Types of Insurance Companies

• Stock insurers are corporations owned by shareholders with the goal of earning profits for them.
• Shareholders elect the board of directors and share in profits and losses.
• The board of directors decides on dividends and appoints the CEO.
• Mutual insurers are owned by policyholders, not shareholders.
• Policyholders elect the board of directors and may receive dividends or rate reductions.

Advance Premium Mutuals

• These assess premiums in advance, maintain a stable rate for a period, and cover losses from surplus.
• They review premium adequacy and may increase premiums at renewal, returning excess surplus to members.

Assessment Mutuals

• These can assess policyholders for additional premiums to cover losses, but this structure is rare due to collection difficulties.

Fraternal Insurers

• These are non-profits owned by members, offering insurance as a primary benefit.

Fraternal Societies

• These have members with a common bond, organized into lodges, existing solely for the benefit of members.

Changing Corporate Structure of Mutual Insurers

• Mergers are on the rise.

Demutualization

• A mutually owned company becomes a public company issuing stock.
• It makes raising capital easier and provides flexibility for expansion.
• Stock options can be offered to attract employees.
• Tax advantages can arise for stock insurers.

Mutual Holding Companies

• A mutual insurer reorganizes as a holding company owning stock insurance companies.

Holding Companies

• These are financial organizations with a controlling interest in other companies.
• It's easier to raise new capital and enter new insurance areas, with stock options available to employees.
• Lloyd’s of London is a marketplace, not an insurer, where brokers and underwriters trade insurance.
• Insurance is written by syndicates, with members sharing profits and losses based on their shares.
• New members need limited liability status and must post a substantial underwriting deposit.
• Lloyd's is only licensed in a small number of jurisdictions.

Reciprocal Exchanges

• Individuals and businesses exchange insurance contracts, spreading risks among themselves.
• Each member insures the other and is insured by them, managed by an attorney-in-fact.

Blue Cross and Blue Shield Plans

• A national association of independent, community-based companies.
• Blue Cross covers hospital services, while Blue Shield covers physician fees.

Managed Care Plans

• These contract with healthcare providers to offer care at reduced costs.
• Providers make up the plan's network, focusing on cost control and case management.

Health Maintenance Organizations (HMOs)

• Offers care within a specific network of doctors and hospitals, requiring referrals to see specialists.

Preferred Provider Organizations (PPOs)

• Allows seeing out-of-network doctors, but usually at a higher cost, and specialists can be seen without referrals.

Point of Service (POS) Plans

• These combine HMO and PPO features.

Captive Insurers

• Self-insurance involves a company creating a subsidiary to insure itself.

Savings Bank Life Insurance

• Life insurance sold by mutual savings banks in certain states

Producers

• Intermediaries like agents and brokers sell most insurance policies.

Retailers

• Intermediaries who acts between carrier and insured.

Wholesalers

• Intermediaries who act between retail brokers and insurance carrier without direct contact with the insured
• Managing general agents, surplus lines brokers

Binders

• Temporary documents providing coverage evidence until the formal policy is received.

Agents

• Represent insurers, soliciting and negotiating policies on their behalf, but generally lack binding authority.

Brokers

• Represent clients, selling and negotiating insurance for compensation.
• They receive commissions but don't have binding authority.

Surplus Lines Brokers

• These procure insurance from non-licensed companies when coverage is unavailable from licensed insurers.
• They do not have authority to bind.

Surplus Lines

• Insurance for which there is no available market within the state.

Managing General Agents

• They have underwriting authority, unlike traditional agents.

Marketing Distribution Systems

• Methods for selling insurance products.

Personal Selling Systems

• Commissioned agents solicit and sell life insurance.

Multiple Line Exclusive Agency System

• Sells property, casualty, life, and health insurance policies.

Independent Property and Casualty Agents

• Sell products from various companies.

Financial Institution Distribution

• Distribution occurs through banks and other financial institutions.

