insurance quiz 2

life and heath insurers

these insurers sell life and health insurance products, annuities, mutual funds, pension plans, and related financial products

property and casualty insurers

these insurers sell property and casualty insurance and related lines including inland marine coverage and surety and fidelity bonds

stock insurer

a corporation owned by stockholders.

• The objective is to earn profits for the stockholders by increasing the value of stock and paying dividends

• The stockholders elect a board of directors who, in turn, appoint executive officers to manage the corporation.

• stockholders bear all losses

• insurer cannot issue an assessable policy

mutual insurer

a corporation owned entirely by the policyholders.

• There are no stockholders.

• The policyholders elect a board of directors who appoint executives to manage the corporation.

• Board of directors have effective management control

• policyholders may receive dividends or rate reductions

mutual insurer categories

1. advance premium mutual

2. assessment mutual

3. fraternal insurer

advance premium mutual

the premiums charged are expected to cover all claims and expenses.

• The company pays claims and expenses beyond those anticipated in the rate from its surplus (that is, net worth).

• owned by the policy owners, there are no stockholders, and the insurer does not issue assessable policies

assessment mutual

has the right to assess policyholders an additional amount if the insurer’s loss, investment, or expense experience is unfavorable.

• very few exist today

fraternal insurer

a mutual insurer that provides life insurance and health insurance to members of a social or religious organization

• members are affiliated with local units (chapters, churches, clubs, and so on) that are knitted together by an overall representative form of governance.5 Only members of the fraternal benefit society can buy coverage from a fraternal insurer, which must operate solely for the benefit of its members or beneficiaries.

• Fraternal benefit societies are nonprofit organizations that provide both social and insurance benefits to their members who may band together because of a common religion, ethnicity, interest, or other factor.

why the corporate structure of mutual insurers is changing

1. increase in company mergers

2. Demutualization - a mutual insurer is converted into a stock insurer.

3. the creation of mutual holding companies

4. A holding company is a company that directly or indirectly controls an authorized insurer

demutualization

a mutual insurer is converted into a stock insurer.

holding company

a company that directly or indirectly controls other companies.

mutual holding company

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.

mutual holding company illustration

Lloyd’s (formerly Lloyd’s of London)

is not an insurer but is the world’s leading insurance market that provides services and physical facilities for its members to write specialized lines of insurance.

• Writes 7 lines of insurance: casualty, property, marine, energy, motor, aviation, and reinsurance

• It is a market where members join together to form underwriting syndicates to insure and pool risks.

• new individual members now have limited legal liability

• corporations with limited legal liability and limited liability partnerships can also join Lloyd’s of London

• members must meet stringent financial requirements

• Lloyd’s is licensed only in a small number of jurisdictions in the US

reciprocal exchange

defined as an unincorporated organization in which insurance is exchanged among the members (called subscribers).

• Each member of the reciprocal insures the other members and, in turn, is insured by them. Thus, there is an exchange of insurance promises (that is, “cross-insurance”) and hence, the name reciprocal exchange.

• it is managed by an attorney-in-fact (a person who is authorized to perform business-related transactions on behalf of someone else)

• most reciprocals are relatively small and specialize in a limited number of lines of insurance

blue cross and blue shield plans

generally organized as nonprofit, community oriented plans

• blue cross plans were initially organized to cover hospital services

• blue shield plans were initially organized to cover physicians’ and surgeons’ fees and other medical services

• most plans have merged into one BCBS entity

• some plans have converted to a for-profit status to raise capital and become more competitive

managed care plans

• In addition to financing healthcare, the plan is involved in making healthcare decisions that previously were made only by the patient and the healthcare practitioner.

• There is a focus on controlling costs.

• It facilitates case management, which means that healthcare practitioners communicate and work toward a unified course of treatment

types of managed care plans

• health maintenance organization (HMO)

• point of service plan (POS)

• preferred provider organization (PPO)

captive insurer (chapter 3)

an insurer owned by a parent firm for the purposes of insuring the parent firm’s loss exposures. There are different types of captive insurers.

• A single-parent captive (also called a pure captive) is an insurer owned by one parent, such as a corporation.

• The captive can be an association captive, which is owned by several parents.

savings bank life insurance (SBLI)

refers to life insurance that was sold originally by mutual savings banks in three states: Massachusetts, New York, and Connecticut. Today, SBLI is also sold to consumers over the phone or through websites in those states, and to consumers who reside in other states as well.

