Reserves

Reserves are the accounting measurement of an insurer’s future obligations to its policyholders.
They are classified as liabilities on the insurance company’s accounting statements since they must
be settled at a future date.

► Liquidity indicates a company's ability to make unpredictable payouts to policyowners.

Types of Insurance Companies

There are many ways to classify organizations that provide insurance. In the broadest of terms, there are two
classifications: private commercial and government. Within these two classes are many categories of insurance
providers as well as insurance plans and insurance producers.

Private Insurance Companies - Commercial

Commercial insurers offer many lines of insurance. Some sell primarily life insurance and annuities, while others
sell accident and health insurance, or property and casualty insurance. Companies that sell more than one
line of insurance are known as multi-line insurers.

Stock Companies - Nonparticipating

A stock insurance company is a private organization, organized and incorporated under state laws for the purpose of making a profit for its stockholders (shareholders). It is structured the same as any corporation. Stockholders may or may not be policyholders. When declared, stock dividends are paid to stockholders. In a stock company, the directors and officers are responsible to the stockholders. A stock company is referred to as a nonparticipating company because policyholders do not participate in dividends resulting from stock ownership.

Mutual Companies - Participating

Mutual insurance companies are also organized and incorporated under state laws, but they have no stockholders.
Instead, the owners are the policyholders. Anyone purchasing insurance from a mutual insurer is both a customer and
an owner. He has the right to vote for members of the board of directors. By issuing participating policies that pay
policy dividends, mutual insurers allow their policyowners to share in any company earnings (divisible surplus).
Essentially, policy dividends represent a "refund" of the portion of premium that remains after the
company has set aside the necessary reserves and has made deductions for claims and expenses. Policy dividends
can also include a share in the company's investment, mortality, and operating profits. Surpluses are typically
distributed to policyowners on an annual basis.

Mutual companies are sometimes referred to as participating
companies because the policyowners participate in dividends.

Occasionally, a stock company may be converted into a mutual
company through a process called mutualization. Likewise, mutuals
can convert to stock companies through a process called
demutualization. Stock and mutual companies are often referred to
as commercial insurers. They both can write life, health, property, and casualty insurance.

Strong Assessment Mutual/Insurers

Assessment mutual companies are classified by the way in which they charge premiums. A pure assessment mutual
company operates on the basis of loss-sharing by group members. No premium is payable in advance. Instead, each
member is assessed an individual portion of losses that actually occur. An advance premium assessment mutual
charges a premium at the beginning of the policy period. If the original premiums exceed the operating expenses and
losses, the surplus is returned to the policyholders as dividends. However, if total premiums are not enough to meet
losses, additional assessments are levied against the members. Normally, the amount of assessment that may be
levied is limited either by state law or simply as a provision in the insurer’s by-laws.

Reciprocal Insurers

Similar to mutuals, reciprocal insurers are organized on the basis of ownership by their policyholders. However, with
reciprocals, it is the policyholders themselves who insure the risks of the other policyholders. Each policyholder
assumes a share of the risk brought to the company by others. Reciprocals are managed by an attorney-in-fact.

Lloyd's of London

Contrary to popular belief, Lloyd’s of London is not an insurer but rather a syndicate of individuals and companies
that individually under­write insurance. Lloyd's can be compared to the New York Stock Exchange, which provides
the arena and facilities for buying and selling public stock. Lloyd's function is to gather and disseminate underwriting
information, help its associates settle claims and disputes and, through its member underwriters, provide coverages
that might otherwise be unavailable in certain areas.

Reinsurers

Reinsurers are a specialized branch of the insurance industry because they insure insurers. Reinsurance is an
arrangement by which an insurance company transfers a portion of a risk it has assumed to another insurer. Usually,
reinsurance takes place to limit the loss any one insurer would face should a very large claim become payable.
Another reason for reinsurance is to enable a company to meet certain objectives, such as favorable underwriting or
mortality results. The company transferring the risk is called the ceding company; the company assuming the risk is
the reinsurer. A common reinsurance contract between two insurance companies is called treaty reinsurance,
which involves an automatic sharing of the risks assumed.

Captive Insurer

An insurer established and owned by a parent firm for the purpose of insuring the parent firm's loss exposure
is known as a captive insurer.

Risk Retention Group

A risk retention group (RRG) is a mutual insurance company formed to insure people in the same business,
occupation, or profession (e.g., pharmacists, dentists, or engineers).

Fraternal Benefit Societies

Insurance is also issued by fraternal benefit societies, which have existed in the United States for more than a
century. Fraternal societies, noted primarily for their social, charitable, and benevolent activities, have memberships
based on religious, national, or ethnic lines. Fraternals first began offering insurance to meet the needs of their
poorer members, funding the benefits on a pure assessment basis. Today, few fraternals rely on an assessment
system, most having adopted the same advanced funding approach other insurers use. To be characterized as a
fraternal benefit society, the organization must be nonprofit, have a lodge system that includes ritualistic work,
and maintain a representative form of government with elected officers. Fraternals must be formed for reasons other than obtaining insurance. Most fraternals today issue group and annuities with many of the same provisions found in policies issued by commercial insurers.

