance company pays no rent for the use of its own premises, the cost accounting has to take imputed rents into account. This makes a
comparison possible with companies or entities that do not have their own premises available.
Imputed risk costs: By setting up imputed risks certain loss risks should be captured. In this connection imputed risk costs should be mentioned for which there
is no equivalent in the financial accounts department (risk of loss of an investment) and such by which there is a premium oriented difference (credit risk, guarantee risk, etc.). Apart from insurance related risks other risks emerge out of the
activity of the insurance business, such as the contractual risk, the investment risk
or the portfolio risk.
Within the framework of cost-type accounting the following terms occur:
Fixed costs are independent of the production volume, whereas variable costs are
dependent on the level of the output (or the degree of employment). Before a business can begin production, certain basic preconditions must be fulfilled (purchase
or hire of equipment, setting up of an organization, etc.). Output (production) presupposes the creation of operational readiness. The creation of operational readiness produces costs, which are called fixed costs. Their level remains the same,
whether 50 cars are turned out each day, or 2,000.
Examples:
Rents (Rent must be paid, irrespective of whether all members of staff work or
only half of them)
Personnel costs for employees
Cost of working capital for depreciations and amortizations
Interest for the use of borrowed capital (credit interest)
Variable costs are production related expenses, i.e. variable costs are costs which
increase with increasing production. They are thus dependent on the use of the
capacity by the production of goods.
135
They vary with the volume of the output.

Examples:
Production costs
Manufacturing costs
Material costs
Distribution costs
Direct costs
Direct costs are costs which can be directly allocated to a reference object (cost
centre or cost object).
Direct costs are the costs for material, wages, among other things, which are
demonstrably used for a particular object, a single order or a special policy.
Direct costs are usually variable costs, since they are caused by the production, of a
product, for example. They could be avoided if this product were not manufactured.
Overhead costs
Whereas direct costs can be directly allocated to a particular cost object (proposal,
policy), this is not the case with overhead costs. They cannot be allocated to a particular product, since they have been incurred for several products or for all products of the cost areas.
6.1.2
Cost centre accounting
In cost centre accounting the individual types of expense are spread over the cost
centres in which they were incurred. Such cost centres are part of the business such
as, for example, the purchasing, assembly, administration and distribution functions. The purpose of this accounting lies first of all in the cost control and cost
organization and it also serves the purpose of determining calculation rates, in order
to allocate overhead costs to the individual products.
Cost centre accounting inquires as to where the costs were incurred. Cost centre
direct costs (e.g. staff salaries) can be directly allocated to the cost centres. Overhead costs (e.g. administration expenses, energy expenses and similar expenses)
have to be allocated to the individual cost centres using a key.
How cost centres can be set up
a) Departments or organization of the insurance company
Important cost centres are intermediaries, branch offices as well as departments
of the head office. It is an advantage that the different types of cost are easy to
calculate, being to a large extent direct expenses of the cost centre, as well as
being easy to control. There are disadvantages in further charging the area costs
to the cost object, because the allocation connection is often not clear.
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Dr. Georg Erdmann
b) Among the business functions are management, procurement, production (business, claims, reinsurance), sales, administration and financing. This organization
can be consistent with the structure of the organization if it conforms to business
functions. It is an advantage that it easy to allocate the area costs to the cost objects since the allocation principles are easily recognizable. There are disadavantages in allocating the types of cost to the cost centres if the structure of the
insurance company does not match the business functions.
c) Areas of responsibility
The allocation is advantageous if the productivity and efficiency are applied
when the cost accounting is further developed to a planned cost calculation or if
individual areas are managed as profit centres (independent profit areas).
Type of cost units
From an allocational point of view a distinction should be made between a preliminary cost centre and a final cost centre. The costs calculated for the preliminary cost
centre are not allocated to the cost object, but assigned to the final cost centre,
which utilizes the products of the preliminary cost centre.
The preliminary cost centre is thus something in which internal company products
are used, which are used in the accounting period by other areas of the business.
Consequently, the terms indirect cost centre and primary cost centre are used. The
most important preliminary cost centres are staff divisions of all kinds, a large part
of the administration areas (personnel, property management, internal administration) the temporary posts for special services. In large insurance companies the area
technical equipment and installation, including IT, is usually treated as a preliminary
cost centre.
Cost centres in practice
In practice cost centres are usually set up to reflect the actual structure of the company. This results in the following organization of the cost centre plan for a composite insurer or an insurance concern with a standard structure:
Decentralized areas
Intermediaries, further subdivided into types of intermediary (agents, brokers) or
according to other aspects
Own company entities, if necessary subdivided into departments as in the main
business.
Inspectorate, further subdivided into types of inspectorate (universal or special
inspectorates for intermediary support, acquisition, claims handling, individual
classes of insurance, individual customer groups)
Claims regulating offices
137
Centralized areas (Head office)