Direct Response System

• Insurance is sold directly to consumers without face-to-face meetings, e.g., via TV or mail.

Property and Casualty Marketing

• Utilizes independent agencies, exclusive agencies, direct writers, direct response teams, and mass merchandising.

Direct Writer

• An insurance company employs its own sales force.

Direct Response Team

• Insurer's employees sell directly to the public by TV, phone, email, and internet.

Mass Merchandising

• Selling individual insurance to group members.

Multiple Distribution Systems

• Using more than one distribution system.

Ratemaking

• The process of determining insurance prices or rates.

Rate

• Price per unit of insurance to cover losses, expenses, and provide profit to the insurer.

Exposure Unit

• A measurement unit used in insurance pricing, varying by insurance line.

Premium

• The amount paid for an insurance policy and calculated as rate x exposure units

Actuaries

• Professionals who analyze statistics to calculate insurance risks and premiums.
• They use company data, advisory organizations, and other sources.

Underwriting

• The process of selecting, classifying, and pricing insurance applicants.

Basic Underwriting Principles

• Attain underwriting profit, reduce adverse selection, select insurers according to standards, and provide equity.

Agent as First Underwriter

• Field underwriting starts with the agent.

Underwriting Information Sources

• Application form, agent's report, inspection report, physical inspection/exam, and Medical Information Bureau (MIB) report.

Underwriting Decisions

• Accept, accept with restrictions, or reject the application.

Production

• The sales and marketing activities of insurers

Producers

• Intermediaries who sell most insurance policies today (agents and brokers).

Agency Department

• Life insurers have agency or sales departments and property/casualty insurers have marketing departments.

Special Agent

• A person tasked by an insurance agent to look for potential policyholders.

Professionalism in Selling

• Requires technical knowledge and prioritizing client needs.

Professional Designations

• Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC), Chartered Property Casualty Underwriter (CPCU), Certified Financial Planner (CFP), Certified Insurance Counselor (CIC)

Claims Settlement Objectives

• Verify coverage, pay claims fairly and promptly, and assist the insured.

Parties Involved

• Agents, staff claims representatives, independent adjusters, and public adjusters.

Agents

• Often have authority to settle small first-party claims.

Staff Claims Representative

• A salaried employee who investigates claims and arranges payment.

Independent Adjusters

• They adjust claims on behalf of insurers but aren't employees of the insurer.

Public Adjusters

• Represent the insured in negotiations with the insurance company and get paid a % of the settlement.

Steps in Claim Settlement

• Notice of loss, insurer investigation, proof of loss, and claim payment decision.

Proof of Loss

• A sworn statement detailing losses and the amount claimed.

Reinsurance

• Insurance purchased by an insurance company from another insurance company to reduce risk.

Ceding Company

• The insurer that transfers risk to another.

Reinsurer

• The company that provides financial protection to the insurance company.

Retention Limit

• The amount of risk retained by an insurance company after reinsurance.

Cession

• Portion of insurance transferred to a reinsurer by the ceding company.

Retrocession

• A reinsurer transfers risks to another reinsurer.

Reasons for Reinsurance

• Increase underwriting capacity, stabilize profits, reduce unearned premium reserve, provide protection against catastrophic loss, enable insurer to retire from a business, obtain underwriting advice.

Unearned Premium Reserve

• The portion of premiums not yet recognized as revenue.

Facultative Reinsurance

• Reinsurance agreement for a specific risk or policy on a case-by-case basis.

Treaty Reinsurance

• Primary insurer cedes all business in a category and reinsurer must accept it.

Quota-Share Treaty

• Insurer and reinsurer split premiums and losses by a fixed %.

Ceding Commission

• Paid by reinsurer to primary insurer for expenses.

Surplus Share Treaty

• Primary insurer retains a portion of the risk and transfers the rest to the reinsurer. Advantage: primary insurer’s underwriting capacity is increased

Excess of Loss Reinsurance

• Reinsurance indemnifies the ceding company for losses exceeding a specific limit to protect against catastrophic loss.

