Insurance in Financial Services

Learning Agenda

• The chapter examines insurers' roles in the financial services sector, different types of insurers, and marketing systems.
• Key organizational structures in insurance, including stock and mutual insurers, are studied.
• After the Financial Modernization Act of 1999, insurance firms offer more investment products like mutual funds and private pension plans; however, insurance remains the core business.

The Financial Services Sector

• The financial services sector includes diverse industries with specialized financial institutions.
• Banking encompasses commercial banks, savings and loan institutions, and credit unions.
• Investment includes mutual funds, securities brokers, and private/state pension funds.
• Insurance includes life and health insurers, as well as property and casualty insurers.
• Government-related financial institutions and finance companies are also part of the sector.
• The financial services sector is heavily regulated due to its essential role in the national economy.
• Insurance is regulated at the state government level, unlike other industries that are federally regulated.
• U.S. state insurance departments regulate insurance
• The Federal Reserve Bank regulates US banking.
• The Securities Exchange Commission (SEC) regulates US investment.
• The Financial Stability Oversight Council (FSOC) regulates US overall financial stability.

Global Insurance Market (Premiums)

• Data includes health insurance premiums, accounting for 49% of the $4.3 trillion total global premiums.
• Largest lines in property-casualty include automobile and property insurance.

US Insurance Market (Premiums)

• The US property-casualty market is larger than the life-annuity market.
• Health insurance premiums are excluded from the data.
• Largest lines within US property-casualty remain automobile and property insurance.
• Measured as of 2023.

US Insurance Market Profitability

• Government regulation aims to promote sustainable industry growth.
• Bankruptcy is infrequent in the insurance sector as a result of such regulation.
• The property-casualty market's premiums amounted to $857.8 billion in 2023, with a net income of $87.1 billion.
• Factoring in investment income, the industry made 7% income, below the Fortune 500 average.
• The industry is designed for long-term income stability, critical to supporting the national economy.
• Property/Casualty industry generates about 9% of the U.S. Gross Domestic Product (GDP).

Insurers Classified by Organizational Form

• Private insurance companies are classified as:
  • Stock insurers
  • Mutual insurers
  • Reciprocal exchanges
  • Lloyd's of London
  • Blue Cross and Blue Shield (BS/BC) Plans
  • Health maintenance organizations (HMOs)
  • Other types of private insurers

Stock Companies

• A stock company is also known as a joint-stock company.
• Stock insurance companies are owned by shareholders.
• The objective is profit through increasing stock value and dividends.
• Shareholders bear losses related to their share ownership.
• Stock insurers sell insurance to policyholders aka insureds.
• Unlike mutual, stock insurers cannot issue assessable policies.

Mutual Societies and Entities

• Mutual operations refer to organizations created and operated by their members.
• Mutuals are owned by members sharing a common interest.
• Mutuals are designed as not-for-profit
• Exceptions to this exist
• If there is a surplus, the mutual distributes it to its members
• It may hold it to support future operations

Mutual Insurance Company

• Mutual insurance operations involve a group sharing similar risks, creating an entity, and sharing exposures and losses.
• the mutual can evolve into a mutual fire insurance company.
• Mutual insurers lack shareholders; policyholders are the owners.
• Policyholders may receive dividends or rate reductions like policyholder's dividend.
• All companies collect premiums in advance, including stock and mutual companies.

Mutual Insurance Company Types

• Advanced premium mutuals are owned by policyholders and do not issue assessable policies.
• Assessment mutuals can assess policyholders for extra amounts if loss, investment, or expense experiences are unfavorable.
• However, the policyholders still own it.
• Assessment means assessing members of the entity their share of losses
• Sharing means an "additional premium" that an assessment mutual insurance company charges insureds when the insurance pool suffers a loss at the end of the operating year.
• The insurer must declare it, and its insureds must acknowledge it when the policy is an assessable insurance policy.
• Only selected mutual insurers may issue such policies.
• Stock insurers do not issue assessable policies.
• A mutual company must attract new policyholders to grow.
• The mutual must increase its capital (so-called owner's equity in the balance sheet).

Mutual Insurance Company – Demutualization

• Demutualization "legally converting it" as a stock company for a mutual.
• It is comparatively easy for the stock insurer to raise additional capital.
• The stock insurer has greater flexibility to expand by acquiring new companies or diversifying.
• the mutual insurer's ability is likely limited.
• Conversion to a stock insurer may provide some tax advantages.
• Some mutuals have completed a demutualization process to become a stock insurance company.

