According to the dictionary, insurance guarantees compensated payment for any loss, damage, death, or illness or protection against any unfortunate loss. In terms of economics, insurance is a contract providing financial protection for any losses. An insurance policy is a document presenting the terms and conditions of an insurance contract. This contract comprises of the company providing the insurance the customer acquiring it.
Insurance plays a vital role in our lives, and we cannot imagine a time without it. The idea of insurance dates back to 1752 when Benjamin franklin cofounded the Philadelphia contributions. The American society developed the concept from the infamous insurer Lloyds of London. Houses were made of wood, making them vulnerable to fire. This lead to the making of Philadelphia Contributions. This company evaluated properties applying for insurances and rejected those not fulfilling their requirements; rates were applied based on property risk.
Like modern times, there were different categories of insurances offered including, disabilities, business, automobiles, health, etc. In the late 19th century, various scandals and illegal practices shook the new-born insurance industry.
A man named A.V. Lamartine moved from town to town pretending to attempt suicide. He would walk into a hotel and express himself as a depressed man to request free accommodation at a hotel. When he called for assistance, he would point at an empty poison bottle. People used to rush towards him for help, and they would find a suicide note. This strategy allowed him to raise funds for himself With 25 dollars and 40 dollars from Dayton and Sandusky.
Other frauds include two women entering a town with a man. The man would rent rooms for the women who used to go for shopping the next day. Once they had shopped, they would instruct the manager to deliver the goods back to their rooms for them to try. Once they received the goods, they would disappear.
By 1820 the idea of insurance was now understood by the locals. There were around 17 stock life insurance companies in New York alone. There were, however, a lot of losses related to insurance companies. Thirty-three life insurance companies failed from 1870 to 1872 and around 48 from 1873 and 1877.
After 1910, life insurance experienced steady growth in the United States. The annual growth rate of insurance from 1910–90 was approximately 8.4 percent. However, the property-liability
Insurance had a relatively shorter growth rate. By 1989, insurance companies were a source of bread and butter for over 2 million workers. Other than that, these companies also contributed to the country’s GDP.
Recent insurance laws:
Eliot spritzer ordered investigations into insurance industry sales and accounting practices in 2004. Furthermore, the Federal Reserve Bank bought a 75% stake in an American international group (AIG). In 2010 president Obama introduced the patient protection and affordable act enforcing health insurance on the locals. The Dodd-Frank Wall Street reform and consumer protection law was introduced to redefine the financial market after the financial crisis of 2008.
What is prorated insurance?
The term pro-rata means equal distribution. In terms of insurance it may refer to the following:
- Policy cancellation:
Here “pro-rata” means equal distribution of premium in case of a void or reduced policy term. If a policy’s term runs from March 1st, 2016 until April 1st, 2017, and cancels on April 6th, the policy was active for 36 days in 12-month policy duration. Pro-rata over the 12 months, the total premium earned would be 9.9%. 90.1% of the premium is paid back to the customer if full payment of annual premium payment.
- Payout claims:
Claims are paid, in a way that the loss settlement clause enforces the customer to bear the pro-rata share of loss. Let’s look at an example. An insurance contract requires the insured property to take 100 % of the full substitution of value at the time of loss. If the property limit is less than 100% of replacement value, the insurance company would have to pay only their share of loss.
Full replacement value of loss = $500,000
Customers share = $250,000
Loss percentage of each = 50%
Generally, all company shareholders have the right to take part in new financing on a pro-rata basis. It permitted the shareholder to decide whether he wanted to invest or not. The invested amount is calculated by multiplying the total amount of that specific round by the stakeholder’s percentage ownership in the company. If there is an increase in the company’s ESOP, the shareholder will have a lower ownership percentage.
The right to take part in financing rounds on a pro-rata basis is a fundamental right protecting the interests of minority shareholders. Some countries have also passed laws stating that shareholders have a pro-rata right.
Ignorance of investor pro-rata rights:
It is highly uncommon for investor pro-rata rights to be ignored and could probably be a mistake. The following could be some possibilities:
- Fund rights: a possibility could be that the rights belong to the funds. In the Angel List round, the syndicate investor and individual investors all participate together. The angel list then creates a purpose vehicle that buys the note. If there is a chance of go along investment, managers have the right to invest money in the fund or create another follow-on fund. Because the right is comparatively small, the A-round investment will also be smaller and probably not worth doing, so they might wave it off.
- Right is isolated: participation rights brought forth by the original investor would divide participation into different funds. A follow-on fund for pro-rata rights might be used, or those rights might be sold to anyone else. Thus people controlling the fund might not present it to the investors.
- Right waived: most rounds allow the majority of investors to waive off their investment terms. Participation rights can be annoying and time taking from the perspective of a company. The procedure doesn’t always work as it is supposed to, so the investors to the company voted in favor of waiving the participation right.
- Minimum investor threshold: a threshold value set by most participation rights prevents investors from participating. It gets easier for the company as they don’t have to deal with too many early investors in the future. Maybe your investment amount is less than the minimum investor threshold.
- Non-qualifying A-round: Rights are only set in motion by certain investments. The A-round could be too small, so it is not considered a new investment chance.
Problems with pro-rata insurance:
Let’s start with an example. A company is not too good and not too bad. Their main goal is to increase company revenue. Fundraising is not possible as it would put a negative impression, so the founders want existing investors to participate.