Reinsurance Pool

• Group of insurers and reinsurers who join their capacities to cover certain risks.

Investments

• Premiums are invested until needed to pay claims and expenses.
• Investment income reduces the cost of insurance.

Life Insurance Investments

• Long-term contracts with safety of principal being the primary consideration.

General Account

• Insurer deposits premiums for day-to-day operations, with investments mostly in bonds.

Special Account

• Assets are segregated from the general account.
• Investments are mostly in stock.

Property and Casualty Insurance Investments

• Short-term contracts where liquidity is very important.

Information Systems

• Speeds up processing of information and eliminates routine tasks.

Financial Statements

1. Balance Sheet (B/S)
2. Income Statement (I/S)
3. Statement of Cash Flows (C/F)
4. Statement of Owner's Equity (O/E)

Balance Sheet

• Shows a company's financial condition (Assets, Liabilities, Owner's Equity) at a specific date.
• Accounting Equation: Assets = Liabilities + Owner's Equity.

Assets

• Owned resources expected to benefit future operations.
• Financial assets are primary, and property/casualty companies prioritize investment liquidity.

Liabilities

• Debts or legal obligations.
• Reserves are established to ensure premiums collected in advance will be available to pay for future losses.

Types of Reserves

• Loss reserves, unearned premiums reserve, and loss adjustment reserve.

Loss Reserves

• Estimates of total future payments needed to settle claims on past accidents.
• Includes: claims reported/adjusted but not paid, claims reported/filed but not paid, and claims for losses incurred but not reported.

Types of Loss Reserves

• Case reserves, reserves based on the loss ratio, and for incurred but not reported claims.

Case Reserve

• Estimate of the ultimate settlement amount for a specific claim.

Judgment Method

• Amount based on judgment in claims department or a computer program.

Average Value Method

• An average value is assigned to each claim.

Tabular Method

• Uses a mortality table to indicate the reserve that applies to the rating of specific insures, amount is based on life expectancy, duration of disability for example

Reserve Based on Loss Ratio Method

• Aggregate loss reserves for a specific coverage line.
• Loss Reserve Amount = (Expected Loss Ratio X Premiums Earned) – (Loss & Loss-Adjustment Expenses Paid to Date)

Incurred-But-Not-Reported (IBNR) Reserve

• Estimated liability for claims that have occurred but haven't been reported yet.

Unearned Premium Reserves

• Amount of unexpired premiums on policies as of a specific date.
• Reasons for unearned premium reserve amount: To pay losses, to pay premium refunds, Serves as a basis for determining amount that must be paid to reinsurer

Loss Adjustment Expense Reserve

• Used to account for costs associated with settling claims.

Policyholders’ Surplus

• Represents paid-in capital plus retained earnings.
• Helps determine how much new insurance a company can write.
• Calculation: Assets - Liabilities = Policyholders’ Surplus.

Income and Expense Statement

• Shows profit or loss for a period.
• Calculation: Revenues - Expenses = Net Income.

Principal Revenue Sources

• Premiums and investments.
• Revenues are recognized when earned (when services are rendered).

Expenses

• Cost of adjusting claims, paying insured losses, agent commissions, and underwriting expenses.
• Loss Ratio = (Incurred Losses + Loss Adjustment Expenses) / Premiums Earned
• Expense Ratio = Underwriting Expenses / Premium Written

Combined Ratio

• A measure of underwriting profitability.
• Combined Ratio = Loss Ratio + Expense Ratio
• An underwriting profit occurs if the combined ratio is <100%.
• Underwriting loss occurs if the combined ratio >100%.
• Investment Income Ratio = Net Investment Income / Earned Premiums.
• Overall Operating Ratio = Combined Ratio - Investment Income Ratio.

Assets

• Primarily financial assets.
• General account assets are invested in bonds.
• Special account assets are invested in stocks.

