Xcel BASIC PRINCIPLES OF LIFE AND HEALTH INSURANCE
CHAPTER SUMMARY - BASIC PRINCIPLES OF LIFE AND HEALTH INSURANCE
The Concept of Insurance
Insurance is a legal contract that transfers an uncertain risk from one party to another. The insured transfers the possibility of suffering a large financial loss to an insurer in return for paying a relatively small, contractually defined premium.
An insurance policy restores an insured to the financial position she experienced before an insured loss. Insurance companies indemnify their insureds when covered losses occur.
Types of Insurance Companies
Stock Companies – Nonparticipating
Stockholders own a stock company.
Stockholders share in company profits, and, if these insurers declare stock dividends, they’re taxable.
Stock insurers issue nonparticipating insurance policies because policy owners are not stockholders and, therefore, are not owners.
Mutual Companies – Participating
The policy holders own mutual insurance companies.
Mutual insurance companies sell “participating policies” because policy owners receive a share of surplus revenue in the form of policy dividends.
The revenue paid out in the form of policy dividends is referred to as the divisible surplus.
In the aggregate, policy dividends represent a refund of excess premium or that portion of premium remaining after a company has set aside the necessary reserves.
Assessment Mutual Insurers
To pay for claims, assessment mutual insurance companies assess premiums at the time members experience losses.
Pure assessment mutual companies charge no premium in advance.
Advance premium assessment insurers levy assessments if the premium is insufficient.
Fraternal Benefit Societies
Fraternal societies are not-for-profit organizations that are noted for their social, charitable, and benevolent activities.
Fraternal membership is based on a common bond, and these organizations may form around a common religion, nationality, ethnicity, charitable cause, or other affiliation.
The three defining characteristics of a fraternal organization are as follows:
It’s non-profit.
It has a lodge system, including ritualistic work and a representative form of government.
It was not formed simply to provide insurance
Reciprocal Insurers
Each policy owner individually assumes a share of another’s risk, which makes reciprocal insurance contracts a form of risk sharing rather than risk transfer.
Policy holders receive policy dividends, and they own a share of the company surplus, which they can receive upon terminating their membership.
An attorney-in-fact is appointed to handle transactions for the reciprocal insurer.
Risk Retention Groups (RRGs)
A risk retention group (RRG) is a specialized insurance company that provides liability insurance for individuals and entities with a common bond.
Risk retention groups retain risks (risk retention) and process claims.
Risk Purchasing Groups (RPGs)
A risk purchasing group (RPG) buys coverage for its members, which must have a common bond.
The risk purchasing group becomes a master policy holder, and its members receive certificates of insurance.
Reinsurers
Reinsurers provide insurance for other insurance companies.
The reinsurer assumes risk from a ceding insurer, which is also referred to as the primary insurer.
Primary insurance companies purchase reinsurance when they underwrite large risks that could result in claims exceeding the primary carrier’s risk retention limit. The risk retention limit is the maximum amount of exposure that the insurer can carry when insuring a single risk.
Treaty reinsurance exists when a reinsurer enters into a contract with a primary insurance company to automatically assume its excess exposure for risks that meet contractually defined criteria. This agreement is also referred to as automatic reinsurance.
When a primary insurer seeks reinsurance for a specific exposure without an ongoing agreement, it’s referred to as facultative reinsurance.
A captive insurer is established to cover the loss exposure of the parent organization that owns it.
Surplus Lines Insurance Carriers are unauthorized insurers that provide coverage when authorized insurers reject buyers or authorized insurers don’t offer the type of insurance being sought.
Lloyd’s of London is a syndicate of individuals that individually underwrite special (unique) risks.
Self-Insurers establish a self-funded plan to cover potential losses and often cap potential losses with a stop-loss insurance policy. “Self-insurance” does NOT EQUAL “no insurance.”
Insurers Classified by Authorization
An authorized or admitted insurer describes an insurer that has been issued a certificate of authority from a state's insurance department authorizing the insurer to transact insurance in that state. Insurers must receive a certificate of authority from each state they wish to transact insurance.
An unauthorized (non-admitted) insurance company is prohibited from conducting insurance operations in that particular state.
Insurer Classified According To Domicile
A domestic insurer is organized and incorporated in the state in which it’s writing business.
A foreign insurer is organized under the laws of a different state.
An alien insurer is organized under the laws of a different nation.
Departments within an Insurance Company
The marketing or sales division prospects for new business.
The sales department meets with clients face-to-face and completes applications.
The underwriting department reviews applications, selects risks to insure, and assigns risk classifications.
The claims department administers claims.
The actuarial department calculates policy parameters, such as risks and costs relative to promised benefits.
Key People Within an Insurance Company
Producers
The term “Producer” describes an individual or organization that is licensed by a state to solicit, sell, or transact insurance in that state.
Licensed producers have a fiduciary responsibility to the companies they represent and the consumers they serve.
The terms “agent” and “broker” are used throughout the insurance industry to describe the legal relationship between a producer, an insurer, and a consumer.
Agents, represent one or more insurers under the terms of an appointment contract, which gives them limited authority to make binding commitments on the insurer’s behalf.