This can put the existing investees in a position where they would prefer not to invest more capital. By doing so, it will put a negative impression on fresh investors and will endanger the current financing.
Most shareholders are in misunderstanding that when they sell a company, each shareholder gets their percentage. However, the formulas are much more complicated, and mistakes can be made.
Most attorneys are aware of these mistakes. The insurance community may not recognize the magnitude and frequency of the problem. The general counsel of a large investment fund revealed that he sacrificed most of his time in identifying mistakes or unsolved issues in capitalization tables. He further added that ignorance of those errors could have led to millions of dollars in losses.
Prorating insurance premium in advance:
In some cases, customers might buy a much shorter insurance policy, such as if insurance is needed for a house, car, etc. in such conditions, people have to cooperate with insurance companies to provide them with terms for how the normal premium will be prorated. This usually depends on the number of days until which insurance is needed.
It is better to carefully look over the time duration and proration works written in the contract to avoid any disputes later on. Bills and other material received from the insurance company should be checked properly.
Prorating Insurance payouts:
The terms of an insurance policy might also point out how claim payments are prorated depending on the amount of coverage. If three-quarters of a value of a house is covered by insurance, the policy might specify that damages would be paid in three-quarters of the cost. Any additional costs would be paid by either the policyholder or by additional coverage.
Multiple policies with such terms tend to pay more. If we ensure three-quarters of the asset with one insurance carrier and the other 25% with another carrier, they will collectively pay more.
Prorate for insurance premiums:
A common use for pro-rata is to determine the due amount for a partial insurance policy term. Most insurance policies are for 12-months, so if a short term policy is needed, the insurance company needs to pro-rate the annual premium. For doing this, divide the total premium by the number of days and multiply the number of days by the truncated policy.
Let us assume an auto policy covering a full year premium of $1000. If the customer only requires the policy for 250 days, the company must reduce the premium accordingly.
Pro-rata for interest rates:
Pro-rata calculations also calculate the amount of interest earned in an investment. Suppose the investment earns a yearly interest rate, then the pro rata amount earned is calculated by dividing the total amount of interest by the number of months in a year and multiplying the number of months by the reduced period.
Calculating the interest earned in two months on an investment that yields 10% interest each year =
Interest % = 10
Total months in a year = 12
Duration of interest = 2 months
= (10% / 12) x2 = 1.67%
In prize bonds, payment on flowing interest is calculated on a pro-rated basis. Accrued interest is the total interest added upon the bond since its last coupon payment. When the person who holds the bonds sells it before the upcoming coupon date, the interest that adds up to the next coupon date is sold. The issuer of the bond is not responsible for paying the bond seller the accrued interest:
The formula for accrued interest:
Accrued interest = face value of bond x rate of coupon x time
Coupon rate = yearly coupon rate
Time = days passed since previous payment/days in the current payment period.
A bondholder sells a corporate bond on May 30th. The bond has a 5 % coupon rate and a face value of $1000, which pays annually on the 1st of March and the 1st of September.
$1000 x (5% / 2) x (120/180) = $16.67
Pro-rated car insurance:
When you modify your car insurance, you should do it in the middle of your bill cycle. If the change affects the insurance cost, then the insurance company will pro-rate your premium. Premium is the amount paid for the insurance policy.
The insurance company is allowed to raise or lower the premium for the remaining billing cycle, depending on the changes you make. If you decide to end the policy, they will pay any extra money paid.
If in case you make any significant modifications to your car insurance policy, it will affect your premium. This gives the insurance company the right to prorate premium for the remaining policy.
If there your car has a basic security payment, you can decide to uplift your comprehensive coverage. You’ve paid $600 of basic security for 6 months, and payment of three months is due in the policy. If the additional payment is $300 for 6 months, then $150 will be needed to cover the last three months in your policy. The total for the next six months would be $900. In case of any downgrade in security, the insurance company will refund the extra amount paid.
A new policy (car insurance):
Prorated premium is not included when starting a new policy with an insurance company. You might receive a prorated premium of your transfer coverage from an old car to a new one, but you’re staying with the same insurance company.
A new car is for sure much more costly to insure, so the insurance company may require more coverage than you currently have. If shopping for a new car, it is best to get in touch with the insurance company to find out how the purchase can affect your premium.
Pro-rated refunds for canceled policies:
If a policy is canceled before the billing period ends, you may receive a refund. Especially in the case of a quarter, semi-annual, or annual payments. Take great care in canceling auto insurance policy. Most states in the USA require some form of auto insurance to be active all the time. So make sure the new policy is effective as soon as the old policy is canceled in case of switching policies.
According to any insurance carrier, you might write the cancellation request to them. Once the request is processed, they will send any remaining premium refunds.
This is similar to pro-rate cancellation, but it involves a penalty for early cancellations. In short-rate, customers receive a lesser amount of refund. This is beneficial for the insurance company as it covers their administration costs and saves more money as they pay less for any loss.
The penalty amount is determined in several ways. Most policies charge a percentage of the unused premium balance. This means the total refund would be less than the unearned premium. As a result, the penalty would be higher if a policy is canceled.
Other policies provide a cancellation charge table listing out the penalty amount charged. It might depend on the number of days the policy was active. The longer the policy is active, the lesser the penalty. Insurance conditions should be thoroughly reviewed before signing an insurance policy.