Products and staff divisions
Manufacturing departments (insurance departments)
Business departments for initial processing and renewal processing, further
subdivided into functions, insurance classes, customer groups, regional areas
Claims departments, further subdivided into functions, insurance classes, types
of claim, customer groups, regional areas
Reinsurance departments
Sales departments, usually includes the department for sales force support
Administration departments, especially personnel, property management and
accounting (mainly preliminary cost centres)
Finance department including the investment department
Internal product departments (preliminary cost centres)
Technical equipment and installation, including IT
Supporting services, e.g. typing pools, registry, fleet, post room, telephone and
facsimile
Allocation of the area costs
The close of the cost centre accounting is the allocation of the area costs to the cost
objects. In practice this is the most difficult cost accounting problem, since in this
allocation step keys for the allocation of the costs have to be used to a considerable
degree.
Before the costs of the final cost centre are allocated, the costs of the preliminary
cost centre are assigned to the final cost centre. For example, the costs for personnel and property management and the costs of the technical equipment and installation must be allocated, which generally happens with the help of keys (e.g. the
costs of the personnel department according to numbers, IT costs according to time
shares for the areas responsible for the assignment). The fact that some of the preliminary cost centres produce reciprocal products for each other can be approximately allowed for by means of a practical sequence of allocation steps. Those preliminary cost centres should be settled first which deliver to many other areas and
whose cost amounts are high.
In allocating the costs of the final cost centres, keys should be used that are customized for each company, provided they are not direct costs of the cost object.
6.1.3
Product cost accounting
The unit costs of the business products are calculated by means of product cost
accounting. The allocation of the direct costs to the cost object is direct, the allocation of the overhead costs being indirect over the bases of calculation in the cost
centre accounting. The unit costs or also the manufacturing costs of a product are
needed in the short-term profit and loss account and as the basis for the company
pricing policy.
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Dr. Georg Erdmann
From the management perspective the aims of product cost accounting are among
other things the
optimization and control of the profitability of the insurance classes and investments, by the product cost accounting preparing the data for strategic estimates
of the contribution margins
calculation of the premiums for the insurance classes
product sales decisions (sell aggressively, brake, stop products)
These goals are achieved within the framework of cost object unit accounting and
cost object time accounting. Cost object time accounting is accruals accounting,
which broken down into products determines all the products and costs as well as
the business result in the accounting period. Cost object unit accounting is individual specification oriented accounting. It establishes the manufacturing costs or
production costs of the business product units (unit costs) and is thus the actual calculation.
Types of unit cost
Depending on the utilization of the benefits produced in the insurance company, a
distinction is made between preliminary cost objects and final cost objects.
Preliminary cost objects are internal benefits, which are designated for renewed use
in the own insurance company and which are thus activated in the internal balance
sheet and are written down in line with their expected useful life. This relates in the
first instance to the conclusion of contracts and the sales force. In particular cases,
the costs for a complete rearrangement of the administration, for an own IT programme and similar investments can also be dealt with in the same way.
Final cost objects are particular products for the business market. They are first of all
the types of insurance protection which are offered by insurance companies or concerns, and secondly products of the insurance company that have nothing to do
with protection. Among these are in the first place the capital and rent utilization
(investments), which are sold in special markets, as well as further benefits, such as
management services in syndicate business, business management assignments
for other companies, insurance intermediary services, intermediate businesses of
other kinds and IT services for third parties.
Above all, in the internal account the costs and revenues for byproducts in the form
of different services should be ascertained with great care, so that their profitability
is transparent. In practice, in accounting the non-insurance business is often mixed
with insurance business, because they are to some extent produced by the same
factors of production and in the same cost centres.
Insurance contracts or insured risks as cost objects?
The allocation of the costs to cost objects assumes that between the costs that have
to be allocated and the cost objects there is a one to one allocation relationship. An
examination of the productivity correlation in the insurance company shows that
the correlations between elements of the factors of production, on the one hand,
and the services that are produced, on the other, are different.
139
The operating expenses, apart from commissions, are linked with respect to their
origin to the individual insurance contracts: that is, their level is mainly determined
by the features of the insurance contracts, irrespective of whether in the individual
insurance policies one risk or several risks, large or small risks, are insured. For example, if there is a causal relationship between collection costs and a household policy as a whole, this is independent of whether this includes the fire peril or the five
risks of the combined household insurance policy. Or: the costs for the preparation
of a motor insurance certificate are almost completely independent of whether the
policy covers only the motor third party liability or the insurance of partial risks. Or:
the costs of claims handling in life insurance do not depend on whether a large or
small sum insured will be paid out. The insurance contract constitutes a joint production of insurance protection consisting of subsets of different types and size. The
costs are only calculable for the combined product: not, however, for its parts. It follows that product cost accounting for the capture of the operating expenses has to
be carried out according to the types of insurance contract.
The risk costs, namely claims expenditure, reinsurance expenses and imputed interest on the insurance liabilities and security, exhibit on the contrary a causal connection to single insured risks: that is, their level is determined by features of the
insured risks without taking into account whether or not they are bundled together
in few or many insurance contracts. In this way the cost of claims for combined
household insurance policies can be allocated to the individual perils of fire, burglary, tap water, storm and vandalism. The reinsurance costs for a motor excess of
loss treaty can be directly allocated, even if these are all bundled in an all risks contract. For the calculation of the claims, reinsurance and interest expenses the product cost accounting must be broken down according to the types of insured risk.
140
Dr. Georg Erdmann
Diagram of cost accounting in the insurance industry

