Insurance Sources | General Insurance Concepts

Insurance is provided to the public by three major sources:

Service Providers
Government
Private Commercial Insurers

Service Providers

Some organizations resemble private insurance companies by offering protection against the financial loss caused by illness and accidents. However, in key respects these organizations are quite different from private insurers. Examples of service providers are health maintenance organizations (HMOs) and preferred provider organizations (PPOs). Service providers will be discussed in detail later in this text.

Government Insurers

The federal government offers a variety of military life and health insurance plans (SGLI, or Servicemen’s Group Life Insurance, TRICARE, and CHAMPUS) as well as Medicare, which is the health insurance part of Social Security.

At the state level, governments are involved in providing unemployment insurance, workers’ compensation programs, and state-run medical expense insurance plans (Medicaid).

Federal, state, and local governments provide social insurance to a segment of the population that would otherwise be without coverage.

Private Commercial Insurers

Private insurers may be organized as stock companies, mutual companies, reciprocal insurers, or fraternal organizations. An insurance company intending to do business in any given state must be authorized by the director/commissioner of insurance. If the director is satisfied that the insurer meets that state’s standards of financial strength, and that allowing them the opportunity to sell insurance in the state doesn’t jeopardize the public interest, they will be granted a certificate of authority and will be referred to as admitted or authorized.

Sidenote

Know this...

The only insurers exempt from obtaining a certificate of authority prior to transacting business in any particular state are Excess and Surplus Lines brokers and reinsurers (discussed later).

Stock Companies

Companies that are structured in a traditional corporate manner are called stock companies. These companies are owned by stockholders who may or may not be policy owners. Profits made by a stock company are passed on to the stockholders in the form of stock dividends. Most life insurance companies today are stock companies, but most of the in force insurance is held by mutual companies.

Mutual Companies

A mutual insurance company is owned by its policy owners. It is structured as a corporation, with the exception that ownership in the company is evidenced through ownership of a policy, not a stock certificate. Earnings from a mutual company’s operations are passed on to the policy owners in the form of policy dividends.

Mutual companies distribute policy dividends through participating policies. This term reflects the fact that policy owners participate in the earnings of the company. Stock companies generally issue only non-participating policies, meaning that policy owners do not share in company profits.

Reciprocal Insurers

Through individual indemnity agreements certain groups of people provide insurance for one another. Each insured of the reciprocal is called a subscriber. Each subscriber is allocated a separate account where his/her premiums are paid and interest earned is tracked. If any subscriber suffers a loss covered by the reciprocal insurance, each subscriber’s account would be charged an equal amount to pay the claim. The party who acts as principal of a reciprocal insurance company is known as an attorney-in-fact.

Fraternal Organizations

A fourth type of organization in the business of issuing life and health insurance is the fraternal organization. A fraternal organization is a nonprofit entity that sells only to its members, and that must be created for some purpose other than selling insurance. These organizations must have a representative form of management with elected officers. A distinguishing characteristic of fraternal life insurance is the open contract, which allows fraternal insurers to assess their policyholders in times of financial difficulty.

Other Types of Private Insurers

Lloyd’s

Lloyd’s of London is not an insurance company, but is similar to a stock exchange. Just as an exchange provides facilities for its members but does not buy or sell securities itself, Lloyd’s provides a meeting place to its members who actually transact the business of insurance. Members may be individuals or corporations and are grouped into syndicates, but they remain individually liable and responsible for the contracts of insurance they enter into.

Excess and Surplus Lines

For some risks, the only market may be with specialty carriers. Excess and Surplus Lines is the name given to insurance for which there is no market or insurance available through authorized carriers in the state where the risk arises or is located.

Reinsurers

Reinsurance is a contract between insurers that exists when one insurer (the reinsurer) agrees to accept a portion of a risk covered by another insurer (typically a smaller company). The ceding company is responsible for any coverage it has written, but will have a legitimate claim against the reinsurer for any portion of its loss that is reinsured.