Changing Corporate Structure of Mutual Insurers

• The corporate structure of mutual insurers has changed over time.
• The following trends are noted:
• There is an increased number of company mergers.
• Demutualization means that a mutual insurer is converted into a stock insurer.
• Stock insurers have greater flexibility to expand by acquiring new companies or by diversification.
• Stock options can be offered to attract and retain key executives and employees.
• Conversion to a stock insurer may provide tax advantages.
• As an alternative, many states have enacted legislation that allows a mutual insurer to form a mutual holding company A mutual holding company is where a mutual insurer is reorganized as a holding company that owns or acquires control of stock insurance companies that can issue common stock. The mutual holding company must own at least 51 percent of the subsidiary stock insurer if the latter issues common stock.

Insurance Market Places: Lloyd's of London

• Lloyd's of London is well-known even outside insurance.
• Lloyd's coffee shop was not an insurance company but a marketplace for insurance coverage contracts.
• The entity that manages the marketplace is Lloyd's Corporation.
• Lloyd's had commonly jointly covered the:
• San Francisco Earthquake (1906)
• The Titanic (1912)
• 2005 Hurricane Katrina
• The World Trade Center (2001)
• It is not an insurer but a marketplace where underwriting companies (Lloyd's syndicates) meet intermediaries (Lloyd's coverholders).
• It is the oldest insurance marketplace, founded in c.1686.
• Members include major insurance companies and high net-worth individuals.
• The U.K. government also regulates members as they are technically insurance companies in the country.

HMO vs. PPO

• With an HMO, you choose a primary care physician (PCP) who coordinates your care through in-network doctors and hospitals but have no option to see out-of-network providers.
• Broad health care services are provided for a fixed prepaid fee.
• Cost control is emphasized
• Choice of health care providers maybe restricted
• Less costly forms of treatment are often provided
• If you want the option to manage your own care without referrals, then a Preferred Provider Organization (PPO) may be right for you.
• With a PPO, members can receive care from any provider, either in or out-of-network, without a referral.
• Under the typical PPS, the deductible and patient copay are (very) high for out-of-network.

Blue Cross and Blue Shield Plans

• BC/BS plans were initially nonprofit, community-oriented prepayment plans that provided hospital/services coverage.
• Today, most plans have merged into single BCBS entities.
• Many BCBS plans voluntarily have converted to a for-profit status to gain access to additional capital and becoming more competitive.
• Review the advantages and disadvantages of buying each of the following types of health insurance providers:
• Traditional commercial health insurance companies
• Blue Cross/Blue Shield (BCBS)
• Managed care plans

Agents and Brokers

• Licensed insurance companies can underwrite risks
• Intermediaries such as (agencies and brokers) are not licensed to underwrite risks
• Intermediaries facilitate insurance contracts between insureds (risk holders) and insurers (risk underwriters).

How Insurers Distribute Their Products

• Some insurance companies sell their products directly (known as direct writers).
• Other companies distribute through agents (representing the insurer(s)).
• Large corporations may hire brokers (representing those corporate clients) to survey risks and facilitate coverage.

Insurance Agents (Authorities)

• An agent is someone legally representing the principal, with the authority to act on their behalf.
• The principal represented is the insurance company.
• Authorities include
• Express (Expressed) authority (clearly known as it is written in the agency contract)
• Implied authority (not written but what is expected as "reasonable” for the agency to perform the duty in line with the expressly given authority)
• Apparent authority (what the public would “reasonably” believe what the agency has)
• A legal term A binder provides temporary insurance until the policy is actually underwritten.
• A life insurance agent normally does not have the authority to bind the insurer
• The applicant for life insurance must be approved by the insurer.
• Some agencies are so big and operate in a region (several states) and represent several insurance companies simultaneously.
• They are often known as independent agencies, wholesale agencies, or managing general agencies.

Brokers

• In contrast to an agent who represents the insurer, a broker is someone who legally represents the insured.
• A broker receives a commission from the insurer.
• Brokers solicit applications and attempt to place coverage with one or more insurers
• Brokers commonly work as a middle man in situations of:
• Commercial lines rather than personal lines
• Group insurance rather than individual insurance
• Property/casualty lines rather than life insurance lines

Top 10 Global Insurance Brokers

• Some well-known brokerage firms employ 10-20,000+ people, operating in over 100 countries.
• They are like insurance companies but cannot underwrite risks by law.