Types of cost
unit costs direct costs
immediate
unit costs overhead expenses
cost centre EK
cost centre GK
immediate
allotted
primary cost centre costs
internal cost allocation

(secondary)
primary cost centre costs
calculation rates
unit costs
Problems in allocating costs

1. Despite complicated assignment keys a causally justified distribution of overhead
costs is only to some extent possible.
2. With simple assignment keys the allocation is relatively arbitrary (e.g. Departments. The different fluctuation and consequently more work for the personnel
department is not taken into account).
3. Occasionally the costs are allocated according to the principle of financial viability. This principle contradicts cost allocation based on the principle of causality.
(Principle of financial viability = a highly profitable class of insurance is allocated
more costs or: Class, for which the cost matching premium matches the risk
and which is higher than the competition, is relieved of costs).
4. The costs incurred must be broken down into non-recurring and recurring costs.
The non-recurring costs (e.g. new business commission for life insurance) should
be spread over the average policy duration. (The sum of the running costs and
the annual share of the acquisition or non-recurring costs are the relevant operating expenses per year).
141
5. Problems also arise, for example, in connection with the cost allocation for combined and packaged policies (allocation of the costs for underwriting: for example, for a family protection policy).
6. A distinction must continue to be made between fixed and variable costs. The
underwriting costs of a life insurance policy are broadly similar irrespective of
whether a sum insured for 20,000 or 80,000 is processed. The commission
costs, however, depend directly on the sum insured.
7. The identification of operating costs is recorded in numerous items of the profit
and loss account, because the expenditure (costs) are captured partly according
to type and partly according to functions or business areas. (For example, salary
expenses in expenditure for insurance business, for insurance claims and for
investments). The total amount cannot be established, because parts of the operating expenses (for example, expenses for claims handling) are included in the
item claims expenditure.
8. The net result of the operating expenses after withdrawal of reinsurance commissions and profit shares can distort the picture.
9. In many insurance companies a fixed extra for operating expenses is added to
the risk costs. This means for low sums insured the operating costs are scarcely
covered, for high sums insured the customer is burdened with operating costs
that are much too high.
Example contents insurance:
Premium rate: 2.0
1.2 risk costs = 60 % of the premium
0.8 operating expenses = 40 % of the premium
2.0
a) Sum insured 50,000; Share of the operating costs 40
b) Sum insured 200,000; Share of the operating costs 160
For a sum insured of 200,000 the policyholder pays a four times higher share of
the operating costs than for a sum insured of 50,000, because these costs increase
proportionately with the sum insured. This is justified for new business and renewal
commission, because these expenses increase proportionately to the sum insured.
The costs for the underwriting and policy issue processes will, however, hardly be
four times those of a policy for 50,000.
Possible solutions
Suitable cost discounts are granted; there are no cost extras; instead a minimum
amount applies.
The operating costs are divided into sum insured variable and sum insured fixed
costs. (Commissions variable costs fixed costs). For sum insured fixed costs a
fixed amount (unit cost extra) is allowed for.
142
Dr. Georg Erdmann
Example contents insurance:

Premium rate 1.7 + 30 units costs extra
1.2 risk costs
0.5 operating costs (variable)
30 operating costs (fixed)
a) Sum insured 50,000. The customer pays 25 variable and 30 fixed operating
costs in total 55
b) Sum insured 200,000. The customer pays 100 variable and 30 fixed operating costs in total 130
6.2
Contribution margin accounting
Cost accounting procedure

Besides the three areas of cost accounting (cost-type accounting, cost centre accounting, product cost accounting) two cost accounting procedures have to be
distinguished, namely: full cost accounting and marginal costing.
Whilst in the case of full cost accounting all costs (direct costs and overhead costs)
are spread over the individual cost objects, in the case of marginal costing at first
only part of the costs for example, only the direct costs are allocated to the cost
objects. The overhead costs are dealt with at the end in this case.
Full cost accounting thus foresees a complete allocation of all costs onto the cost
object. On the one hand, this is also its great advantage, since there cannot be any
gaps which can be used to avoid cost controlling by those who do not want to take
responsibility for costs they have induced. On the other hand, the result is that the
distribution of overheads is only possible by breaking down costs. In doing this the
principle of cost causality is inevitably violated, which can result in various strains in
individual cost centres. This means that full cost accounting cannot deliver the basis
for business planning.
In marginal costing, as already mentioned, the distribution of particular costs, such
as fixed costs, is waived. In the insurance industry contribution margin accounting
is being increasingly employed as results oriented accounting on the basis of marginal costing.
Features of contribution margin accounting
Contribution margin accounting allocates only the direct costs and revenues that
can be assigned to the cost centres and cost objects. The enterprise reports the
overheads as a whole. In this way a more or less correct allocation of the overhead costs to the cost objects and cost units (= branches and insurance policies) is
avoided with the help of keys.
As reference figures (= headers) cost objects (products), cost centres and other
items can be chosen.
143
Controlling using contribution margin accounting

Control of periodical contribution margins for other allocation bases. Using the
same procedure contribution margins can be calculated from insurance business
with individual company groups, in certain sales areas, with branches and intermediaries. To do this, the allocation bases (headers of the contribution margin
accounting) must be suitably changed.
Control of the periodical contribution margin of customer portfolios or individual
insurance contracts. By using this itemization it is possible to control which contribution margins a business connection with a particular customer brings over a
period of time. The contribution margin for only one accounting period is, however, hardly meaningful).
Premium decisions: The premium revenues for the individual classes of insurance
must cover at least the calculated direct costs. Furthermore, the contribution margin should also cover part of the overhead costs. In the underwriting policy it must
be checked on a case by case basis as to whether additional business brings a
positive contribution margin. If this were the case, the overall results of the insurance company would improve, because an additional contribution margin would
be available for the overhead costs. But if the premium for this business is not
even sufficient to cover the direct costs that can be allocated directly, then this
business must be declined.
However, premiums and underwriting decisions must be made only for the individual case with the assistance of contribution margin accounting. If the insurer
oriented its complete pricing policy on the contribution margin, the overheads
would probably not be covered in the long-term. A long-term general premium
policy is thus only possible with full cost accounting.
Programme decisions: If capacity is tight for the sales force or for advertizing
measures contribution margin accounting can give good information. The insurer will then choose the class of insurance for more intensive sales and advertizing measures from which it can expect the higher contribution margin.
Advantages of contribution margin accounting
A more or less correct allocation of overhead costs to the cost objects and the cost
centres is avoided with the help of keys.
The overheads are mainly fixed costs. If the business is shrinking, in the case of
full cost accounting individual contracts have to be declined, because the share of
fixed costs per cost object (= fixed costs per contract) increases without the premium being able to be increased or the gross premium would be higher than the
market premium and the business would shrink even more.
144
Dr. Georg Erdmann
Example:
The fixed costs of an insurance companys motor vehicle liability insurance are
200,000.
With 10,000 policies the fixed cost share per policy is 20. If the number of policies
decreases to 5,000, for example, the fixed cost share per policy increases to 40 per
policy: that is, the insurer would have to raise the premium. Then the number of
units would presumably further sink.
Summary
Construction of contribution margin accounting (Head office)
Revenues per class of business
Direct costs per class of business
= Contribution margin per class of business
The overheads are not distributed, but shown together as a block by the insurance
company.
Total of the contribution margins
Overhead costs
= Insurers profit
Example:
Contribution margin accounting head office (simplified)
Relation Indusrevenues trial
& costs fire
AgriSimple
cultural busifire
ness
fire
Premium 80
revenues
26
Total
fire
70
Rest
Total
Investnon-life non-life ments
140
26
70
Personnel
costs
Intermediary
costs
140
1
14
Total
316
Investment
revenues
Total
80
revenues
Total
company
20
20
20
336
30
52
37
145
Relation Indusrevenues trial

