Insurance Concepts PDF

IKAT Version 1 For US Division GGB (US, AUS, CAN), GB (US), RPS, ARTEX, Lead Enrichment, Support  Contents Assignment1Understanding 01 Insurance Benefitsand Costsof InsuranceMajor RolesofInsuranceCo...

IKAT Version 1 For US Division GGB (US, AUS, CAN), GB (US), RPS, ARTEX, Lead Enrichment, Support  Contents Assignment1Understanding 01 Insurance Benefitsand Costsof InsuranceMajor RolesofInsuranceCommon Types 02 of Personal and Commercial Insurance 09 Types of PrivateInsurers Government 13 17 InsurancePrograms Overview of 21 InsuranceFunctions Summary 25 Assignment 2Insurance Regulation 27 WhyInsuranceOperations AreRegulated 28 Insurer Licensing 29 Insurance Rateand Form RegulationMarket 33 ConductandSolvencyRegulation Summary 35 41 Assignment3 InsurerFinancialPerformance Understanding 43 InsurerFinancial Statements AnalyzingInsurer 49 FinancialRatioCalculation 53 KnowledgetoAction:Financial Ratiosand InsurerFinancialPerformance case 59 Summary 63  Assignment4 Marketing 64 Understanding Factors That InfluenceanAgencyRelationship 65 Summarizing Types of InsuranceDistributionSystems Functions of 69 Insurance Producers 75 79 Selecting InsuranceMarketing Distribution Systems and Channels 84 Summary Assignment5 86 UnderwritingandRate-making 87 Underwriting Activities The 90 Underwriting Process 96 UnderwritingManagement 99 Rate-making 102 PremiumDetermination 107 Summary 108 Assignment6 Claims 109 Goals of the Claims Function 111 Claims DepartmentStructure,Personnel,and PerformanceThe 116 123 Claims Handling Process 13 Aspects of Property Insurance Claims 0 Aspects of Liability Insurance Claims 13 Good-Faith ClaimsHandling 3 Summary 13 7 Assignment 7Risk 139 Management 140 Basic Purposeand Scope of Risk Management Identifying and Analyzing Loss Exposures 141 Examining the Feasibility of Risk Management Techniques Selecting, 148 Implementing,and Monitoring RiskManagementTechniques. 153 Benefitsof Risk Management 160 Applying theRisk ManagementProcess Summary 163 Assignment8 166 LossExposures 168 169 175 183 188 193 197 202  Assignment9 204 InsurancePolicies 206 Elements of a Contract 209 DistinguishingCharacteristics of InsurancePolicies 214 InsurancePolicy Structure 218 Policy Provisions Property 224 PolicyProvisions Liability 231 Policy Provisions Summary 239  tions, andsociety. :, insurance. liability insurance. Distinguishamongthefollowinginsurancefunctions: Marketing Underwriting Claims control audit 1  ing measuresinvolvetheuseofinsurancetosomedegree.Whenpotential andcostsof insuranceshouldalsobecarefullyconsidered. legal requirements.Butbeyondthat,insuranceprovidesseveralbenefitsto loss control activities, providing insurers with a source of investment funds, andreducing socialburdensbyhelpinginsuredsrecoverafteraloss.There losses. aftera loss,isoftenconsidereditsmainpurpose.Providedthatthelossisto benefits thatinsuranceprofessionalsshouldbeawareof. Insurancealsoenablesanindividualororganizationtomanagecashflow uncertainty.Theinsuredcanbeconfidentthataslongasalossiscovered,the financialeffectontheinsured'scashflowwillbereducedtoanydeductible paymentsoranylossamountsthatexceedthepolicylimits.Theremainderof flows. Insurance also helps an insured meet legal requirements that might apply, whether for personal or commercial insurance customers. For example, all I i/ 2  formof datathatcanbeusedtopreventorlimitlossesbeforetheyhappen. pensation Forinstance,withagrowingnumberofdevicesconnectedtothe Internetof insurancetomeet Things,itispossibletouseinformationgatheredtomonitoraninsureddevice's thisfinancial maintenanceneeds.Ifamanufacturer'smostimportantpieceof obligation.An exampleofalegal thesituation progressestoaninsuredloss. Anotherexampleistheuseoftelematicsinpersonalautos.Byproviding of insureds.Riskcontrolmeasurescansavenotonlyfinancialresourcesbutalso lives.Therefore,societyasawholebenefits. ownordrivean automobile. makesit unnecessarytosetasidealargeamountofmoneytopayforthe Insurancecan oftenbeusedor requiredtosatisfy bothstatutoryand tocontributetothe con, growthofanorganization. to provideevidence ofliability insurancebefore aconstruction contractis 3 granted. effectiverisk control measures. Thisincentive usuallytakesthe  by aninsuredevent. insteadbeinvestedinbonds,thestock market,ordevelopmentprojects. Similarly,insurerscaninvestthefundsthattheycollectinpremiumsuntiltheyare neededtopayinsureds'claims.Theseinvestmentscanprovidemoneyforprojects suchasnewconstruction,research,andtechnology Finally, insurancecanhelpreducesocialburdens.Forexample,thesocial medicalcareorwhomightbeunabletoworkbecauseoftheaccident. large, italsocomeswithsomecosts,includingthese, costs suffersa coveredlossandthesubsequentclaimispaid.But,asnotedprevi- financialgainscanbe usedtomitigatesomeofthiscostforinsureds. The operating costs incurred by insurers, unfortunately, cannot be reduced as 4 equipment,taxes,licensingfees,andsoforth. ductive contributionstosociety.Forinsureds,thefundstheyusecopaytheir premiumsto helpcoverthecostsofthosewhodefraudinsurers). pany's investmentintheeventthehomeisdamagedordestroyed. What exactlyisinsurance? four majorroles: abusiness acontract 5 expense,butitsfinancialimpactisrelativelyminor.Andbecauseitisa muchasa newtire. constructionworkers toreducethefrequencyofinjuries)andlossreductionmeasures(suchasthe placementoffireextinguishersinthehomeorwork-placetoreducetheseverityof firelosses). friends- soowningandoperatingamotorvehiclemakessenseforhim. damagethatmightresultfromhisnegligentoperationoftheautomobile loss exposures,anditisnotpracticaltoavoidthem. commercialinsurancecustomers. an insured'shistoryandneeds.Theycanthenrecommendcoverages,aswellasrisk controlandlosspreventiontechniques,thatcouldmaketherecom- thepolicy premium,buthelpstheinsurerkeepclaimscostsdown. Insuranceenablesaperson,afamily,oranorganizationtotransferthecosts 6  and sharingthecosrsoflosses. funds topayinsuredswhoincurcoveredlosses.Thetotalcostoflossesistherebyspread (orshared)amongallinsureds. Insurersdeterminethetotalamountofpremiumstheymustcollectfrom ence andthelawoflargenumbers.Becauseinsurershavelargenumbers combinedarelikelytoexperience. consequencesofdeath,injury,andsickness. of businessintheUnitedStates.Despitetheirsizeandnumber,however,pri-vate insurersdonotfilleveryinsuranceneed.Insomeinstances,federalandstate governmentssteplntomeetthepropertyandliabilityinsuranceneedsofthe public. insurancedepartments,requiringprivateinsurerstobelicensed(formosttypesof insurance)inthestateswheretheysellinsurance.Becauseregula-tionof licensedinsurersencompassesallinsureroperations,state insurance stateregulations, regulatorscanrevokeitslicense. must,inthe longrun,matchorexceedtheamount itpaysforclaimsand Theprimarysourcesofrevenueforinsurersarepremiumsandtheincome 7 Aninsurancepolicyisacontractbetweentheinsurerandtheinsuredwherethe insuredtransfersthepossiblecostsofcoveredlossestotheinsurer.In insurancepoliciesgiveslegalforce andprotectiontotherightsandresponsi-bilitiesofalloftheparties. insurance policieshavecertainspecialcharacteristics, includingthese: the insuredandtheinsurer,areexpectedtobeethicalintheirdealingswith eachother. Anabligafontoactin Acontractofadhesion-Becausetheinsurerwroteorchosethepolicy courtwill generallyapplytheintetpretatlonthatfavorstheinsured. Contractofadhesion Anycontractinwhichone Acontractofindemnity-Insurancedoesnotnecessarilypaythefull the samefinancialpcsition,buttheamounttheinsurerpaysisdirectly otherpartyorrejectit. toprofitfrom theloss. Acontractinwhichthe amountdirectlyrelatedto Setvices theamountoftheloss. Office,Inc.