• The objective of SBLI is to provide low-cost life insurance to consumers by holding down operating costs and the payment of sales commissions to producers.

producers

intermediaries who are licensed as agents and/or brokers and who sell most insurance policies today.

• Sometimes they are called “retail” agents or brokers to distinguish them from other intermediaries called “wholesalers” who do not deal with the end consumer of insurance.

agents

someone who legally represents the principal and has the authority to act on the principal’s behalf. The principal represented is the insurance company.

can represent the insurer based on either:

• express authority

• implied authority

• apparent authority

The principal is legally responsible for the acts of an agent whenever the agent is acting within the scope of express, implied, or apparent authority.

express authority

refers to the specific powers that the agent receives from the insurer.

implied authority

he agent has the authority to perform all incidental acts necessary to exercise the powers that are expressly given.

apparent authority

the authority the public reasonably believes the agent possesses based on the actions of the principal.

differences between a property and casualty insurance agent and a life insurance agent

A property and casualty agent has the power to “bind” the insurer immediately with respect to certain types of coverage. In contrast, a life insurance agent normally does not have the authority to bind the insurer. The agent is merely a soliciting agent who induces persons to apply for life insurance. The applicant for life insurance must be approved by the insurer before the insurance becomes effective.

binder

the temporary insurance that is based on the agent’s word until the insurer actually underwrites the policy. Binders can be oral or written.

broker

someone who legally represents the insured even though he or she receives a commission from the insurer.

A broker does not have the legal authority to bind the insurer. Instead, he or she can solicit or accept applications for insurance and then attempt to place the coverage with an appropriate insurer. Nevertheless, the insurance is not in force until the insurer accepts the business.

surplus lines broker

Specialized insurance broker licensed to place business with a nonadmitted insurer (a company not licensed to do business in the state).

surplus lines

refer to any type of insurance for which there is no available market within the state, and coverage must be placed with a nonadmitted insurer

managing general agent

a specialized type of “wholesale” producer that, unlike “retail” producers, is vested with underwriting authority from an insurer.

• MGAs “are involved with unusual lines of coverage, such as professional liability and surplus lines of insurance, in which specialized expertise is required to underwrite the policies.

• However, MGAs also write some personal lines business, especially in geographically isolated areas (such as western Oklahoma and North Dakota) where insurers do not find it feasible to set up a branch office. Thus, MGAs deal with both admitted and non-admitted insurers. When they deal with admitted insurers, they deal directly with the client and act as retail agents or brokers.

• MGAs benefit insurers because they possess expertise that is not always available within the insurer’s home office

• The functions of MGAs and surplus lines have become intertwined

marketing systems

refer to the various methods for selling and marketing insurance products. These methods of selling are also called distribution systems.

major life insurance distribution systems

• personal selling systems

• financial institution distribution systems

• direct response system

• other distribution systems

personal selling systems

systems in which commissioned agents solicit and sell life insurance products to prospective insureds.

• Today the majority of life insurance policies and annuities are sold through personal selling distribution systems

career agents

full-time agents who usually represent one insurer and are paid on a commission basis. These agents are also called affiliated agents because they sell primarily the life insurance products of a single insurer.

multiple line exclusive agency system

a system in which agents who sell primarily property and casualty insurance also sell individual life and health insurance products. These agents are also called captive agents.

• Under this system, agents represent only one insurer or group of insurers that are financially interrelated or under common ownership. For example, an agent may sell an auto or homeowners policy to a client. Depending on the client’s needs and insurance products available, the agent can also sell life insurance, health insurance, annuities, mutual funds, individual retirement accounts, and other products as well. State Farm Mutual and Allstate are examples of this system.

independent property and casualty agents

independent contractors who represent several insurers and sell primarily property and casualty insurance.

• In addition to property and casualty insurance, many independent agents also sell life and health insurance to their clients.

personal producing general agent

an independent agent who places substantial amounts of business with one insurer and enter into a special financial arrangement with that insurer.

• an independent agent who receives special financial consideration for meeting minimum sales requirements.

brokers

independent agents who do not have an exclusive contract with any single insurer or an obligation to sell the insurance products of a single insurer.

• Although brokers may place a substantial amount of business with a particular insurer, they have no obligation to sell a certain amount of insurance for that insurer.