& costs fire
AgriSimple
cultural busifire
ness
fire
Total
fire
Depreciation &
amortizetion
of new
business
18
34
10
28
46
118
Reinsur- 20
ance
expenses
25
56
25
48
70
100
23
Total
Total
costs
Total
company
Costs of
working
capital
Claims
expenditure
f.o.a.
Rest
Total
Investnon-life non-life ments
58
33
314
Business result = 336 314 = 22
Explanation
This insurer offers only non-life insurance. The premium revenues (= directly allocated revenues) are allocated to the insurance branches. Then the direct costs, for
example, of the clerks of the industrial fire insurer ( 4,000) are allocated to this
class. For the fire insurance departmental management there is a total of 1,000, for
the whole of non-life (for example, board of management, non-life) 3,000 for personnel costs. Total fire insurance and Total non-life have no revenues, since
the premiums are allocated to the individual sub-classes of insurance. In the case of
Total fire/non-life only the costs of the departmental management are shown. The
intermediary expenses (commissions) are also distributed as directly allocated
direct costs to the sub-classes of insurance. 5,000 (under intermediary costs)
could not be directly allocated. They are captured under insurance company as a
whole. To this, office allowances could be credited to the agents.
Belonging to the operating costs are, for example, depreciations and amortizations,
repair costs, material and electricity costs, as well as office rents, IT plant, and so on.
Here, too, direct costs (for example, 2,000 for industrial fire) and overhead costs
(for example, 23,000 under insurance company as a whole) are differentiated.
146
Dr. Georg Erdmann
Contribution margin flow

Industrial
fire
Agricultural
fire
Simple
business
fire
Rest
non-life
Investments
Individual revenues
80
26
70
140
20
Direct costs of the

sub-classes
70
25
48
100
10
22
40

73
Contribution margin
of the sub-classes
Direct costs of the
insurance classes
Contribution
margin of non-life
Direct costs
of capital
Contribution
margin of lines
of business
Total costs of
insurance co.
Profit
3
4
66
6
14
80
58
22
Explanation
The direct costs are subtracted from the directly allocated direct revenues of the
sub-classes of insurance. The result (= 73,000) is the contribution margin for the
sub-classes of insurance. (Contribution margin = surplus from direct revenues and
direct costs which should cover the overhead costs). If the direct costs of the departmental management are subtracted from the contribution margin of sub-classes of
insurance, the contribution margin of the non-life line of business is obtained, a
total of 66,000. If the direct revenues (= interest, dividends, etc.) and direct investment costs are taken into account, the contribution margin for the classes of business is obtained ( 80,000). This contribution margin has to cover the overheads
( 58,000). This gives a business result of 22,000.
147
Example of premium calculations:

For contents insurance the insurance company has calculated a premium rate with
a full cost account of e.g. 2 .
The contribution margin is 1.6 : that is, with 1.6 the claims and direct operating
expenses are covered.
If the insurer in particular cases cannot achieve 2.0 , it can go down to 1.6 . But
these policies then cover only the direct costs not their share of overhead costs. If
many policies between 1,6 and 2,0 are accepted, then the contents insurer will
probably make a loss, since this class must also carry its share of the overhead
costs.
Example for controlling customer relationships