(ISO)PersonalAutoPolicy.Modularpolicies,mean- example,are modularpolicies. » 8 9  It alsohelpstopayexpensesrelatedtoaninsured'sdeath. insurancethatreplacesaninsured's incomeiftheinsuredisunabletowork becauseofillnessorinjury. the exhibit"CommonTypesofPersonal Insurance." alsand families.Thepropertycoverageprotectsaninsured'shomeanditscontentsfor damagecausedbyfire,wind,andothercausesofloss.Most coveragefor allegationsofnegligence. A personalautopolicy(PAP)coversliabilitylossesoccurringfrombodily resulting fromacollision,whileOtherThanCollisioncoveragecoversthe Thepersonalliabilitycoverageinthehomeownerspolicyandtheauto ► 10  umbrella policyrangefrom$1millionto$2million,buthigherlimitsareavailableif necessary. Themainpurposeoflifeinsuranceistoreplacetheincome,earningpoten- termlife insurance,whichlastsforadefinedperiodoftimeanddoesnot tionanddoesaccrue cashvalueovertime. home healthcare. mercial insurancepolicies.Seetheexhibit"CommonTypesofCommercial lnsurance.11 11 property,crime,andliabilitycoverages.Inthepast,abusinessownerwould ofthe necessarycoverages. to defend the insured are also included, up to the policy limits. Auto physi- theft, orcollisionwithananimal. Commercialpropertyinsurancecoversdamagetobuildingsand/ortheir generallylimitedtopropertylocatedonorneartheinsured's premises. Oceanmarineinsurancecoversshipsandtheircargoagainstlosseslikefire, lighming,and"perilsofthesea."Mostcargothattravelsbywaterisinsuredas "oceanmarine"or"wetmarine."Cargotransportedbylandistypically commercialenterprises.Thiscoverageprotectsgoodsindomestictransitand propertyusedintransportationandcommunication,aswellaspropertyusedonjob sites,suchasbackhoesandothermobileequipment. Commercialcrimeinsuranceprotectstheinsuredagainsttheftofjob-sitecon- tents,suchascashregisters,computers,andinventory.Italsoinsuresmoneythat mightbestoleninarobberyduringbusinesshoursorinaburglarythat byemployees. Commercialgeneral liability(CGL)insuranceoffersbroadprotectionagainst claimsallegingthattheinsuredislegallyliableforbodilyinjuryor bleifacustomer fallsonthe.store'swetfloorandisinjured. ifacustomerisinjuredbyaproduct thestoresold,theCGLpolicymightcoverdefensecostsaspartofthestore's legalliability.Evenifasuitisgroundless,theCGLpolicyoffersprotectionand peaceofmindtothebusinessowner. neys,orconsultantsforhannresultingfromerrorsoromissionsarisingoutoftheir professionalpractices.Italsocoversdoctors,professionaltrainers,andother healthcareprofessionals,suchasphysicaltherapists, forinjurytotheircustomers orpatientsthatresultsfromtheirerrorsoromissions. environmentaldamagethatmayoccurasaresultofbusinessoperations.It 12  cover mostpollution-relatedclaims. commercialauto,and other policiesandprotectstheinsuredintheeventof umbrellapolicy. Workerscompensationinsurancepaysthecostofmedicalcare,lost wages,andotherstate-mandatedbenefitswhenemployeesareinjuredonthejob or bylawtopaycertainbenefitstoinjuredorillemployees,thesebenefits employer. provide incorrectadvicethatcausesfinancialinjurytoacustomer? their professionalpractices. their fonnofownership.Proprietaryinsurersarefannedtoearnaprofitfor 13 ferencesandsimilaritiesamongthese: Stockinsuters insurers insurers companies insurer toits stockholders. Thesecompanieshavebeenabletoattractandretain as stockholdersbytheexpectationofinvestmentreturns.Thestockformof acorporationforthe forthestockholders. stock. Stockholdershavetherighttoelectaboardofdirectors, whichhasthe activities. insurer Aninsurerthatisownedby itspolicyholdersand policyholdersofamutualinsurerhavetherighttoelectaboardofdirectorsthat performsthesamefunctionsastheboardofdirectorsofastock insurer. thepurposeofproviding insurancetothem. called demutualization. Somemutualinsurershavetherighttochargeinsuredsanassessment,or might bemadeaftertheinsurerhasenduredaseriesoflossesfromacata-strophicevent, suchasahurricane.Theseinsurersareknownasassessmentmutualinsurance companies,andtheyarelesscommonthaninthepast. is bothaninsuredandaninsurer.Becausearedprocal's members,calledsub- 14  an attorney-in-fact.Anagreement(knownasasubscriptionagreement)authorizes theattorney-in-fact toactonbehalfofthesubscriberstomarket asmallpercentageof theinsurancecompaniesintheU.S.,buttheyincludesomemajornationaland internationalinsurers.Smallregionalreciprocalsalsooperateonastate-by-state basis. Lloyd's (formerlyLloyd's ofLondon)isaninsuranceandreinsurancemar- groupedinsyndicates, unincorporatedassociation.MembersofLloyd'sareinvestorsthathopeto whoarerepresentadby underwriterstowrite of insurance,suchasinsuringthelegsofafamousathleteagainst injury. the surpluslinesmarket.Lloyd's isalsoareinsurerintheU.S.1 tumto surpluslinesinsurers. Surpluslinesinsuranceconsistsofinsurance is eligibletoinsurerisks lineslaw. insurerwouldcharge. Producers andconsumersoftentumtothesurpluslinesmarketwhenthey ersmay takelongertoanalyzetheneedforneworrevisedcoverage,andtofilepolicyforms andratesforstateapproval. insurer Aninsurernotauthorized lines bythestateinsurance insurance iswrittenby nonadmitted insurers. Nonadmittedinsur- withinthatstate. 15 16  Stockinsurer insurer than stockholders. tornadoescommonlyoccurcanusereinsurancetoreduceitsexposureto windstormlosses. Reinsurancealsoenablesasmall insurertoprovideinsuranceforlarge losses forthisinsuredoveracertainamount,suchas$1million.Now,theprimary insurerandthereinsurersharetheliabilitylossexposuresforthisinsured. obrained onlythroughgovernmentinsuranceprograms. insurers,orasa competitortoprivateinsurers.Somegovernmentproperty- othersareoperatedatthe federallevel. 17 Whenprivateinsurersareunableorunwillingtosatisfycertaininsurance demands. Byofferingsuchprograms,thegovernmentprovidesprotectionagainstlossthat wouldotherwisenotbeprovided. facilitatecompulsoryinsurancepurchases.Forexample,workerscompensa- insuranceiftheywerenotrequiredtodoso. Becausestatesrequireemployerstopurchasethisinsurance(orprovide insuranceforthosedriverswhocannotobtaincoverageatareasonablepricein theprivatemarket.Intheworkerscompensationandautoliabilityinsur-ance markets,mostconsumersobtaincoveragethroughprivateinsurers. efficiencyinthemarketandprovidingconveniencetoinsureds.Ineconomic insureds,byreducingeitherthetimeortheresourcestheyneedtoexpendto obtainthedesiredinsurancecoverage,addstotheefficiencyofthemarket. Legislatorsoftenfinditismoreefficienttoestablishgovernmentinsurance plansforparticularpurposesthantoinviteandanalyzebidsfromprivate providedby thegovernmentiscompulsory,spendingmoneyonmarketingorpayingsales commissions(twolargeexpensesforinsurers)isunneces- 18 ducers whoalsomarketotherinsurance. Thegovernmentmayparticipateininsurancetoaccomplishsocialgoals mechanism,insurancecanreducerisktosociety.Thisisbeneficial bothto societyandtotheoveralleconomy. ance, eventhoughitwouldbenefitsociety.If,forexample,anorganization insurancewas tooexpensive,itwouldnotwanttopurchasetheinsurance. tion,benefits society. ance program: Thegovemmentcanbeanexclusiveinsurereitherbecauseoflawor sion andpasstheremainderofthepremiumontotheNFIP. ance planindirectcompetitionwithprivateinsurers.Thisrypeof states. 19 Thefinaldistinctionamonggovernmentproperty-casualty insurancepro-grams iswhetherastategovernmentorthefederalgovernmentisinvolved includeNFIP andfederalcropinsurance. Examplesofstategovernmentinsuranceprogramsincludeworkerscom- the exhibit"ExamplesofProperty-Casualty InsuranceOfferedbyState Governments."  ► 20  they alsodomuchmorethanmat. multiple functions: Marketing Underwriting Claims control audit Whilemanyinsurershaveestablisheddepartmentsforeachofthesefunc-tions, someofthefunctionsmaybeperformedbyindividualproducers,actuarial firms, third-partyadministrativefirms,orotheroutsideentities. thecourseoftheirdaily routines. Whatevernametheygobyandwhoevermayperformthem, theefficient an organization. marketingfunctioncontributessignificantlytoaninsurer'sgoalsofmeeting customers'needsandmakingaprofitwhiledoingso. services needs The role of the underwriting function is to determine how much coverage 2 1 underwhatconditionsthecoverageshouldbeoffered.Underwriterstypi- implementingit. Underwritersmustcarryoutavarietyofactivitiestoapplytheunderwriting insureds coverage Underwriterscarefullyscreenpotentialinsuredstodeterminewhichonesto theinsurerto thelossexposuresofcustomerswhohaveappliedforinsurance areselected receivethelevelofcoveragethatadequatelyreflectstheirlossexposuresatthe appropriateprice. offered. price for the insurance being offered. The goal is to charge a premium that is commensurate with the loss exposure. The premium should be adequate reasonableprofit. Selectionofinsuredsandpricingofcoverageareintertwinedwithathird tain qualifiersinplace,somethatexcludecoverageincertaincircumstancesand othersthatoutlinetheresponsibilitiesofinsuredsintheinstanceoflossofor damagetoinsuredproperty(suchasnotifyingauthoritiesifacrimeoccurred). Insurersexpecttopayclaims-withoutthem,insurancewouldbeunneces- the potentialfinancialconsequencesofcoveredlosses.Theinsurer'sclaims functionisresponsibleforkeepingthepromisetomakepaymentstooron loss adjustmentservices. 22 processthatincludesthesesixactivities: The growi lengthoftimeeachstepintheclaimsprocesstakes,providinganoppor- representatives. Businessprocessmanagement(BPM)can pe appliedtotheclaimsrum- To achieveitsgoalofoptimizingtheclaimshandlingprocess,BPMbegins oping models. becauseitgenerallycostslesstodoso.Forexample,installinghandrails preventingalllosses isseldompossible. other technologytoobtaininformationbeyondwhattheinsuranceapplica- at loweringtheamountofrisktheyfaceand,asaresult,helpingtolowertheinsured's premiums. 2 3 Whencommercialinsurancepoliciesarewritten,itisnotuncommonforthepremiumto becalculatedusingalossexposuremeasurementthatcouldchangeduringthe policyperiod(usuallyoneyear).Therefore,the pre-miumauditfunction,which occursattheendofapolicyperiod,determines actuallossexposuresduringthat period. expenseswhenanemployeeisinjuredonthejob,isbasedonthetotalamount oftheinsuredemployer'spayroll.However,becauseofnewhires, won'tknow theactualsizeofitspayroll untiltheendofthepolicyperiod.Onlyafterthepolicy periodiscompletedcantheinsurerandtheinsureddeterminehowmuchthe actualpremiumshouldbe. Foreachoftheseactivities,identifytheinsurancefunctionthatismostclosely associatedwithit: Underwriting control Marketing audit Marketing Riskcontrol Claims Thisactivityisariskcontrolfunction. Riskcontrol audit C. Marketing Claims c.Thisactivityisamarketingfunction. 24  policy period control Marketing aai ms audit Thisactivityisapremiumauditfimction. a. Marketing b. Underwriting c. Claims d. control socialburdensby helpinginsuredsrecoverafteraloss.Therearecoststo opportunitycosts,andthe possibilityofincreasedlosses. systeminwhichtheinsuredtransferstheriskoffinanciallosstotheinsurer, astated regularpaymentbytheinsured. ► l> 25 Governmentinsuranceprogramsexisttofillunmetneedsintheprivateinsurance market,tofacilitatecompulsoryinsurancepurchases,toprovideefficiencyinthe marketandconveniencetoinsureds,andtoachievecol-lateralsocialpurposes. Therearethreelevelsatwhichthegovernmentcan into functionalareas,ordepartments.Thesedepartmentscooperatetoservethe primaryfunctionsofmakinginsuredsfinanciallywholeagainafteraloss 26  of insurers. ual statesintheUnitedStates, marketingactivitiesandinsurersolvency. 27  them.Insurance regulationismeanttoaddressmanyoftheseconcerns. Insuranceconsumers'concernsincludewhetherthepolicyformsgivethemthe coveragetheyexpectandneed,whetherthepriceisappropriate,and allofthestatesintheUnited Statesregulateinsurance.Regulationvaries effortsonthesamekeyareasofinsurer operations:licensing,insurancerates,insurancepolicies,marketconduct,and insurersolvency. Insuranceisregulatedtoprotectconsumers.Manyinsurancepoliciesare and disapproveunacceptablepolicies. claims. insurance thatisviewedasanecessity.Forexample,allstatestrytomake orrefusetorenew personalautoinsurancepolicies. 28 Solvency Theabilityofaninsurerto reasons: astheybecomedue,even the future.Ifaninsurerbecomesinsolvent,futureclaimsmightnotbe ficultto evaluateinsurers'financialabilitytokeeptheirpromises. Regulationisneededtoprotectthepublicinterest.Largenumbersof HurricaneAndrewstruckFloridain1992andcausedseveninsurer insolvencies. regulation minimizesthenumberofinsolvencies. Attimes,someinsurerspricetheirpoliciestoolowinanefforttoattractcus- levelsinthewholeinsurancemarket.Therefore,wheninsuranceratelevels mightbe unabletoobtainthecoveragetheyneed. before theyareauthorizedtowriteinsurancepoliciesinthatstate. IntheUnitedStates,insurersarelicensedasdomesticinsurersinthestates 2 9 speciallylicensedproducer. Inadditiontorequiringthatinsurancecompanies(mostcommonlystock,mutual, orreciprocalexchangeinsurers)belicensed, statesalsogenerally claims representatives,belicensed. forms: thatofadomesticinsurer, a foreigninsurer,oranalieninsurer. Insurer incorporated. insurerandanalieninsurergenerallymustberenewedannually. insurer AAinsurerlicensedto operateinastatebut engagedinnoninsuranceactivitiesaswellassomeadditionalconditions state. imposedoninsurers.Anapplicantforadomesticinsurerlicensemustapplyfora insurer corporatecharterandprovidespecificinformation,including(butnotlimitedto) theseitems: insuranceitplanstomarket numberofshares,ifany,thatacorporationcanselltoraisemoney),andits policyholders'surplus insurancecompanies,andreciprocalinsuranceexchanges. cally organizedasstockinsurers.Stockholderssupplythecapitalneeded toformtheinsurancecompanyortheadditionalcapitaltheinsurerneedsto expanditsoperations.Stockholdersexpecttoreceiveareturnontheir investmentintheformofstockdividends,increasedstockvalue,orboth. Stockholdershavetherighttoelectthebeardofdirectors.Theboardof chiefexecutiveofficer(CEO)tocarryouttheinsurer'soperations. 30 31 IntheU.S.,aninsureristypicallylicensedasadomesticinsurerinonestateandas aforeigninsurerinallotherstateswhereitwishes;ooperate.Less insurerintheU.S. stareswhereitwishestooperate. Tobelicensedinanadditionalstate(thatis,asaforeigninsurer),aninsurer first mustshowtheregulatorintheadditionalstatethatithassatisfiedthe requirementsimposedbyitshomestate(itsstateofdomicile,orthestate whereitisadomesticinsurer).Aforeigninsureralsomustgenerallysatisfy insurers withinthestateinwhichitisseekingtobelicensed. the stateinwhichtheywanttobelicensed.Additionally,theymustusuallyestablisha branchofficeinanystateandhavefundsondepositintheU.S. equaltothe minimumcapitalandsurplusrequired.Thefundsondepositare theU.S.legal system.Seetheexhibit"LicensingStatusofaHypotheticalInsurer. Insurersthatarelicensedtodobusinessinastate,whetherasdomestic,for, special circumstances,insurersthatarenotlicensedintheparticularstate, thatstate.A nonadmittedinsurermaybeanadmittedinsurerinotherstates,oritmayevenbe analieninsurer. Nonadmittedinsurersarefrequentlyreferredtoassurpluslinesinsurers.Surplus linesinsurersareusuallypermittedtosell onlyinsurancethatisnot nonadmittedinsurermust stillmeetsomeoftheregulatoryrequirementsof policy forms, Inadditiontolicensinginsurers,allstatesrequirelicensingofcertaininsurer are anattempttoensurethattheseinsuranceprofessionalshaveaminimumlevelof insuranceknowledgeandmeetethicalstandards. 