Matching Principle

• Matching of maturities of sources and uses of funds.
• Life insurance investments have a longer duration than property and casualty insurance investments.
• State laws limit life insurance company investments to protect policyholders.

Policy Loans

• Loans policyholders obtain from their insurance company using the cash value of their life insurance policy as collateral.

Liabilities

• Policy reserve (loss reserves) is the major liability of life insurance companies, which Represent an obligation of insurer to pay future policy benefits
• Is difference between present value of future benefits & the present value of future net premiums, Must be offset by assets of an equal amount, State law specifies the minimum required amount

Reserve for Amounts Held on Deposit

• Represents funds owed to policyholders and beneficiaries.

Asset Valuation Reserve (AVR)

• Designed to absorb asset value fluctuations not caused by changing interest rates.
• Helps smooth a company’s reported surplus over time.

Income and Expense Statement

• Benefit payment is a life insurer's major expense.
• Calculation: Revenues – Expenses - Policyholder Dividends - Federal Income Taxes = Net Gain from Operations.

Major Expense Categories

• Benefits paid, claims expenses, underwriting expenses, commissions, premium taxes, and general insurance expenses.

Regulatory Objectives

• The goal is to protect the public.
• Rates must be adequate, must not be excessive, and must not be unfairly discriminatory.

Business Objectives

• Simplicity as the rating system should be easy to understand
• Responsiveness to changing loss exposures and economic conditions
• Stability over the short term
• Encouragement of loss control activities.

Ratemaking Definitions

• Rate per unit of exposure
• Pure premium - Portion of rate needed to pay losses and loss-adjustment expenses
• Loading element - Additional amount added to pure premium to cover other expenses, profit
• Gross Rate = Pure Premium + Loading Element
• Gross Premium = (Gross Rate) X (# of Exposure Units).

Judgment Rating

• Each exposure is individually evaluated, and rates are determined largely by the underwriter's judgment.
• Used where loss exposures are diverse or loss statistics aren't available.

Class (Manual) Rating

• Exposures are grouped into underwriting classes and charged the same rate, and Charges reflect the average loss experience for that class.
• Pure Premium = (Incurred Losses + Loss Adjustment Expenses) / # of Exposure Units
• Gross Rate = Pure Premium / [1 − (Expense Ratio)]

Loss Ratio Method

• Actual loss ratio compared to the estimated ratio & the rate is adjusted accordingly Rate Change = (𝑨𝒄𝒕𝒖𝒂𝒍 𝑳𝒐𝒔𝒔 𝑹𝒂𝒕𝒊𝒐) − (𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑳𝒐𝒔𝒔 𝑹𝒂𝒕𝒊𝒐) / 𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑳𝒐𝒔𝒔 𝑹𝒂𝒕𝒊𝒐

Schedule Rating

• Modifies manual rates with debits or credits to reflect individual risk characteristics.
• Factors to consider: Construction, Occupancy, Protection, Exposure, Maintenance

Experience Rating

• Class or manual rate is adjusted based on past loss experience.

Retrospective Rating

• Final premium is based on the insured's actual loss experience during the current policy term.

Life Insurance Ratemaking

• Use mortality tables or company experience to determine the probability of death at each attained age.
• Expected Value of Death Benefits = (Probability of Death) X (Death Benefit Amount)
• Present value of annual expected value amounts are used to determine the net single premium.

Reasons for Insurance Regulation

• Maintain insurance solvency (if insurance becomes insolvent, future claims will not be paid, policy holders are exposed to financial insecurity if insurers become insolvent)
• Compensate for inadequate consumer knowledge, ensure reasonable rates, make insurance available to all.

Early Regulatory Efforts

• Insurance regulation began when state legislatures granted charters to insurers

Paul v. Virginia

• Affirmed the right of states to regulate insurance.

U.S. v. South-Eastern Underwriters Association

• Supreme Court ruled that insurance was interstate commerce and, therefore, was subject to federal regulation, overturned the Paul v. Virginia case.