For example, the total costs of the customer Schulz have been observed over the
last five years (premiums, commission and claims added together)
Premiums
Commissions
Claims
Contribution
margins
Domestic
buildings
insurance
Contents
insurance
Liability
insurance
Combined
shop
contents
insurance
Traders
combined
policy
2,500
450
400
2,000
360
1,800
320
9,200
24,800
2,880
4,600
12,000
1,440
13,000
1,650
1,640
7,720
16,520
2,840
The total contribution margin is 9,250, so that the development of costs is positive.
This accounting could be even more finely tuned if further direct costs were brought
into it. In practice often only the premiums and the claims are accounted for,
whereby large claims are capped.
Controlling
by
Dr. Georg Erdmann
Controlling
7.1
149
Nature of controlling
The term controlling is often translated into German by the word kontrollieren
(double-check), based on the English word control, and this is how the task of
controlling is perceived. Controlling, however, does not mean to double-check, but
manage, plan or supervise. Controlling is not geared to the past, as is accountancy,
but is future oriented, in order to safeguard the long-term future of the enterprise.
A company management that sets itself objectives needs a system that will enable
it to
receive and evaluate information about the procedures in a company
plan and manage with this information
supervise the company processes
recognize dysfunctions early and react immediately
learn from experience and incorporate the insights into the new planning and management.
Controlling is the totality of tasks which the co-ordination of the company leadership has as well as the supplying of the company management with information, in
order that its objectives can be realized.
Controlling supports the board in corporate management, especially in
planning and co-ordination,
the analysis of deviations,
the capture and preparation of information,
the organization of a comprehensive reporting system
performance reviewing and reporting.
Sub-areas of controlling
Controlling consists of the four functional sub-areas information, planning, corporate management and control.
1. The information function should capture the communicative and directive connections between decision makers, the totality of controlling tasks and the basis
of information.
2. The planning function consists of the sub-areas
Supply of the relevant control instruments
Strategic definition of aims
Operative definition of strategies
3. By corporate management is understood the objective orientation of company
activity. Its main purposes are:
Supply of controlling instruments
Provision of information appropriate for the level of the decision-makers
Co-ordination
150
Dr. Georg Erdmann
4. The efficient employment of the above-mentioned corporate management instruments presupposes continuous control. The main focus of control is the comparison of the planned target with the current specifications using a comparison
of the two figures.
Where controlling can be used in an insurance company
Cost controlling is the planning, corporate management and control of the costs
incurred in company business activity that is undertaken to achieve company targets, especially the cost targets set.
Distribution controlling is the planning, corporate management and control of the
sales organizations whose aim is the realization of the sales targets.
Claims controlling is the planning, corporate management and control of the
claims that occur.
Process controlling means those steps which are concerned with making company processes as focussed and co-ordinated as possible.
From an organizational point of view controlling is usually institutionalized in insurance companies in the form of staff divisions or staff departments, which are under
the immediate direction of the management. Because of its proximity to the directors the function of controlling is expressed as corporate management, as well as
being important for the whole company.
7.2
Strategic and operative controlling
Depending on the time frame a distinction is made between strategic controlling

(time frame long-term, three to five years) and operative controlling (time frame
short-term, one month to two years). In the course of strategic planning the company management establishes the targets it wishes to reach in the longer term. This
is a rough plan, lasting for a period of at least three years. Operative controlling, on
the other hand, generally covers a business year. The short and long-term goals to
be targeted are established.
The areas of activity of strategic controlling are
Participation in the capture and further development of the planning and corporate management system
Service task. By service task is meant the function of controlling to prepare decisions: that is, to filter out the most important data and to prepare accordingly.
Security and controlling function. By means of constant supervision the company
processes and decisions are controlled so that the existence of assets / and the
survival of the company are assured.
The targets of operative controlling can be, for example:
Increasing profit
Decreasing costs
Understanding the deviations between planned and realized results
151
Controlling
For the targets aimed at plan figures are developed (for example, cost reduction by
10 % of premium collection). The plan figures for the near future can also be adapted from historical data. Furthermore, controlling accompanies target-focussed
business activity and supports it with information and co-ordination.
7.3
Controlling instruments
Important controlling instruments are the following:

Performance figures systems: performance figures are calculated from the actual
figures and these are evaluated.
Target/Actual comparison. Plan data (target figures) are compared with the actual
earned data and the deviations are examined.
Budgeting. The planning simulates target values in the form of quantifications (for
example, number of units of new business in a class of insurance) or values (e.g.
reduction of claims expenditure in a class of insurance), which are then later compared with what has actually been achieved.
Information and reporting systems. Information about the targeted goals is collected, evaluated and presented.
Controlling instruments in insurance companies
A performance figures system in insurance is a systematic collection of business
indicators that is compiled either for the internal business comparison or for the
comparison of entities (= branch performance indicators) or to control the business
results.
Besides the business performance figures about efficiency to be found in all companies, the performance figures relating to productivity and production are of great
importance. As indicators of business changes, developments and results they indicate to the controller when and to what extent intervention is necessary.
Basically, the whole cost accounting is suitable for cost controlling. Investment indicators can also provide capital controlling with information. For the insurance company, distribution and internal business indicators are important. The hit rate is the
ratio of insurance offers to closed contracts:
Hit rate new business =
Total acquisitions of new business * 100