32 IndividualstatesintheUnitedStatesregulateinsuranceratestostrikea theyare readable,understandable,andfair. Asolvent,profitableinsurancemarketthatprovidesinsuranceproductsataffordable ratesisimportanttothecitizensofeverystate.Fromcoverageon enactlawstoensurethatratesare sufficientforinsurersand reasonableforconsumers. to beabletounderstandtheinsuranceproductstheypurchase,Therefore, 3 3 statestypicallyregulateinsurancepolicyformstoenableconsumerstoread arefair andreasonable. of operating,andtoallowareasonableprofit. insurancecommissionerusuallyconsidersthreemajorcriteria: relatedtothoseclaims,helpingtomaintaininsurersolvency. or unreasonableprofit. ratesmustbefairandconsistent.Insuredswithsimilarlossexposures shouldbechargedsimilarrates. inthe typeandextentofcontrolthestateassertsoverinsurers'rates: insurerlsrates. approvedbystateregulators. use therateswhilestateapprovalispending. fied periodaftertheyareused. exceeda certainpercentageabovepreviousrates. However,stateinsurancedepartmentstypicallyhavetheauthorityto criteriathat ratesmustbeadequate,notexcessive,andnotunfairlydis-criminatory continuetoapply. ►'. 34 it-or-leave-itbasis,manystatesrequireinsurerstofiletheirpolicyformswiththe stateinsurancedepartment. any policyprovisionsthatareunfairorunreasonable. regardingpremium ratesandpolicyforms. ing topolicyformsandrates.Theseinsurersarewillingtoprovidecoverage coveragesincludeinlandmarine,oceanmarine,andaviation.Inlandmarine other valuableproperty. state,for example,mayrequireanaggregateannualpremiumof$500,000, property, fromregulation. Statesregulatehowinsurersconductthemselvesinthemarketplaceand consumers. 35 ders.Solvencyregulationsthatestablishinsurerfinancialrequirementsand in theeventofaninsurer'sfinancialfailure. Marketconductregulationfocusesonhowinsurerstreatapplicantsforinsur-ance, insureds,andotherswhopresentclaimsforcoverage.Moststateshave Manystateshaveadoptedunfairtradepracticeslawsthatprohibitcertain trade practicesasthese: Misrepresentationandfalseadvertising-Insuranceagentsandother insurancepersonnelcannotgenerate,issue,orcirculateinformationthat misrepresentsthebenefits, advantages,conditions,ortermsofanyinsur- ancepolicy;misrepresentsthedividendstobereceivedonanypolicy; on anypolicy;orusesapolicynameortitlethatmisrepresentsthetrue mentsabout insuranceoranypersonintheinsurancebusiness. Tie-insales-Producerscannotrequirethepurchaseofinsurancetobe dependentonsomeotherpurchaseorfinancialarrangement, apractice knownasatie-insale.It'salsoanunfairtradepracticeforalenderto orproducer recommendedbythelender.Eachtransactionmuststandonitsown. Rebating-Producersarenotallowedtopayaportionofthepremium purchaseofapolicy. Unfairtradepracticeslawsprohibitotherpracticesthataredeceptiveor ofanother insurer.Enteringfalseinformationonaninsuranceapplication to earn a commission from the insurance sale is also an unfair trade practice. Both insurers and policyholders count on insurance transactions being con- ductedingoodfaith. 36  ditions insurerscanoffer.Aninsurerthatisguiltyofunfairunderwriting discriminationandrestrictionson cancellationsandnonrenewals. Theabilitytodiscriminatefairlyamongapplicantsisoneofthemostimpor- status,orrace. Whenitcomestorestrictionsoncancellationandnonrenewal, moststates requirethataninsurernotifytheinsuredwithinaspecifiedperiod,suchasthirty days,beforeapolicy tobecanceledornomenewed.Thisnoticeisintendedto givetheinsuredanopportunitytoreplacethecoverage.While coverageforaninsured whohasbecomeundesirable. include these: claimants liabilityisreasonablydear worth,therebyforcingthemtosuetorecovertherightfulamount completinganinvestigation the proofoflossinformation 37  dar daysofarequest Failingtoadoptandimplementreasonablestandardstoensurethatrepairs areperformedinaworkmanlikemannerwhen·therepairsare theclaimanttouse are exposed onlywhenaninsuredoraclaimantlodgesacomplaint. Every consumer-protectionobjectivesandhelpinsuredsdealwithproblemsthey encounterwithinsurersandtheirrepresentatives.Stateinsurancedepart, of theinvestigationprocess.Claimsrepresentativesmustbeabletojustify practicesunder scrutiny,itmayfaceareprimand,fine,licensesuspension,substantiallegal judgment,orsomeotherlegalpenalty, Richard,asalesmanforacardealership, alsoholdsaninsuranceagent'slicense withDelmondInsurance.JuliapurchasesacarfromRichard,who fromDelmond. a. Rebating. b, Atie-insale. advertising, Misrepresentation. insurancetothefinancingofthecar. claimsrepresentatives,andotherinsurancepersonnel. mum standardsoffinancialstrength,competence,andintegrityandthatit 38 laws,rules,andregulations. withoutalicensearesubjecttocivil,andsometimescriminal,penalties. educationcourses beforethestatewillrenewtheirlicenses. consultant inbothlife-healthandproperty-casualtyinsurance. Somestatesrequireclaimsrepresentativestobelicensedsothatthosewho inmoststatesincludes anexamination.Thelicensingprocessalsotypically licensedtoensuretechnicalcompetenceand toprotectthepublic. Anotherareaofinsuranceregulationisinsurersolvency.Anoninsurance in excessofitsordinaryexpensesinordertobeconsideredsolvent. 39  each insurermustmeetcertainminimumfinancial requirements,suchas by state. directionof theinsurancedepartmentofthestatewheretheinsurer'shomeofficeislocated. accountingprocedures.Ofparticularinteresttotheexaminersistheinsurer's requirements. departmentsinaprescribedformat.TheNationalAssociationofInsurance Commissioners(NAIC)hasprescribedaformatcalledtheNAICAnnual lyze thesestatementstoassessinsurers'financialstrength. RegulatorsadministertheInsuranceRegulatoryInformation System Designed bytheNAIC,IRISusesdatafromaninsurer'sfinancialstatements Iftheinsurer's ratiosareoutsidepredeterminednorms,IRJSidentifiesthe thatmightenableregulators torehabilitateaninsureror,ifrehabilitationisnotpractical,tominimizethe damagefromliquidation. 40 mentplacesitinreceivership.Iftheinsurercannotherehabilitated,itis liquidatedaccordingtothestate'sinsurancecode.Atthatpoint,thestate's guaranty fund maybeavailabletoreducetheeffectsoftheinsurer's insol- andclaim representatives,becomelicensed. are exemptfromstateregulation. States regulateinsurers'marketingactivities and solvencytoprotectcon- tocustomers andclaimantscanbemet. 4 1  :·:· expensesdeterminesitsprofitability. Summarizetheinformationfoundonthebalancesheetandtheincome statementofaproperty-casualtyinsurer. financialratiocalculations: ratio ratio Givenacaseregardingaproperty-casualtyinsurer's financialratio insurer'soverallfinancialperformance. 42 Soundmanagementofaninsurerincludescarefulattentiontoitsfinancial Tosurvivelongterm,aninsurermustgeneratemoreincomethanitspends;thatis, aninsurer's revenuemustexceeditsexpenses.Inagivenmonthor anoverallincomegain (revenueminusexpenses)fromitsoperationsandtoensureprofitability. insurersinvesttoearnadditional income.Consequently,insurersreceiveincome fromthesetwomajorsources: thesaleofinsuranceandtheinvest-mentof funds. Thesaleofinsurancegeneratesunderwritingincome,whichistheamount duringa period.Whilesomeinsurersreceiveotherincomefromthesale insurerreceivesiseitherunderwritingincomeorinvestmentincome. of January1throughDecember31ofthatyear.Writtenpremiumsarethetotal premiumsonallpoliciesputintoeffect,or"written,"duringagiven apremiumof $600,thatentire$600iscountedaswrittenpremiumsonJuly1, onSeptember12, resultingina$75refund,theinsurer's writtenpremiums 43 arereducedby$7 onSeptember12.Althoughwrittenpremiumsprovidea earnedpremiumsontheirincomestatement. Earnedpremiumsaretheportionofthewrittenpremiumsthatapplytothe beprovided. lisherdoesnot"earn"theentire$24subscriptionamountuntilthemagazine tion afterreceivingonlysixmonthlyissues,thepublishermightrefund$lZ, aninsured paysapremiumof$600onJuly1foraone-yearpolicy,the$600 rentcalendaryear. the insurercalculates$300ofearnedpremiumsand$300ofunearnedpre-miums forthispolicy.Seetheexhibit"EarnedPremiums-One-YearPolicyIssuedon July1for$600." 