Brokers, represent themselves and the insured. The state licenses brokers, but they are not appointed by the insurer whose product is being considered by a consumer. Brokers cannot bind the insurer.
Underwriters
Underwriters identify, examine, assess, and classify loss exposures.
Underwriters approve or decline applications and determine the cost of insurance.
Actuaries calculate policy rates, reserves, and dividends.
Adjusters investigate and settle claims.
How Insurance is Sold
Most insurance purchased in the United States is sold through licensed insurance producers. Typically, these producers are agents who are appointed to represent one or more insurance companies.
Agents represent the insurer during a sales transaction and can bind insurance. In other words, they can commit the insurers that they represent to cover a risk exposure—at least temporarily.
Career Agency System
Major insurers (including direct writers) often establish career agencies, which recruit and train new agents. The agency is often a branch of a significant stock or mutual insurance company.
Some career agencies are contracted to represent an insurer in a specific geographical area or market.
A general agent typically runs a career agency.
The managerial system features career agencies that are run by a salaried branch manager.
Personal Producing General Agency System
The personal producing general agency (PPGA) system is affiliated with one or more insurers, but a PPGA doesn’t recruit, train, or supervise career agents. Instead, a PPGA focuses on sales in its assigned market or territory.
PPGAs generally maintain their own offices and staff. The staff consists of employees of the PPGA rather than of the appointing insurer.
Independent Agency System
Independent agents represent any number of insurance companies through contractual agreements.
Other Methods of Selling Insurance
Insurance companies also sell coverage using mass marketing methods that expose their products to large groups of consumers, with occasional follow-up by agents.
Insurance companies that use these methods deal directly with consumers.
Direct sellers use vending machines, advertisements, or salaried producers.
Evolution of Industry Oversight
Federal Court Cases and Legislation Affecting Insurance Industry Regulation
Paul v. Virginia (1868): The United States Supreme Court ruled that insurance is not interstate commerce, thereby upholding the states’ right to regulate it.
The United States v. Southeastern Underwriters Association (SEU) (1944): The United States Supreme Court reversed Paul v. Virginia and ruled that insurance is a form of interstate commerce and is subject to federal regulation.
The McCarran-Ferguson Act(1945): Congress responded to the SEU decision by delegating the regulation of insurance to the states while requiring compliance with federal antitrust standards – either directly or through comparable state laws. McCarran-Ferguson (also referred to a Public Law 15) also levied a maximum penalty of up to one year in jail and a fine of $10,000 for violators.
The Fair Credit Reporting Act (1970): This Act was established to protect privacy by requiring the fair and accurate reporting of consumer information.
Amendments to USC 1033 and 1034 regarding Fraud and False Statements (1994): This section of the United States Code (USC) prohibits felons (those guilty of crimes involving dishonesty or breach of trust) from participating in the insurance industry without a “Letter of Written Consent” from their state insurance regulator. Any person who engages in intentionally unfair or deceptive insurance practices is subject to a fine of up to $50,000, 15 years in prison, and license revocation.
The Financial Services Modernization Act (1999): This Act allowed banks to sell insurance and prompted states to create regulations for insurance companies to protect the privacy of consumer personal information.
The USA PATRIOT Act (2001): This Act focuses on the funding sources for terrorists and international money laundering in general.
The Do Not Call Implementation Act (2003) implemented the Do Not Call Registry, which allows consumers to opt-out of receiving calls from telemarketers, except for those on behalf of charities, political organizations, and surveys.
2003-CAN-SPAM Act: This Act outlines the right for consumers to request a business to stop sending emails, the requirements for businesses to honor such requests, and the penalties incurred for those who violate the Act. The Act does not apply to transactional and relationship messages.
National Association of Insurance Commissioners (NAIC)
The National Association of Insurance Commissioners (NAIC) is an industry association of state insurance regulators focused on establishing model acts and regulations that provide a common framework for state officials to address industry-wide issues. These regulatory models help streamline the legislative and administrative processes while encouraging uniform standards.
The NAIC lists four objectives: (1) To encourage regulatory uniformity among the states. (2) To promote efficient regulatory administration. (3) To protect policy owners and consumer interests. (4) To preserve state regulation of the insurance industry.
The NAIC’s Model Advertising Code labels certain words and phrases as inherently misleading and bans their use.
NAIC Unfair Trade Practices Act (Model) Act gives a state insurance department the power to:
Investigate insurance companies and producers.
Issue cease and desist orders.
Impose penalties.
Seek a court injunction to restrain unfair activities.
The National Conference of Insurance Legislators (NCOIL) is an association of state legislators that serves on insurance and financial institutions committees to educate policymakers and preserve state regulation. NCOIL also writes model laws.
The National Association of Insurance and Financial Advisors (NAIFA) and The National Association of Health Underwriters (NAHU) created a Code of Ethics for agents.
Agent Marketing and Sales Practices standards include:
Selling to needs: Learning and addressing client needs
Suitability: Recommending products that address client needs and match client capabilities
Full and accurate disclosure of product information
Documentation of each client meeting and transaction
Client service after the sale
Rating Services describe companies that determine an insurer’s financial strength. These services publicize the financial health of insurers after analyzing company reserves and liquidity.