Number of visits
Hit rate business in force =
Total acquisitions of business in force * 100

Number of visits
If the insurer combines them, it obtains the total hit rate of its sales staff. The significance is limited, however, because the rate changes greatly with the (individual)
specifications of the target visits.
152
Dr. Georg Erdmann
The cancellation rate is significant for the insurance company. It gives the ratio of
the withdrawn policies to those taken out in an accounting period and directly
affects the income of the sales personnel (new business and renewal commission).
To prevent sales personnel forcing up their new business commission and bonuses
by acquiring hazardous business, insurers grant these only for longer term business
that is in force. The rate can be calculated by various parameters: for example, units
or premiums.
Cancellation (unit) * 100
Cancellation rate of new business =
New contracts * 100

Cancellation rate of business in force =
Cancellation (premium) * 100

Business in force (premium)
The premium growth rate indicates to the insurer how its portfolio is developing
from the beginning to the end of an accounting period. Using the example of motor
insurance the following values are obtained (slice view):
Development of private motor business
Insurance Premium
class
vol. 1.1.
Bus. Yr
Motor-full
Rider
Bus. in
New bus.
force can- in Bus.
cellation
Yr.
in Bus. Yr.
%
1,200,000
300,000
1,500,000
2.5
4.5
90,000
24,000
114,000
New bus.
cancellation in
Bus. Yr.
%
4.0
2.0
Premium
vol. 31.12.
Bus. Yr.
Growth
rate in %
1,256,400
310,020
4.7
3.3
1,566,420
Furthermore, a short term calculation of the growth rate can give the insurance
agency an ongoing indication of whether the insurance target will be reached or not.
The agency owner can then react before the year is over when his financial targets
would be unattainable.
For the area of cost controlling the calculation of the administration cost ratio is important. It shows the relationship of the agency costs to the revenues and finds its
logical conclusion in profit centre considerations, since here the responsibility for
expenses and revenue are transferred to the agency. Only personnel and administration costs should be regarded as expenses, the revenues corresponding to that
part of the renewal commission which is earned by customer service. The administration cost ratio is calculated as follows:
Administration cost ratio =
(Expenditure for personnel + general

administration) * 100
Revenues from customer service
153
Controlling
Example:
From the cost accounting the insurance company has the following data:
Expenditure for administration costs
Expenditure for energy
Salaries
Social expenditure
Expenditure for rents
Expenditure for taxes
37,400
5,000
115,000
32,000
24,000
14,000
Administration costs
227,400
Revenues from renewal commissions
372,250
Administration cost ratio =
227,400 * 100
= 61.09 %
372,250
So far the loss ratio has been ignored in considering the performance figures. The
loss ratio is calculated as follows:
Loss ratio =
Total claims of business class in agencys portfolio * 100

Premium volume of portfolio
Selected performance figures for sales management (using the example of a branch
office)
1)
1)
1)
1)
Production output
Target compared to new business
Class comparison new business
Contribution margin new business
2)
2)
2)
2)
Costs and profits

Loss ratio
Expense ratio
Growth rate gross premium
3)
3)
3)
3)
3)
Portfolio
Composition of portfolio
Average premium per contract
Cancellation rate
Contribution margin per contract / customer
Balanced scorecard as a controlling instrument