McCarran-Ferguson Act

• Formally protected states' rights to regulate insurance, limiting federal regulation.

Financial Modernization Act of 1999

• Changed federal law and earlier protected banks, insurers, investment companies from competing outside core area, both state and federal authorities are now involved in insurance regulation.

Dodd-Frank Wall Street Reform and Consumer Protection Act

• Make the US financial system safer for consumers and taxpayers, created the Financial Stability Oversight Council (FSOC), created to treat systematic risk and identify nonbank financial companies and insurance companies that could increase risk of collapse of the entire financial system, created Federal Insurance Office(FIO): authority to preempt state law in areas where state law conflicts with negotiated international agreements

FIO Authority

• Monitor all aspects of insurance industry, identify gaps in insurance regulation and identify issues that contribute to systemic risk, assist FSOC in identifying insurers that contribute to risk, represent federal government in international discussion dealing with insurance, negotiate international agreements with foreign countries [pertaining to insurance regulation

Legislation

• All states have insurance laws.

Courts

• Determine the constitutionality of state insurance laws.

State Insurance Departments

• Commissioners have power over insurers doing business in their states.

Formation and Licensing of Insurers

• Insurers must have a state license and meet minimum capital and surplus requirements.

Domestic Insurer

• Domiciled in the state in which the policy is written.

Domicile

• means the state in which an insurer is incorporated, charted, or organized

Foreign Insurer

• Domiciled in the US but outside the state in which the insurance is to be written.

Alien Insurer

• Incorporated under the laws of a foreign country but licensed to do business in this state.

Statutory Accounting Principles

• Accounting regulation set by National Association of Insurance Commissioners (NAIC) for preparation of insurance firms financial statements

Solvency Regulation

• Assets must be sufficient to offset liabilities.

Admitted Assets

• Assets that can used in a company financial statement, must be liquid and hold measureable value

Non-Admitted Assets

• Difficult to sell, not easily converted to cash or are not permitted by state insurance department

Reserves

• Estimated amounts assigned by an insurer to account for total possible future claims, liabilities, obligations that must be met in the future.

Surplus

• The difference between insurer’s assets and liabilities, represent insures net worth under statutory accounting principals.
• Amount new insurance that can be written is limited by amount of policyholder surplus.

Risk Based Capital (RBC) Requirements

• Method to determine the capital requirement for an insurance company to support its operation and write coverage.
• Statutory minimum level of capital based on 2 factors: company size, inherent riskiness of financial assets.

Four Major Categories of Risk to Arrive at Overall RBC

1. Asset Risk: Risk of default or decrease in the calls of the assets insurers hold in portfolio, examples, bonds, stocks, mortgages
2. Insurance Risk: Risk associated with mispricing of products, example under estimating loss reserves
3. Interest Risk: The risk caused by possible changes in the interest rate levels during investment period
4. Business Risk: The risk caused by possible changes in the interest rate levels during investment period

RBC Methodology was Developed to Provide:

• a capital adequacy standard that is related to risk, a safety net for insurers, uniformity among all of the states, regulatory authority for timely intervention.

Investments

• Purpose of regulating insurance company investments is to prevent insures from making unsound investments which could threaten their solvency

Life Insurance Accounts

• general account assets, special account assets

General Account Assets

• State laws place restrictions on type of assets in the general account, most investments are bonds.

Special Account Assets

• State laws place fewer restrictions on investment in the special account, most investments are stocks, used to fund liabilities for investment-risk products such as variable annuities and private pension benefits

Dividend Policy

• life insurance profits can be distributed as dividends or retained and added to surplus, many states limit the amount of surplus life insurer may accumulate.

Reports and Examinations

• Each insurer must file an annual report with the state insurance department.

Liquidation of Insurers

• State assumed control of insurer if insurer is financially impaired, guaranty funds, guaranty laws, and guaranty associations, assessment method (other solvent insurers are assesses to help pay claims on insolvent insurers)

Prior-Approval Laws

• Rates must be approved before use.