• Brokers usually enter into separate agency contracts with each insurer in which business is placed.

financial institution distribution systems

Many insurers today use commercial banks and other financial institutions as a distribution system to market life insurance and annuity products.

direct response system

a marketing system by which life and health insurance products are sold directly to consumers without a face-to-face meeting with an agent.

advantages:

• Insurers gain access to large markets;

• acquisition costs can be held down;

• and uncomplicated products, such as term insurance, can be sold effectively.

disadvantages

• complex products are often difficult to sell because an agent’s services may be required.

other distribution systems

• worksite marketing

• stock brokers

• financial planners

• group insurance

the major distribution systems for marketing property and casualty insurance

• Independent agency system

• Exclusive agency system

• Direct writer

• Direct response system

• Multiple distribution systems

independent agency system

• a major distribution form for property and casualty insurance

basic characteristics:

• the independent agency is a business firm that usually represents several unrelated insurers. Agents are authorized to write business on behalf of these insurers and, in turn, are paid a commission based on the amount of business produced.

• Second, the agency owns the expirations or renewal rights to the business. It may bill the policy holders and collect premiums, but most insurers use direct billing

• the independent agent is compensated by commissions based on the amount of business, which vary by line of insurance.

• They are frequently authorized to adjust small claims.

• Larger agencies may also provide loss control services to their insureds, such as accident prevention and loss control engineering.

direct billing

the policyholder is billed directly by the insurer.

exclusive agency system

the agent represents only one insurer or a group of insurers under common ownership

• Agents under the exclusive agency system do not usually own the expirations or renewal rights to the policies.

• Agents are generally paid a lower commission rate on renewal business than on new business

• exclusive agency insures provide strong support services to new agents

mass merchandising

a plan for selling individually underwritten, property and casualty coverages to members of a group; popular products include auto and homeowners insurance.

• used by some property and casualty insurers

multiple distribution systems

The distinctions between the traditional marketing systems are breaking down as insurers search for new ways to sell insurance. To increase their profits, many property and casualty insurers use more than one distribution system to sell insurance. These systems are referred to as ________

• used my many property and casualty insurers

direct writer

an insurer in which the salesperson is an employee of the insurer, not an independent contractor, and which pays all selling expenses, including salary. In property and casualty insurance, the term direct writer is also used to describe insurers that use the exclusive agency system.

• employees are usually compensated on a “salary plus” arrangement

direct response insurer

where the insurer directly sells to the consumer by television or some other media

end ch 5

most important operations of an insurance company

• rate making

• underwriting

• production

• claims settlement

• reinsurance

• investments

rate making

refers to the pricing of insurance and the calculation of insurance premiums.

rate

the price per unit of insurance

exposure unit

the unit of measurement used in insurance pricing, which varies by line of insurance.

premium equation

= rate*exposure units

how insurance pricing differs from the pricing of other products

The total premiums charged for a given line of insurance may be inadequate for paying all claims and expenses during the policy period. It is only after the period of protection has expired that an insurer can determine its actual losses and expenses.

actuary

a professional who is highly skilled in mathematics and statistics.

• they determine rates and premiums

• Actuaries are involved in all phases of insurance company operations, including planning, pricing, expenses allocation, research, and compiling statistics for company management and for state regulatory officials.

premium requirements that actuary’s look for

1. allow the company to pay claims and expenses as they occur

2. enable the company to compete effectively with other insurers

3. make the business profitable.

underwriting

refers to the process of selecting, ­classifying, and pricing applicants for insurance. The underwriter is the person who makes those decisions.

statement of underwriting policy

Underwriting starts with a clear statement of underwriting policy that is consistent with a company’s mission and goals.

underwriting guide

The underwriting policy is implemented through a detailed underwriting guide that governs the daily operations of the underwriting department. It provides rules and guidelines for all important components of the underwriting process.

States:

1. what lines of insurance to sell

2. what classes of business are acceptable, borderline, or prohibited

3. whether to write a large volume of business with a low profit margin or a smaller volume with a larger margin of profit

4. the amounts of insurance that can be written and retained

5. territories to be developed

6. forms and rating plans to be used.

basic underwriting principles

• the underwriting process must achieve an underwriting profit so that the company will be successful.