1/1 7/1 12/31 7/1 12/31 $ 3 0 0 - - $30 44  portion ofthepremiumisearnedascoverageisprovidedbytheinsurer.If See the exhibit"ExamplesofWritten,Earned,andUnearnedPremiums." the insurer's paidlossesandlossadjustmentexpenses(LAE)fromitsearned premiumsandtheportionthatisunearnedpremiumsduringtheperiod, 45  aresecureand availabletomeettheinsurer's obligations. for investment. Second,theinsurerusuallyreceivespremiumsbeforeitpaysclaimsonthe investment department. Themajorexpensecategoryformostinsurersispaymentforlossesarising losspayments oftenrepresent70percentto80percentoftheirtotal costs. the lossisnotreportedrightaway.Whenthelossisreported,theinsurer's proceedings. Somelossesoccurinoneyearbutaresettledinalateryear.In burnotadefiniteamount itwillultimatelypayonclaims. 46  do notincludethoselossesintheprocessofsettlementorincurredbutnotreported (IBNR) losses.Therefore,anothermethodofmeasuringlossesisto duringagivenperiod. Incurredlosses period, nomatterwhen lossesare paid. {IBNA)losses injuryor propertydamagethatisthebasisoftheclaimand,ifso,forhowmuch. Determiningthelegalresponsibilityoftheinsuredforalossmight claimcanbe substantial. generalexpenses;andpremiumtaxes,licenses,andfees. ershaveamarketingsystemtomarketanddistributetheirproducts.TI1is manage andsupportthesaleseffort. commission.Othersreceiveasalary,oracombinationofsalaryandcommis- and theInternet),theseinsurersmuststillemployandpaystafftomanage significant componentofinsureracquisitionexpenses. 47  Someinsurerschoosetoreturnaportionofpremiumstopolicyholdersas Dividends Theportionofan paidtoshareholders. frontwithlittlemarginfor error. theseexpensesfrom investmentincomeontheirfinancialstatementsto investedassetsareaddedtonet investmentincome,resultinginnetinvest- activities. gainor lossforaspecificperiodtonetinvestmentgainorlossforthecor- Aninsurer'snetincomebeforetrucesisthesumofitstotalearnedpremi-ums andinvestmentincomeminusitstotallossesandotherexpensesin 48 lectedpremiums,oritmighthavetoaddpremiumsthatwerewrittenoff policyholders fromtheirincome. Likeotherbusinesses,insurerspayincometaxesontheirtaxableincome. Taxableincomemightdifferfromnetincomebeforetaxesbecauseofthe specialrequirementsofthetaxcode.Forexample,aportionofinterestearnings fromqualifiedmunicipalbondsisnottaxed,anddeductionsfor responseto changingtaxlaws. expenses,andincometaxes,theremainderisnetincome,whichbelongsto the shareholders. Tomeet theirobjectivesofprofitabilityandcontinuityforthelongterm, financial statements. Tomonitorfinancialperformance,insurersandothers, includingregulators &Poor's Corporation),examineinsurers'financialstatements.Insurersmustprepare accuratefinancialstatementsthatdescribethecompany's financial theydonot overstatetheirtruefinancialcondition.Twoimportantfinancialstatementsare thebalancesheetandtheincomestatement. in timeandincludestheinsurer's assets,liabilities,andpolicyholders'sur- 20XX." ► 49 50 overdue. mate claimssubmittedbyinsuredsandotherparties.Themajorliabilities ofaninsurer arisefromthisfinancialobligationtopayclaims.Threetypesofliabilitiesare foundonaninsurer'sfinancialstatements: Thelossreserveisconsideredaliabilitybecauseitrepresentsafinancial obligationowedbytheinsurer.Itistheinsurer'sbestestimateofthefinal settlementamount onclaimsthathavenotyetbeensettled. Although costofsettlingtheclaimsincludedinthelossreserve. umson allpoliciesataparticulartime.Theunearnedpremiumreserveis servicesthattheinsurerhasnotyetrendered.Iftheinsurerceasedopera, policyholders. The"otherliabilities"categoryismuchsmallerthanthelossreserve,the transactions. While premiumsmayincludeamarginforerror,thatmarginmightnotbe exceed expecrations,theinsurermustdrawonitssurplustomakerequired theinsurerdecides toexpandintoanewterritoryordevelopnewinsuranceproducts.Thus,the amountofpolicyholders'surplusaninsurerholdsisanimportantmeasureofits financialcondition. 51 orarerenewed.Meanwhile,theinsurerbuysandsellsstocks,bonds,andother investmentsasneededtomeetitsobligationswhileearninginvest-mentincome. Therefore,ananalysisofaninsurer's assetsandliabilitiesis financialpositionofthe insureratthatpointintime. statement liststheseitems: licenses,andfees) investmentincome IntheincomestatementdepictedforCalladellInsurance,itsrevenuesfrom earnedpremiumsduringtheyeartotaled$14.5million.Inthesameyear,the insurer's expensestotaled$20.3million.Theseexpensesincludedincurred million duringtheyear.Therefore,CalladellInsurancerealizedanetincome Income StatementfortheYearEndingDecember31,20:XX." 52  2.0 53  ratio expenses toitsearnedpremiumsforaspecifictimeperiod. Insurers maysetatargetfortheirlossratioandthenanalyzetheratioperi- eachmonth progressed,thelossratiowasrecalculated,basedonthecom- targeted70percent. Theresultofthelossratioisconverredintoapercentageandtheratioindi,cates the proportionofearnedpremiumsthatisusedtofundcorrespondinglossesand theirsettlement.Ifaninsurerisnotmeetingirslossratiotarget,it implementto bettermeetitstargetandimproveitsfinancialhealth. Aninsurercouldexaminethetotallossesitincurredandconsiderhowitmight reducethatamount.Aninsurercouldreviewthetypesofinsurancethatitwrites andevaluatethelosspotentialforthosetypesortheterritorieswhereitwritesthat insurance.Forexample,autoinsurancelnCaliforniais tolosses.Likewise, theinsurermight consideritsexposuretocatastrophicstorms.Ifitwritesahighvolumeofproperty insurancealongtheFloridacoaststhataresusceptibletohurricane-drivenwinds, theinsurermight winds. Inconsiderationofthelossadjustingexpensecomponentofirslossratio,an becauseofdamagetotheinfrastructureinthecatastrophearea.Computer 54 transmissionequipment,cellphonetowers,andtelephonelinesmaynotbe its pricingisappropriatebasedonthelossesandlossexpensesitincurs.An aninsurermight improveitsearnedpremiumbyexpandingtowriteother ancemight offerasolution. Asitreviewseachcomponentofthelossratio,aninsurershouldconsider financial health. scribed formula,asillustrated: writtenpremiumsinaspecifictimeperiod. expenses; andpremiumtaxes,licensing,andfees.Thisratioindicatesan written.(Investment incomeand investmentexpensesarenotpartofeitherthelossratioorthe expenseratio.) operating. Insurersexaminetheirexpenseratiosroutinelytomanagetheircashflowand controlexpenses.Aninsurermightsetatargetamountforits ratio. growthmode. 55  reduce itsacquisitioncosts.Forexample,aninsurermightdiscontinueanagency incentiveprogramthatgenerateshigheracquisitioncostsincom terms. Alternately,thegeneralexpensecomponentoftheexpenseratiomightsug- more efficientlyandmakefewererrors.Or,aninsurermightinstallmodem ofexpenses helpstoincreaserheinsurer'soverallprofit. Writtenpremiumsareusedintheexpenseratioinsteadofearnedpremiums involve acquisitionexpenses,whichoccuratthebeginningofthepolicyperiod.Written premiumsrecognizetheentirepremiumassoonasitiswrit·ten;thereforeitis appropriateforcomparingexpensestorevenues.Financial formula,asillustrated: Thebasiccombinedratioisdeterminedbyadding the lossratiototheexpense ratio.Thecombinedratioisoneofrhemostcommonlyusedmea- anceunderwriting operations. are typicallyexpressedwithoutthedecimals,suchas"70"or"115,"muchas cal calculationofgettingonehit ineachthreeat-barsresultsinabattingaverageof0. 333.Aninsurer's combinedratioof70percentindicatesthatforevery$1.00in premiumitearned,itpaid$0.70forlossesandexpenses. expectedlossexperience. 