Modified Prior-Approval Law

• Must obtain pre-approval for rate changes from insurers loss experience.

File-And-Use

• Rates can be used immediately after filing.

Use-And-File

• Rates used immediately but must be filed within a period.

Flex-Rate

• Approval needed for rates that exceed a specified percentage.

State Made Rates

• The state determines rates, some states set rates for title insurance

No Filing Requirement

• Rates do not need to be filled or approved in advanced.

Life Insurance Rates

• Are not regulated by the state.

Policy Forms

• State commissioner approves new policy forms to protect the public from deceptive provisions.

Sales Practices and Consumer Protection

• Licensing of agents, all states required agents to be licensed

Discipline

• State insurance departments have authority to: levy fines, suspend license, revoke license.

Unfair Trade Practices

• Misrepresentation, twisting, rebating, deceptive advertising, inequitable claim settlement, unfair discrimination.

Twisting

• Inducing a policyholder to drop a policy and take out a new one that is not in policyholders best interst.

Rebating

• Inducement of money to a policyholder to give the incentive to make a sale.

Taxation of Insurers

• Insurers pay local, state, and federal taxes.

State Premium Tax

• Sales taxes assessed on insurance premiums charged for polices issued in that state, provide revenue for state.

Retaliatory Tax Laws

• Promote interstate business by deterring discriminatory taxes.

Claimed Advantages of Federal Regulation

• Provide uniformity in regulations, more effective negotiation of internal insurance agreements, more effective identification and treatment of systematic risk, greater efficiency of insurance.

Claimed Advantages of State Regulation

• Quicker response to local insurance problems, federal regulation could lead to dual system of insurance regulation & increase cost, poor quality of federal regulations, reasonable uniformity can be achieved by model laws of the NAIC, greater opportunity for innovation, unknown consequences of federal regulation.

Alleged Shortcoming of State Regulation

• Inadequate protection of consumers, improvements needed in handling complaints, inadequate market conduct examinations, insurance availability, regulators overly responsive to the insurance industry.

Repeal of McCarran-Ferguson Act

Argument for Repeal

• Insurance industry no longer needs broad antitrust exemptions, federal regulation needed because of defects in state regulation.

Arguments Against Repeal

• insurance industry is already competitive, small insurers may be harmed, insurers may be prevented from developing common coverage forms.

Important Regulatory Issues

• modernizing insurance regulation, insolvency of insurers, market conduct regulation.

Solvency

• Ability to meet long term financial obligations.

Reasons for Insolvency

• inadequate reserves for claims, inadequate rates, rapid growth and inadequate surplus, mismanagement and fraud, bad investments, problems with affiliates, overstatement of assets, catastrophe losses, failure of insurer to pay claims.

Solvency Modernization Initiative (SMI)

• Critical self-examination of US insurance solvency regulation, addressing capital requirements, risk management, corporation governance, group supervision, reinsurance, statutory accounting and financial reporting.

Methods of Ensuring Solvency

• Minimum capital and surplus requirements, risk based capital standards, legal reserve requirements, restrictions of types of investments, review of annual financial statement by regulatory officials, field examinations (periodic review of insurers, every 3-5 years), early warning system (insurance regulatory info system), Financial analysis solvency tracking (FAST) system.
• Fast scores indicate insurers considered a priority for additional regulatory action.

Market Conduct

• Marketing practices of insurer and agents involving interaction with insurers, claimants, or consumers.

Practices

• sales of insurance policies, advertising of insurance products, underwriting and rating, collection of premiums, policy renewals and termination, policy changes, claims settlement.

Areas of Concern

• Sale of unsuitable insurance products, misrepresentation of coverage, excessive sale pressure, excessive rates, discriminatory rates, denial of legitimate claims, improper termination of policies.

Insurance Score

• Rating used by insurance companies that represents the probability of a client filling an insurance claim while covered.