• the underwriting department must select prospective insureds according to the company’s underwriting standards. In other words, the underwriters should select only those insureds whose actual loss experience is not likely to exceed the loss experience assumed in the rating structure.

• equity among the policyholders. This means that equitable rates should be charged, and that each group of policyholders should pay its own way in terms of losses and expenses.

adverse selection

the tendency of people with a higher-than-average chance of loss to seek insurance at standard (average) rates; if it is not controlled by underwriting (and policy provisions) it will result in higher-than-expected loss levels.

field underwriting

After the insurer establishes an underwriting policy it must communicate the policy to its sales force. Initial underwriting starts with the agent in the field

• The agent is told what types of applicants are acceptable, borderline, or prohibited.

sources of information for underwriting

• application

• agent’s report

• inspection report

• physical inspection

• physical examination and attending physician’s report

• Medical information bureau (MIB) report

underwriting decisions

• accept the application

• accept the application subject to certain restrictions or modifications

• reject the application

computerized underwriting

Computerized underwriting is widely used for certain personal lines of insurance that can be standardized, such as auto and homeowners insurance. It promotes faster, more efficient underwriting decisions.

other factors considered in underwriting

• rate adequacy and underwriting

• reinsurance and underwriting

• renewal underwriting

rate adequacy and underwriting

Property and casualty insurers are more willing to underwrite new business for a specific line if rates are generally considered adequate. However, if rates are inadequate, prudent underwriting requires a more conservative approach to the acceptance of new business. If moral hazard is excessive, the business generally cannot be insured at any rate.

reinsurance and underwriting

Availability of reinsurance may result in more liberal underwriting. However, if reinsurance cannot be obtained on favorable terms, underwriting may be more restrictive.

renewal underwriting

In life insurance, policies are not cancellable. In property and casualty insurance, most policies can be cancelled or not renewed. If the loss experience is unfavorable, the insurer may either cancel or not renew the policy. Most states have placed restrictions on the insurer’s right to cancel.

production

refers to the sales and marketing activities of insurers.

producers

agents who sell insurance

• especially in property/liability insurance, because “no business is produced until a policy is sold.”

life insurer departments

Life insurers have an agency or sales department.

• This department is responsible for recruiting and training new agents and for the supervision of general agents, branch office managers, and local agents.

property and casualty departments

Property and casualty insurers have marketing departments.

• To assist agents in the field, special agents may also be appointed.

special agent

a highly specialized technician who provides local agents in the field with technical help and assistance with their marketing problems.

• For example, a special agent may explain a new policy form or a special rating plan to agents in the field.

professionalism in selling

For many years the marketing of insurance has been characterized by a distinct trend toward professionalism.

• This means that the modern producer should be a competent professional who (1) has the high degree of technical knowledge required to manage the risks facing individuals and businesses today and (2) places the needs of his or her clients first.

several organizations have developed professional designation programs for insurance personnel

• the American college: (chartered life underwriter, chartered financial consultant)

• the American Institute for Chartered Property and Casualty Underwriters: CPCU

• certified financial planner board of standards, inc.: CFP

• National alliance for insurance education and research: certified insurance counselor (CIC)

basic objectives in claims settlement

• verify that the loss is covered

• pay the claim fairly and promptly

• provide personal assistance to the insured

Some unfair claim practices prohibited by the National Association of Insurance Commissioners’ Unfair Claim Settlement Practices Model Act

Some unfair claim practices prohibited by these laws include the following:

• Refusing to pay claims without conducting a reasonable investigation

• Not attempting in good faith to provide prompt, fair, and equitable settlements of claims in which liability has become reasonably clear

• Compelling insureds or beneficiaries to institute lawsuits to recover amounts due under its policies by offering substantially less than the amounts ultimately recovered in suits brought by them

• Misrepresentation of material facts or policy provisions by insurers that pertain to a coverage issue

party involved in claims settlement

• agents

• staff claims representatives (aka staff adjusters)

• independent adjusters

• public adjusters

insurance agents (claims settlement)

often have authority to settle small first-party claims up to some maximum limit.

• A first-party claim is a claim submitted by the insured to the insurer, such as a small theft loss by the insured. The insured submits the claim directly to the agent, who has the authority to pay up to some specified amount. This approach to claims settlement has several advantages: It is speedy, it reduces adjustment expenses, and it preserves the policyholder’s goodwill.

staff claims representatives (claims settlement)

salaried employees of an insurer. After the company receives notice of a loss, a claims representative, also known as a staff adjuster, will investigate the claim, determine the amount of loss, and arrange for the appropriate payment. Staff adjusters handle most claims.

independent adjusters (claims settlement)

an organization or individual that is not part of an insurance company and settles claims for a fee.