56 ,..,. writingperformance,eventhoughitdoesnottakeintoaccounttheinsurer's investmentincome.Thelowerthecombinedratio,thebetteritisforaninsurer. Mostinsurersconsideracombinedratiounder100tobeaccept- ratioover100andattempt tooffsetunderwritinglosseswithinvestmentincome.Overallfinancial performanceincludestheresultsfrombothaninsurer'sunderwritingactivitiesand itsinvestmentactivities. Withintheinsuranceindustry,thecombinedratioisusedtocompareprofit-ability amonginsurersofvaryingsizes(aninsurer'ssizedoesnotaffecttheratio). Consequently,thecombinedratioismeaningfultoinvestorsandregu-lators,and itprovidesameasuretobeusedinbenchmarkingandintrending. orapooreconomic environment intermsofexpensesforaparticularyear, maintainsalowercombined ratioforthatyearwouldstandoutasanexcep-tional insurer. prescribedformula,asillustrated: Theinvestmentincomeratiocomparesthe amountofnetinvestmentincome aspecific period. Theinvestmentincomeratioindicatesthedegreeofsuccessachievedinan insurer'sinvestmentactivities.Themoresuccessfulaninsurer'sinvestment activitiesare,thehighertheratio.Theinvestmentincomeratioisaffectedbyan insurer'sabilitytomanageitsinvestmentsandselectabalancedblendof investments(stocks,bonds,realestate,andsoforth)sothatinvestmentincome (dividends,interest,andotherearnings)isregulatedovertime.Theinvestment incomeratioisalsoaffectedbythephasesintheunderwritingcycleandbyother financialmarkerconsiderations.Whentheproperty- stockpricesplummerandotherinvestmentsinthe marketaredepressed(asinarecession),underwritinggainsareessentialto insurers'profitabilityandfinancialwellbeing. lowingaprescribedformula,asillustrated: 57 Theoveralloperatingratioisthecombinedratio(lossratioplusexpense financialperformanceofaninsurerforaspecificperiod. Actuariessubtracttheinvestmentincomeratiofromthecombinedratio writingexpenses.Forexample,ifthecombinedratiowas115(aloss),andthe investmentratiowas25(aprofit),thentheoveralloperatingratiowouldbe90 (115-25).Ofallthecommonlyusedratios,theoveralloperatingratioisthe mostcompletemeasureofinsurerfinancialperformance. Toobtainatruepictureofaninsurer'sfinancialhealth,overalloperatingratiosfor anumberofyearsshouldbeanalyzed.Aninsurermighthavea lowing aprescribedformula,asillustrated: profitablenewbusinessoverthepastninemonths. underwritingprofitability? ratio ratio ratio ratio Thecombinedratioisconsideredtheacceptedmeasureofan insurer'sunderwritingperformanceorprofitabilitybecauseitprovidesa snapshotoftheinsurer's incomefromitsunderwritingoperations(earned premium) withthecostsit incurs ingeneratingtheincome(expenses)and the costsofprovidingtheservicepromisedintheinsurancecontract(loss paymentsandtheexpensesassociatedwiththoselosses)---essentially, the 58 resultsorprofitability. over thenine-monthperiod. itableoverthenine-monthperiod. underwritingprofitforthenine-monthperiod. underwritingexpensesforthenine-monthperiod. Feedback:a.Acombinedratiooflessthan100(suchas95)indicatesthat premiumthat Calladellearned,itpaid$0.95forlossesandexpenses. answeringthe KnowledgetoActionquestions. she recommendsforfutureyears. 59  and,ifso, thecausesofthisoutcome,Maggiemustperformthesesteps: date.See theexhibit"LeightoffInsuranceIncomeStatementfortheYearEnding December31,20XX." 18.5 3.0 5.2 2.5 0.3 29.5 Leightoff's lossratio.Toperformthelossratiocalculation,Maggiereviewstheincome statementtoobtainLeightoff's earnedpremium($28.7million),itsincurred losses($18.5million),anditslossadjustmentexpenses($3 mil- 75percent. Whilethisratioisacceptable,MaggiedeterminesthatLeightoffcouldtakesome actionstoreduceitslossratio. 60  the ratiowouldbeaffected. losses. to generatehigherearnings. higher premiums. cl. ing andcoolingcosts. Leightofftochargehigherpremiums,leadingtoanincreaseinitsearned premiums.Stockinvestmentswouldnothaveaneffectonthelossratio,and loss ratio. TodetermineLeightoff's combinedratio,Maggiemustnextcalculate attheendofthe year(assumeitisequalfortheexpenseratiocalculation). Toperformtheexpenseratiocalculation,Maggiereviewstheincomestate-ment toobtainLeightoff'swritten(earned)premium($28.7million)andits acquisition expensesof$5.2million;generalexpensesof$2.5million;andpremiumtaxes, licenses,andfeesof$0.3million.Maggiedeterminesthat tofurtherreduceits expenseratio. 61 howtheratiowouldbeaffected. investmentportfolioandregulateitsinvestmentearnings. rewardserror-freeworkproductsandreducestheneedforandcostofrework. electroniccommunications. settlements. but neitheroftheseactivitieswouldaffectLeightoff'sexpenseratio. has calculatedforLeightoff's lossratio{75percent}andexpenseratio(28percent). Maggiecalculatestheratioas103percent. improveitscombinedratio. 62  policiesof thosetypesthatexceedaspecifiedlossthreshold. expensesforthenextyearby percent. has sufferedanunderwritinglossof3percentfortheyear.Thismeansthatforevery $LOOinpremiumiteamed,Leightoffhaspaid$1.03forlosses andexpenses.IfLeightoffincreasedthevolumeofthemostprofitabletypesof insuranceitwritesandreducedthevolumeofthenonprofitabletypesit increaseand itslossesandlossadjustmentexpenseswilldecline.Theresult reductionin departmentalbudgetscanhelplowerotheroperatingcosts. measureofaninsurer'sprofitabilityforinvestorsandregulators. Foraninsurertosurvivelongtermandgrow,itsrevenuemustexceedits overall incomegain(revenueminusexpenses)fromitsoperationsandtoensure profitability. Thebalancesheet,whichmeasuresaninsurer'sfinancialposition,showsthe the lastdayoftheyear.Theincomestatementisafinancialstatementthat usuallyoneyear. Analyzingtherelationshipofdifferentratios,thecomponentsoftheratios, thisanalysis, includingtheinsurer's lossratio,expenseratio,combinedratio,investment incomeratio,andoveralloperatingratio. help aninsurermonitoritsfinancialhealthandmakenecessarychangestoimprove itsfinancialperformance. 63  ► nativemarketingchannels. I- t·- tion-systemanddistribution-channelselectionprocess. 64 Inaninsurancecontext1 "producerl)anduagent"aresynonymoustermsthat 65  other party,asrequiredbythecontract. createsresponsibilitiestothirdparties. agents: ship. Thisisthedutyofrelayinginformation. on thatright.Thecontractalsospecifieshowtheagentistohandlefunds, the insurer.Insuranceagencycontractsusuallygivetheagenttherightto termsofthe agencycontract. Inthecaseofaninsuranceagent,theprincipal'sdutytopaytheagentfor compensationtotheagentfortheinsurancetheagentsells or renews.The principalalsohasadutytoindemnify,orreimburse,theagentforanylosses actions onbehalfoftheprincipal.Ifathirdpartysuestheagentinconnec-tionwith activitiesperformedonbehalfoftheprincipal,theprincipalmustreimbursethe agentforanyliabilityincurred,iftheagentwasnotatfault. principal'sauthorization,eventhoughtheprincipalmaybeliabletoothersfor thoseacts.Animportantfactorinvolvedinthisdutyistheexposureof 66 customermisleadingorincorrectadviceregardingthecustomer's insurance, fers damageduetotheagent'sadvice. Theagent'sauthorizedactionsonbehalfoftheprincipallegallyobligate insuranceagentandtheinsurer.Becausetheagentrepresentstheinsurer,the the insurer. lf,forexample,theagentvisitsthelnsured'spremisesandrecognizesanexposure (suchasvacancyofthebuilding}thatcouldsuspendorvoidthe theagentfailedto communicatethatinformationtotheinsurer.Accordingtoagencylaw,thefact thattheagentknewabouttheexposuremeansthattheinsurerisalsopresumed toknowaboutit. apparent, Actualauthoritycanbeexpressauthorityorimpliedauthority.Express authorityappliesnotjusttocarryingouttheprincipal'sspecificinstructions,but alsotoperformingactsincidentaltocarryingoutthoseinstructions.To determinethescopeofexpressauthority,courtsexaminethegoalsofthe agencyinlightofallsurroundingcircumstances.Forexample,thepowertosell generallyincludesauthoritytocollectpaymentandtomakecustomary warranties.However,toillustrateconsiderationofscope, asalesagentwho to collectthepurchaseprice.Inmostcommercialsituations,theagenthas can deal. Bindingauthority,generallygrantedtotheagentintheagencycontract, isa aformal writtenpolicyisissued.Binderscanbeeitherwrittenororal.Whenaninsurance agentbindscoverageforanewclient,theagentcommitsthe carefully.Seetheexhibit "BindingAuthority:AnExample." 