Industrial Insurer

Insurance is also sold through a special branch of the industry known as home service or "debit" insurers. These
companies specialize in a particular type of insurance called industrial insurance, which is characterized by relatively
small face amounts (usually $1,000 to $2,000) with premiums paid weekly.

Service Providers

Service providers offer benefits to subscribers in return for the payment
of a premium. Benefits are in the form of services provided by the
hospitals and physicians participating in the plan. They sell medical
and hospital care services, not insurance. These services are
packaged into various plans, and those who purchase these plans are
known as subscribers.

Another type of service provider is the health maintenance organization (HMO). HMOs offer a wide range of health care
services to member subscribers. For a fixed periodic premium paid in advance of any treatment, subscribers are
entitled to the services of certain physicians and hospitals contracted to work with the HMO. Unlike commercial
insurers, HMOs provide financing for health care plus the health care itself. HMOs are known for stressing preventive
health care and early treatment programs.

A third type of service provider is the preferred provider organization (PPO). Under the usual PPO arrangement, a
group desiring health care services (e.g., an employer or a union) will obtain price discounts or special services from
certain select health care providers in exchange for referring its employees or members to them. PPOs can be
organized by employers or by the health care providers themselves. The contract between the employer and the
health care professional, whether physician or a hospital, spells out the kind of services to be provided. Insurance
companies can also contract with PPOs to offer services to insureds.

Government as Insurer

As noted at the beginning of this unit, federal and state governments are also insurers, providing what are commonly
called social insurance programs. Ranging from crop insurance to bank and savings and loan deposit insurance, these
programs have far-reaching effects. Millions of people rely on these plans. Social insurance programs include the following:


►Old-Age, Survivors, and Disability Insurance (OASDI), commonly known as Social Security

►Social Security Hospital Insurance (HI) and Supplemental Medical Insurance (SMI), commonly known as Medicare

►Medicaid

The government plays a vital role in providing social insurance programs. These programs pay billions of dollars in
benefits every year and affect mil­lions of people.

Self-Insurers

Though self-insurance is not a method of transferring risk, it is an important concept to understand. Rather than
transfer risk to an insurance company, a self-insurer establishes its own self-funded plan to cover potential losses.
Self-insurance is often used by large companies for funding pension plans and some health insurance plans. Many
times, a self-insurer will look to an insurance company to provide insurance above a certain maximum level of loss.
The self-insurer will bear the amount of loss below that maximum amount.

How Insurance is Sold

Insurance is sold by a variety of companies and methods. Most consumers purchase insurance through licensed
producers who present insurers’ products and services to the public via active sales and marketing methods.
Insurance producers may be agents, who represent a particular company, or brokers, who are not tied to any
particular company and can represent many insurers' products. In a sales transaction, agents represent the insurer
and brokers represent the buyer. An agent has an agent's contract; a broker has a broker's contract. Agents are also
classified as captive or career agents and independent agents. A captive or career agent works for one insurance
company and sells only that company's insurance policies. An independent agent works for himself and sells the
insurance products of many companies.

• The agent's contract and appointment with the insurance company grants the authority to bind an insurer to an insurance contract

 

In any dispute between the insured or beneficiary and the insurer, the agent who solicits an insurance application
represents the insurer and not the insured or beneficiary. In most states, however, the agent may represent as
many insurers as will appoint him.

There are three systems that support the sale of insurance through agents and brokers. These are the career
agency system, personal producing general agency system, and independent agency system.

Career Agency System

Career agencies are branches of major stock and mutual insurance companies that are contracted to represent an
insurer in a specific area. In career agencies, insurance agents are recruited, trained, and supervised by either a
manager employee of the company or a general agent (GA) who has a vested right in any business written by the
GA's agents. GAs may operate strictly as managers, or they may devote a portion of their time to sales. The career
agency system focuses on building sales staffs.

Personal Producing General Agency System

The personal producing general agency (PPGA) system is similar to the career agency system. However, PPGAs do
not recruit, train, or supervise career agents. They primarily sell insurance, although they may build a small sales force
to assist them. PPGAs are generally responsible for maintaining their own offices and administrative staff. Agents
hired by a PPGA are considered employees of the PPGA, not the insurance company, and are supervised by regional directors.

 

Independent Agency System

The independent agency system, a creation of the property and casualty industry, does not tie a sales staff or agency
to any one particular insurance company. Instead, independent agents represent any number of insurance companies
through contractual agreements. They are compensated on a commission or fee-basis for the business they produce.
This system is also known as the American agency system.