In the past few years the concept of the balanced scorecard, developed by Kaplan
and Norton, has gained universal recognition.
The balanced scorecard is an achievement-oriented and strategic management
instrument that brings together qualitative and quantitative performance figures
from the perspectives of finance, customers/market, processes and members of
154
Dr. Georg Erdmann
staff. On the basis of a clear vision strategic targets are abstracted from these perspectives into a causal relationship with each other, as well as being operationalized
and made quantifiable by performance figures.
Aims of the balanced scorecard
Conversion of the company strategy into measurable targets.
High degree of transparency and shared understanding of the strategy (cause and
effect relationships) and of the strategic aims at all levels of the company.
High degree of acceptance, motivation and identification by the members of staff
(promotion of the company culture)
Communication of achievement-oriented results and value drivers
Improved customer relations
Increase in company value
Effective and efficient cultivation of the market
Strategic management of investments
By balanced is meant the equilibrium between short and long-term targets, monetary and non-monetary performance figures as well as between external and
internal criteria. From this a holistic view of the company emerges.
The word Scorecard indicates that the company is observed from the point of
view of strategically relevant reports.
The balanced scorecard contains four perspectives for comprehensive corporate
management:
1. Financial perspective (Appraisal of the company achievement from the investors
point of view)
2. Customer perspective (Appraisal of the company achievement from the customers point of view)
3. Organizational and process perspective (Which processes are important for the
company and how efficient are they?)
4. Learning and development perspective (How will the companys long term
success be safeguarded? Personnel, IT, Organization)
Solvency II as a requirement for the controlling in the insurance company
Solvency II is a project of the EU Commission for a fundamental reform of insurance
supervision in Europe, especially of the solvency regulations for the supply of equity
capital for insurance companies. On July 10th 2007 the European Commission submitted a proposal to the European Parliament and Council for a Solvency II framework regulation. According to a directive regarding the relevant implementation
regulations Solvency II will be implemented at a national level. As with Basel II (solvency regulations for the equity capital requirements for banks) there will be a 3 pillar concept. In contrast to the banks, however, the focus is not on single risks, but
the concept is holistic with the focus being on total solvency. As well as quantitative
aspects (Is adequate solvency capital always available?), qualitative aspects are also
considered (Does the company have adequate risk management?)
Controlling
155
The 1st pillar deals with the level of the minimum solvency capital, the minimum
capital requirements (MCR minimum capital requirements) and the target solvency
capital that has to be set up, the solvency capital requirement (SCR) in relation to the
deductible equity capital (eligible own funds).
The 2nd pillar applies to the risk management system and above all contains qualitative requirements, such as the qualification of the board members of insurance
companies (the so-called fit and proper criteria).
The 3rd pillar regulates the reporting duties of the insurance company: the reporting
duties to supervisory authorities (supervisory reporting) as well as information that
must be published (public disclosure). With the reporting duties a close connection
to other legal reporting duties should be attained, especially to other legally required reporting duties, such as that in the field of accounting, especially IFRS (International Financial Reporting Standards).

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Study Book for the

A project of the East European Committee of the GDV

The study book consists of the volumes

Published by the Berufsbildungswerk der Deutschen Versicherungswirtschaft

Authors of this volume

2010 Berufsbildungswerk der Deutschen Versicherungswirtschaft (BWV) e.V.

Satz hgk:fotosatz Weingarten/Baden

Munich and Berlin in August 2010

Basic principles of the insurance industry ......................................................

Organization of the insurance industry ...........................................................

Legal basis of the insurance contract ..............................................................

Insurance practice and statistics ...................................................................... 94

Coinsurance and reinsurance............................................................................ 117

Cost accounting and results accounts............................................................. 131

Controlling .......................................................................................................... 148

Dr. Georg Erdmann

Security, risk, insecurity

damage, destruction, loss,

Basic principles of the insurance industry

They are different depending on how they arise

are based directly on human behaviour

are generally not influenced by human

is immediate financial loss for the

affects the wealth directly because of

Dr. Georg Erdmann

Pure financial loss

Reduction in the wealth itself

Loss of sources of income

replacement of household goods

death of the breadwinner

Analysis and control of risks

Basic principles of the insurance industry

Re 1) Risk analysis and evaluation

Root cause analysis

Dr. Georg Erdmann

Re 2) Dealing with risk

For limited areas it is

Against the occurrence

To contain the loss

Basic principles of the insurance industry

Nature of the threat

Reason for occurrence

1 Loss = realization of a threatened peril

Dr. Georg Erdmann

Financial coverage of the risk

State benefits can be claimed under certain circumstances in most countries.

Measures to support the

State support for those in

Basic principles of the insurance industry

Individual self help

Dr. Georg Erdmann

Insurance can take two forms:

Insurance is characterized by the following features:

This depends basically on the size of

It is decided by the policyholder himself,

Basic principles of the insurance industry

Re 2. Uncertainty, but the need can be estimated

Many persons threatened by perils

Dr. Georg Erdmann

Uncertainly about the assessment

Spreading of risk over many entities

Classification of individual and the social insurance