• Property and casualty insurers often use independent adjusters when a ­catastrophic loss (such as a hurricane) occurs and a large number of claims are submitted at the same time.

• They also may be used with specialized types of claims (for example, fine arts) or in a geographic area where an insurer cannot justify maintaining a branch office with full-time adjusters.

public adjusters (claims settlement)

represents the insured rather than the insurance company and is paid a fee based on the amount of the claim ­settlement.

• A public adjuster may be employed by the insured if a complex loss situation occurs and tech­nical assistance is needed and in those cases where the insured and insurer cannot resolve a dispute over a claim.

steps in settlement of a claim

• The insured provides prompt notice of loss.

  • usually immediately or as soon as possible

• The insurer investigates the claim with the cooperation of the insured.

  • an adjustor must determine that a covered loss has occurred and determine the amount of the loss

• The insured provides a proof of loss if required.

• The insurer makes a decision about paying the claim.

  • can be paid as submitted, denied, it may be valid but there may be a dispute between the insured and the insurer over the amount paid

  • policy provisions address how disputes may be resolved

reinsurance

an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance.

ceding company (reinsurance)

the primary insurer that initially writes the insurance.

reinsurer (reinsurance)

the insurer that accepts part or all of the insurance from the ceding company.

retention limit (or net retention)

The amount of insurance retained by the ceding company for its own account

cession

The amount of ­insurance ceded to the reinsurer

retrocession

the reinsurer in turn may reinsure part or all of the risk with another insurer.

• In this case, the second reinsurer is called a retrocessionaire

reasons for reinsurance

• increase underwriting capacity

• Stabilize profits

• Reduce the unearned premium reserve

  • a liability item on the insurer’s balance sheet that represents the unearned portion of gross premiums on all outstanding policies at the time of valuation

• Provide protection against a catastrophic loss

• Enable an insurer to retire from a territory or class of business

• Obtain underwriting advice from the reinsurer

types of reinsurance

• facultative reinsurance

• treaty reinsurance

facultative reinsurance

an optional, case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit.

• often used when the primary insurer has an application for a large amount of insurance

• Not automatic. The primary insurer negotiates a separate contract with a reinsurer for each reinsured loss exposure.

Adv.

• flexible because it can be tailored to fit any type of case

• it can increase the capacity of the primary insurer to write large amounts of insurance

• it can help stabilize the financial operations of the primary insure by shifting part of the large loss to the reinsurer

Disadvantages

• There is some uncertainty because the primary insurer does not know in advance whether a reinsurer will accept any part of the insurance.

• There can also be a problem of delay because the policy will not be issued until reinsurance is obtained.

• Finally, during periods of poor loss experience, reinsurance markets tend to tighten, and facultative reinsurance may be more costly and more difficult to obtain.

treaty reinsurance

an agreement under which the primary insurer must automatically cede to the reinsurer all business written in a certain category, and the reinsurer must accept the business.

• all business that alls within the scope of the agreement is automatically reinsured according to the terms of the treaty

advantages:

• It is automatic, no uncertainty or delay is involved, and it is economical because it is not necessary to negotiate reinsurance terms before the policy is written.

disadvantages:

• Treaty reinsurance may be unprofitable to either party, however. The primary insurer may negotiate terms that prove to be disadvantageous to it and be unable to withdraw from the treaty as quickly as it would like. On the other hand, the reinsurer must follow the fortunes of the primary insurer. It generally has no knowledge about each individual loss exposure and must rely on the underwriting judgment of the primary insurer. The primary insurer may write bad business that automatically is reinsured. Also, the ­premiums received by the reinsurer may be inadequate. Thus, if the primary insurer has a poor selection of risks or charges inadequate rates, the reinsurer could incur a loss. However, if the primary insurer consistently cedes unprofitable business to its reinsurers, the ceding insurer will find it difficult to operate because reinsurers will not want to do business with it.

methods for sharing losses

• pro rata

• excess of loss

pro rata method

the ceding company and reinsurer agree to share losses and premiums based on some proportion.