67  ably inferthattheyhaveauthoritytoactaccordingtoprevailingcustom agent's positionusually does. allthe authoritythatareasonablepersonacquaintedwiththecustomsand arisesinoneoftwo overlappingcircumstances: businessusuallyhave. otherbusinessesofthesamekindintheprincipal'sarea. the totalcredittoacustomerexceeds$200,anunusualrestrictioninPaul's ityinthatsituation. Theauthoritywasapparent,andPaulcannotdenyit. 68 69  goals trol,appraisal,actuarial,riskmanagement,claimadministration,andother ally, nationally,andinternationally.Theycantailorinsuranceprogramsfor for multiplelocations.Thebrokersreceivenegotiatedfeesfortheservices regulation. and independence. Theexactdutiesandresponsibilitiesofamanaginggeneralagent(MGA) specialty insurance. expertise Assumption of insurer activities 7 0 71 limitedownershipofexpiration's. be restrictedintheirabilitytooffersomeriskmanagementservicestotheir customers. bysalary,bycommission,orbybothsalaryandaportionofthecommission policynot availablefromthedirectwriterinsurerthatthesalesagentrepre-sents.Whenthis happens,thesalesagentmayactasabrokerbycontacting Insurancesoldinthis mannerisreferredtoasbrokeredbusiness. ers. Theseinsurer-assumedfunctionsincludepolicyissuance,premium Thedistributionchannels usedbyinsurersand theirrepresentativesarecon- prospectivecustomers. Asadistributionchannel,theInternetandonlineaccesstoinsurancetrans- 7 2  awareness. Thebest-equippedcallcenterscanreplicatemanyoftheactivitiesofpro-ducers. Inadditiontomakingproductsales,callcenterstaffcanrespondto policy endorsements.Insomecases,acustomercanbeginaninquiryoratransactionon theInternet,thenhaveacustomerservicerepresentativeat concludethe transaction. Thedirectresponsedistributionchannelmarketsdirectlytocustomers.Noagent isinvolved;rather,thedirectresponsereliesprimarilyonphoneor office.Seetheexhibit "DistributionChannelsforInsuranceMarketing." 73  profession,interests,hobbies,orattitudes. Worksitemarketingorpayrolldeduction-Employerscancontract coverageasa benefittotheiremployees. program. exhibit"Producers'TradeAssociations." a bankoranotherfinancialservicesinstitution,eitherexclusivelyorthrough 74  many financialinstitutions. these qualities: andservices and channel Omnichannelmarketingallowsinsurerstomarkettocustomersinmultiple channelsandmeettheneedsofcustomersseekingalternativemethodsto purchaseinsurance.Byusinganomnichannelapproach,insurerscantarget call centers,orotherapproachesbasedonthecustomers'preferredmethod tent marketingdecisions. Thefunctionsinsuranceproducersperformvarywidelyfromonemarketing initialcontactwith insurancecustomersandprovideexpertiseandongoingservices.Thisisparticularlytrue forcommercialinsurancecustomers. Insuranceproducersrepresentoneormoreinsurancecompanies.Asasourceofinsurance knowledgefortheircustomers,producersprovideriskman-agementadvice, solicitorsellinsurance,andprovidefollow-upservicesas customers'loss exposuresorconcernschange. Prospecting 75  Sales collection service handling Consulting locatedusingseveralmethods: estatebrokers solicitations Cold canvass characteristics. exposures,andinsurance. Theriskmanagementreviewprocessforbusinessesislikelytobemorecom- 7 6  is requiredtodevelopandanalyzelossexposureinformationforalargefirmwith diversifiedoperations. currentrisk managementefforts,identifyproblemareas,andprojectcosts. commercial customers,theproducermayworkwiththecustomer's RiskManagement Departmentinidentifyinglossexposuresandriskanalysis. can bemade.Theproducercanthencoordinatefurthercoveragediscussions betweenthecustomerandtheinsurer. the agencyorbrokerage.Commissiononbusinesssoldistheprincipalsource the businesssoldistheprincipalassetofaninsuranceagency. Attheproducer's request,insurersissuepoliciesandtheirassociatedforms, along withendorsements,bills,andlosshistoryinformation. insurers,aprocedureknownastheagencyblllprocess. Togivetheproducersomeprotectionagainstpolicyholders'latepayments, premiumsareusuallynotduetotheinsureruntilthirtyorforty-fivedaysafterthe policy's effectivedate.Thisdelayalsopermitstheproducertoinvestthe incomecanbeasignificantpartoftheproducer'sremuneration. Agencybillingmaybeusedforpersonalinsurancepolicies,butitismore commonlyusedwithlargecommercialaccounts.Forsmallcommercial accountsandthevastmajorityofpersonalinsurance,thecustomerisusually procedureknownasthedirectbillprocess. 77 Mostproducersareinvolvedtosomedegreeincustomerservice.Forinde- insurancepackagesarewhatdifferentiatetheminthemarketplace.Forthe holderwho hashadalosstotheClalmsDepartment. insurer,includingthese: requiremenrs contact withtheinsurer,thepolicyholderusuallycontactstheproducerfirstwhenaclaim occurs. Insomecases,theproducermightprovideinformationoncontactingthe insurer.Alternatively,theproducermightobtainsomebasicinformation their policieswitha"claimkit"thatinformstheirpollcyholdersabouttheproper proceduresandcontactsintheeventofaloss. Mostoften,theauthorizationislimitedtosmallfirst-partypropertyclaims. contract. overpaymentof claimscanoffsetthesavings. 78  missionsreceived oninsurancewrittenbecauseoftheconsultingcontract. due, whereascommissionsareincludedinthepremiumtotalsbilled. Anyfirmthatsellsaproducthasadistributionsystemtocarryoutsomeof customers. tives aremorereadilychangeable. exhibit"DistributionSystemsandConduitsforInsuranceMarketing." 79 [OA06250) markets--arekeyfactorsinaninsurer's selectionofdistributionsystemsand examplesofcustomerneedsandcharacteristics: willseekthe expertiseofanagentorbrokertoprovideadvice,assistin internaland externalenvironmentschange. Price-Towhatdegreeisthepriceofproductsandservicesafactorfor Othersareconcernedwitbpricetoadegreebutareunlikelytomake ment alternativesthatwill minimizetheadverseeffectsof!ossesforthe organizationoverthelongterm. theyoftenexpectthesameresponsefromtheirinsuranceproviders. 80 distributionsystemsandchannels. or mergers. personallinesinsurerthatcontractsindependentagentsasadistributionsystem mayadoptastrategytoexpandtothenational market.Ratherthan territory,theinsurer assumestheroleofadirectwriterandusesanonline utors.Thisapproachcanreduce long-termcostsandacceleratetheinsurer'smarket-sharegrowth. threats.Onceaninsurerdetermineswhereitsstrengthslie,itselectsthose lyze thesefactors: Financialresources--Theinitial fixedcostofenteringamarketthrough so throughtheindep endentagencysystem.Theinsurermusthire,train, ln comparison,thecostofconductingadirectresponsecampaign canbe 81  marketstheycanenter. Corecapabilities-Corecapabilitiesincludetheabilitiesofanorgani- onthefirm's corecapabilities.Complexcommercialaccountsrequire whichtheinsurermarketsoritsgeographicmarket. canprovidetheneededexpertise andreputation. sivenew competitorhasampleincentivetochangeitsapproachtobetteraddress customers'needsandcharacteristics. Customers'needsandcharacteristicsaredrivingfactorsforaninsurerthatis through marketingresearch,theinsurer is lesslikelytogainmarketshare.To new accountsitwillwrite. 8 2 demographics,coverageneeds,andotherfactors.Thisanalysiscanassistin and totargetnewmarkets. geographicarea. tiesfor insurerstoreachthesecustomers.Thisisespeciallytrueforpersonal omnichannel marketingapproaches,suchasonlineorthroughcallcenters. tions mayinfluenceitschoiceofadistributionsystem: Aninsurercanexercisethegreatestcontroloverproducersinthedirect company,andthecompanycanexercisecontroloverboththeresults can specifythenumberandtypeofnewapplicationstheproducermustsubmit eachmonth(results)aswellasthemarketingapproachestheproducercan use(methods). Underboththeagencyandbrokeragesystemandtheexclusiveagency can controlonlytheresultstheyproduce,notthemethodstheyuseroproduce them.Forexample,aninsurercanspecifythenumberandtypeofnew applicationstheproducermustsubmiteachmonth(results).Toachieve thoseresults,however, theagentorbrokercanengageinany tionsor contractualagreementswiththeinsurer. the insurerhascompletecontrol ofitsdistributionsystem. ment advicethatincludesariskcontrolrecoveryplanincaseatainteddrug 83 lowingproductsliabilitylosses. Otherinsurersvaluediscretionintheproducerswhorepresentthem.Forexample, aninsurerthatspecializesinchurchinsuranceordistributesinsur- forumscancausean insurertoloseaccounts.Therefore,theinsurermight eesandsubjecttothe insurer's guidelinesformediause. Thelegalrelationshipofagencyempowerstheinsuranceproducer-the insurancedistributionsystemsarethese: to communicatewithexistingandprospectiveinsureds. thesetypical functions: Sales issuance collection service handling Consulting 84  the responsetimetheyrequire. control required. ► 85  I and staffunderwriters. Explain howinsuranceratesaredeveloped. policy, calculatethepolicypremium. 