Other Methods of Selling Insurance

While most insurance is sold through agents or brokers under the systems previously described, a large volume is
also marketed through direct selling and mass marketing methods.

 

With the direct selling method, the insurer deals directly with consumers by selling its policies through vending
machines, advertisements, or salaried sales representatives. No agent or broker is involved. A large volume of
insurance is also sold through mass marketing techniques, such as over the Internet, newspaper, magazine, radio,
and television ads. Mass marketing methods provide exposure to large groups of consumers, often using direct
selling methods with occasional follow-up by agents.

Evolution of Industry Oversight

The insurance industry is regulated by a number of authorities, including some inside the industry itself. The primary
purpose of this regulation is to promote public welfare by maintaining the solvency of insurance companies. Other
purposes are to provide consumer protection and ensure fair trade practices as well as fair contracts at fair prices.
It is very important insurance agents understand and obey the insurance laws and regulations.

History of Regulation

A brief overview of the history of insurance regulation will show a seesaw between the authority of the states and
the federal government. Though a balance between these two bodies has been reached and maintained for many
years, arguments favoring control by one governing authority over another are still being waged.

► 1868-Paul v. Virginia. This case, which was decided by the U.S. Supreme Court, involved one state's attempt to
regulate an insurance company domiciled in another state. The Supreme Court sided against the insurance company,
ruling that the sale and issuance of insurance is not interstate commerce, thus upholding the right of states to regulate
insurance.

► 1944-United States v. Southeastern Underwriters Association (SEUA). The decision of Paul v. Virginia held for 75
years before the Supreme Court again addressed the issue of state versus federal regulation of the insurance
industry. In the SEUA case, the Supreme Court ruled that the business of insurance is subject to a series of federal
laws, many of which were in conflict with existing state laws, and that insurance is a form of interstate commerce
to be regulated by the federal government. This decision did not affect the power of states to regulate insurance,
but it did nullify state laws that were in conflict with federal legislation. The result of the SEUA case was to shift the
balance of regulatory control to the federal government.

► 1945-The McCarran-Ferguson Act. The turmoil created by the SEUA case prompted Congress to enact
Public Law 15, the McCarran-Ferguson Act. This law made it clear that continued regulation of insurance by the
states was in the public's best interest. However, it also made possible the application of federal antitrust laws
"To the extent that [the insurance business] is not regulated by state law." This act led each state to revise its insurance laws to conform to the federal laws. Today, the insurance industry is considered to be state-regulated.

• A fine of $10,000 or up to one year in jail is the penalty for any person who violates the McCarran-Ferguson Act

► 1958-lntervention by the FTC. In the mid-1950s the Federal Trade Commission (FTC) sought to control the
advertising and sales literature used by the health insurance industry. In 1958 the Supreme Court held that the
McCarran-Ferguson Act disallowed such supervision by the FTC, a federal agency. Additional attempts have been
made by the FTC to force further federal control, but none have been successful.

► 1959-lntervention by the SEC. In this instance, the issue was variable annuities: Are the insurance products to be
regulated by the states or securities to be regulated federally by the Securities and Exchange Commission (SEC)?
The Supreme Court ruled that federal securities laws applied to insurers that issued variable annuities and, thus,
required these insurers to conform to both SEC and state regulation. The SEC also regulates variable life insurance.

► 1970-Fair Credit Reporting Act. In an attempt to protect an individual's right to privacy, the federal government
passed the Fair Credit Reporting Act, which is the authority that requires fair and accurate reporting of information
about consumers, including applications for insurance. Insurers must inform applicants about any investigations
that are being made. If any consumer report is used to deny coverage or charge higher rates, the insurer must
furnish to the applicant the name of the reporting agency conducting the investigation. Any insurance company that
fails to comply with this act is liable to the consumer for actual and punitive damages.

• The maximum penalty for obtaining Consumer Information Reports under false pretenses is $5,000 and 1 year imprisonment

► 1999-Financial Services Modernization Act. The Glass-Steagall Act of 1933, which barred common ownership
of banks, insurance companies, and securities firms and erected a regulatory wall between banks and nonfinancial
companies, came under repeated attack in the 1980s. In 1999 Congress passed the Financial Services
Modernization Act, which repealed the Glass Steagall Act. Under this new legislation, commercial banks, investment
banks, retail brokerages, and insurance companies can now enter each other's lines of business.

The chronology cited reflects the roles the courts and the federal government have played in regulating the insurance
industry. Let's now take a look at how individual states regulate this business and how the industry practices
self-regulation.

Agent Marketing and Sales Practices

Marketing and selling financial products, such as life insurance and annuities, requires a high level of professionalism
and ethics. Every state requires its licensed producers to adhere to certain standards designed to protect consumers
and promote suitable sales and application of insurance products. Some of these standards are listed below.

► Selling to needs. The ethical agent determines the client’s needs and then determines which is best
suited to address those needs. Two principles of needs-based selling include find the facts, and educate the client.

 

► Suitability of recommended products. The ethical agent assesses the correlation between a recommended
product and the client's needs and capabilities by asking and answering the following questions.

1. What are the client's needs?
2. What product can help meet those needs?
3. Does the client understand the product and its provisions?
4. Does the client have the capability, financially and otherwise, to manage the product?
5. Is this product in the client's best interest?

► Full and accurate disclosure. The ethical agent makes it a practice to inform clients about all aspects of the
products recommended, including benefits and limitations. There should never be an attempt to hide or disguise the
nature or purpose of the product nor the company being represented. Insurance products are highly effective financial
planning tools. They should be presented clearly, completely, and accurately.

► Documentation. The ethical agent documents each client meeting and transaction. The agent uses fact-finding
forms and obtains the client's written agreement for the needs determined, the products recommended, and the
decisions made. Some documentation is required by state law. Ethical agents know these laws and follow them precisely.

► Client service. The ethical agent knows that a sale does not mark the end of a relationship with a client, but the
beginning. Routine follow-up calls are recommended to ensure that the client’s needs always are covered and the
products in place still are suitable. When clients contact their agents for service or information, these requests are
given top priority. Complaints are handled promptly and fully.

Buyer's Guides and Policy Summaries

To help ensure that prospective insurance buyers select the most
appropriate plan for their needs and to improve their understanding
of basic product features, most states require agents to deliver a
buyer's guide to consumers whenever they solicit insurance sales.
These guides explain the various types of life insurance products (including
variable annuities) in a way that the average consumer can understand. In addition, a policy summary containing
information about the specific policy being recommended must be given to a potential buyer. It identifies the agent,
the insurer, the policy, and each rider, and includes information about premiums, dividends, benefit amounts, cash
surrender values, policy loan interest rates, and life insurance cost indexes of the specific policy being considered.
Most states require this to be done before the applicant's initial premium is accepted.

The policy summary also contains cost indexes that help the consumer evaluate the suitability of the recommended
product. The net payment cost comparison index gives the buyer an idea of the cost of the policy at some future
point in time compared to the death benefit. The surrender cost comparison index compares the cost of
surrendering the policy and withdrawing the cash values at some future time.

Because all states are interested in protecting the interests of the buying public, the actions of individuals soliciting
insurance sales are strictly regulated. However, the laws regarding insurance marketing and trade practices vary
from state to state. As a result, it is very important that you examine and understand your state's laws.

National Association of Insurance Commissioners

All state insurance commissioners or directors are members of the National Association of Insurance Commissioners
(NAIC). This organization has committees that work regularly to examine various aspects of the insurance industry
and to recommend appropriate insurance laws and regulations. The NAIC has four broad objectives:

1. To encourage uniformity in state insurance laws and regulations

2. To assist in the administration of those laws and regulations by promoting efficiency

3. To protect the interests of policyowners and consumers

4. To preserve state regulation of the insurance business

Advertising Code

A principal problem of states in the past was regulating misleading insurance advertising and direct mail solicitations.
Many states now subscribe to the Advertising Code developed by the NAIC. The Code specifies certain words
and phrases that are considered misleading and are not to be used in advertising of any kind. Also required under
this code is full disclosure of policy renewal, cancellation, and termination provisions.

Unfair Trade Practices Act

Most jurisdictions have also adopted the NAIC's Unfair Trade Practices Act. This act gives chief financial officers
the power to investigate insurance companies and producers, to issue cease and desist orders, and to impose
penalties. The act also gives officers the authority to seek a court injunction to restrain insurers from using any
methods believed to be unfair. Included in the context of unfair trade practices are misrepresentation and false
advertising, coercion and intimidation, unfair discrimination, and inequitable administration of claims settlements.

State Guaranty Associations

All states have established guaranty funds or guaranty associations to support insurers and to protect consumers if
an insurer becomes insolvent. Should an insurer be financially unable to pay its claims, the state guaranty association
will step in and cover the consumers' unpaid claims. These state associations are funded by insurance companies
through assessments.

Claim settlement practices

Claim settlement practices of insurers are regulated by State insurance departments.

Do Not Call Registry

The Do Not Call Registry allows consumers to include their phone numbers on the list to which solicitation calls cannot be made by telemarketers. Calls made on behalf of charities, political organizations, and surveys are exempt.

Rating Services

The financial strength and stability of an insurance company are two vitally important factors to potential insurance
buyers and to insurance companies. The PRIMARY purpose of a rating service company, such as A.M. Best, Standard & Poor’s, and Moody’s, is to determine the financial strength of the company being rated.

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