86  andstaff underwriters-canthereforeinfluenceitsprofitabilitymorethananyothersingle factor. profitablegrowth. individualactivitiesthesetasksentailincludethese; profitability. ing theinsurertomakeaprofitandmaintainanadequatepolicyholders' 87  drivendecisionmaking. that existingaccountsareadequatelyprotectedthroughnon-insurance erstoensurethatapplicantsobtainthecoveragetheyrequest. Finally, toa specifictypeofloss;lineunderwritersrespond(usuallythroughthe quotations. underwritingpolicyshouldbecompatible. activities essential toprofitableriskselection,suchasthese: into additionalstates,orofretiringfromstatesaninsureroperatesin; fueledpredictiveanalysismethods. gies that,intum,determinethecompositionoftheinsurer'sbookof textofthe market(s)theyserve-thestandardmarket,thenonstandardmarket,orthe specialtymarket.Beyondthesebroadmarketselections, policymaybe establishedaccordingtotypesofinsuranceandclassesofbusinesstobe written;territoriestobedeveloped;orforms,insurancerates(suchasfiled ratesandsurpluslinespricing),andratingplansto beused. 8 8  final decision,waystoimplementthedecision,andmethodstomonitorthe decision.Otherinsurersuselesscomprehensiveguidelines. writing guidelines. update ratesandratingplanscontinually,subjecttoregulatorycon-straints,to respondtochangesinlossexperience,competition,and todevelop prospectivelosscosts.Each insurerthenexaminesitsown becomeevenmorecrucialto ensuringthatthelosscostsadequatelyreflectlossdevelopmentand trending. significantfirst-handexperienceinlineunderwriting.Theyregularly audits.These auditsfocusonproperdocumentation;adherencetopro-cedure, classification,andratingpractices;andconformiryofselection 89  theextenttowhichunderwritinggoalsaremet,butitdoesnotcon- underwriting guidelines. ness goals. of business. activities. Afteraproducersubmitsanapplicationforinsurancetoaninsurer,theinsurer mustqualifytheapplicationforacceptance. Underwritersperformthisfunction byfollowingthestepsintheunderwritingprocess.Inaddi- toapropertypolicy. Applications,renewals,andpolicychangestowhich submissions. Althoughunderwritersultimatelydeterminewhethertoacceptorreject commerciallinessubmissions,theirdecision-makingisofteninfluencedby ligence todatacollectionandtheever-expandinguniverseofinformationaboutrisk factors,pricing,andothercrucialfactors,thesesystemshaveaccel- manuallywhile infusingthemwithmoredataandsophisticationthanwould underwritingdecisions. Althoughexperiencedunderwritersdonotalwaysfollowthestepsinthe "Stepsin theUnderwritingProcess." Thefirststep.intheunderwritingprocessisevaluatingasubmission'sloss exposuresandassociated hazards.Hazardsfallintofourcategories:physical, moral,morale,andlegal.Underwritersmustunderstandtheactivities,opera- 90 (DA07556) necessary information. Underwritersapplyinfonnationefficiencytoweightheneedforinforma-tion againstthecosttoobtainit.Forexample,anunderwriterislikelyto information to underwriteagiftshop.Sometimes,anaccount'spremium or availablewhendeterminingwhetheritshouldbeobtained. a submissionandpaycloseattentiontoasubmission'shazardstodetermine Producers-Anunderwriterreliesmoreontheproducerthanonany applicant's reputationinthecommunity,andhasdeterminedtheappli- cant1s coverage needs. Applications-Insuranceapplicationsprovidegeneralinformation Inspectionreports-IndependentinspectionsorriskcontrolreportJS the business'ssafetyrecord,andthepolicyholder's management. information, such asmotorvehiclereports;criminal court records; and 91 92  changecouldensureitsacceptability.Forexample,increasingadeduct,ible mightmakecoveragemoreviableforasmallcommercialaccount experience. Usefacultativereinsurance-Anunderwritermaybeabletotransfera Thethirdstepintheunderwritingprocessisselectinganunderwriting underwritingauthority. thesupportingbusiness-aredesirable. insurer's mix-of-businessgoals. Producer-underwriterrelationships--Therelationshipbetweenthe tionand underwritersfocusonstrictadherencetoselectionstandard.. lations thatrestrictunderwriters'abilitytoacceptorrenewbusiness. sified sothatit is properlyrated. 93  and operatingexpensesandtoproduceaprofit. loss exposures. decision. Itgenerallyinvolvesthreetasks: Communicatethedecision-Ifthedecisionistoacceptthesubmission rejectthe application,heorsheshouldcommunicatetherejectiontothe to issueabinderandpreparecertificatesofinsurance. Abriefdescriptionof insurancecoverage agentandcommonlyused purposes. evidenceofinsurance. Thesixthstepintheunderwritingprocessismonitoringtheunderwriting booksofbusiness. in thenatureofaninsured'sbusinessoperation,forexample,couldsignifi, 94 policiesaremonitoredinresponsetoanyofthesetriggeringevents: Significantanduniquelosses-Anoticeoflossprovidestheunder- whether thatlossisthetypetheunderwriterexpected.Summaryinfor-mationabout theclaimorareviewoftheclaimfileprovidesvaluableinformationabout thenatureofthelossandtheinsured's operations. occurredand, ifso,repeattheunderwritingprocess. operations,orfinancialproblems. identify specificproblemsforeachtypeofinsurance,whichcanbesubdi- costsandoverhead expensesforeach bookofbusiness. these characteristics; Territoriesorgeographicareas-Monitoringterrirorialunderwriting 95  regulators. ratio areevaluatedbothorianoverallbasisandbytypeandclassof desired betweenpersonalandcommercialinsuranceandtheprojected ducer establishedandtheprogressmadetowardachievingthem. Tomeetitsgoals,aninsurermustadjustitsunderwritingrulesandstandards ment implementstheseadjustments. businessdecisions for each reinsuredpolicy) Delegatingunderwritingauthority,whichestablishesthetypesofdeci- at a higherlevel er's overallunderwritingobjectives guidelineshavehadthedesiredeffect Aninsurer'sseniormanagementgenerallyincludesofficersresponsiblefor functionsinadditiontounderwriting.Theheadofaninsurer'sunderwriting departmentparticipateswithothermembersoftheinsurer'smanagementteam inmakingbroadbusinessdecisionsabouttheinsurer's goals, includingannual writtenpremiumandlossratiogoals,andindevisingplanstomeetthosegoals. Decisionsatthislevelmightdeterminewhattypeofmarketingsystemthe commercial insurance,andsoforth.Givenseniormanagementconsensusontheinsurer'sbroad goalsandhowtheinsurer'scapacityshouldbeallocated, contributetothese goals.Aninsurer'sunderwritingmanagementmustthen 96  overall goals. Reinsurance(sometimesreferredtoas"insuranceforinsurers")servesseveral tionagainst catastrophiclosses,andallowinganinsurertoprovide alargeamountof insuranceunderasinglepolicy.Reinsurersalsocanprovidethe generaltypesof reinsurance:treatyandfacultative. Treatyreinsuranceisanarrangementinwhichareinsureragreestoautomaticallyreinsure aportionofalleligibleinsuranceoftheprimaryinsurer.Thetreatyisacontractthat definestheeligibleinsurance.Theprimaryinsureris thetreaty.Policiesarenotselected individually.Primaryinsurersandrein-surersperiodicallyrenegotiatethe reinsurancetreaty.Beforeenteringintoatreatyandagreeingonpricing,the reinsurercarefullyevaluatestheprimary reinsurerismoreconcernedwiththegroupof insuredsa