Under facultative reinsurance, the risks are considered individually by both parties. The ceding insurer may submit the risk to the reinsurer and who may either accept or reject it.
Under automatic reinsurance, the reinsurer agrees, in advance, to automatically accept a portion of a risk from the ceding insurer. Conversely, the ceding insurer has agreed to “cede” a portion of the risk automatically to the reinsurer.

A quota share agreement involves a ceding insurer agreeing to pay a reinsurer a specific percentage (i.e. 30%) of the premium collected if the reinsurer agrees to pay the same percentage of any loss that occurs.

An excess loss agreement involves the reinsurer agreeing to pay only when a loss exceeds a specific amount.

Regulatory Classifications

Another method of categorizing private insurers that disregards whether they are a stock, mutual, reciprocal, or fraternal organization relates to the regulation of insurers. To better understand this concept, it is important to know that the insurance industry is regulated primarily at the state level (not federal) and insurers can be categorized by their state of domicile.

After the South-Eastern Underwriters Decision established that insurance transacted across state lines was interstate commerce, the McCarran-Ferguson Act was drafted to give the federal government the right to regulate insurance, but only to the extent that the state does not.

An insurance company headquartered and charted in the state in question is a domestic insurer. For example, XYZ Life Insurance Company is headquartered in Arizona. In Arizona, XYZ Life Insurance Company is a domestic insurer.
A company whose home office is in another state is a foreign company. Using the example from above, XYZ Life Insurance Company is a foreign company in Vermont. A company headquartered in another country is an alien company. XYZ Life Insurance Company would be considered an alien insurer in Canada.

Lesson Summary

Insurance is provided to the public through 3 main sources: Service Providers, Government, and Private Commercial Insurers.

Service Providers: Organizations like Health Maintenance Organizations (HMOs) and Preferred Provider Organizations (PPOs) offer protection against financial losses from illness and accidents.
Government Insurers: The federal government offers various military life and health insurance plans like SGLI and Medicare. At the state level, government involvement includes providing unemployment insurance, workers’ compensation, and state-run medical expense insurance.
Private Commercial Insurers: Private insurers can be stock companies, mutual companies, reciprocal insurers, or fraternal organizations. They must be authorized by the state’s insurance director or commissioner to operate in that state.

Private insurers are further divided into different types:

Stock Companies: Owned by stockholders; profits are distributed as stock dividends.
Mutual Companies: Owned by policyholders; profits are shared through policy dividends.
Reciprocal Insurers: Groups of people provide insurance for each other through indemnity agreements.
Fraternal Organizations: Nonprofit entities sell insurance exclusively to members with elected officers.

Other types of private insurers include Lloyd’s of London (not an insurance company but a market for insurance transactions), Excess and Surplus Lines (specialty carriers for unique risks), and reinsurers (accept a portion of risk from other insurers).

Chapter Vocabulary

Definitions

Admitted (Authorized) Company: An insurance company authorized and licensed to do business in a given state.
Alien Insurer: An insurer organized and domiciled in a country other than the United States. The company must conform to state regulatory standards to legally sell insurance products in that state.
Authorized Company: See Admitted Company.
Ceded Premium: Amount of premium (fees) used to purchase reinsurance.
Ceding Company: An insurance company that transfers risk by purchasing reinsurance.
Direct Writer: An insurance company that sells policies to the insured through salaried representatives or exclusive agents only; reinsurance companies that deal directly with ceding companies instead of using brokers.
Domestic Insurer: An insurance company that is domiciled and licensed in the state in which it sells insurance.
Excess and Surplus Lines: The name given to insurance for which there is no market or insurance available through authorized carriers in the state where the risk arises or is located.
Foreign Insurer: An insurance company selling policies in a state other than the state in which they are incorporated or domiciled.
Fraternal Insurance: A form of group coverage or disability insurance available to members of a fraternal organization.
Lloyd’s of London: Association offering membership in various syndicates of wealthy individuals organized for the purpose of writing insurance for a particular hazard.
McCarran-Ferguson Act: Federal law signed in 1945 in which Congress declared that states would continue to regulate the insurance business. Grants insurers a limited exemption from federal antitrust legislation.
Mutual Insurance Company: A privately held insurer owned by its policyholders, operated as a nonprofit, that may or may not be incorporated.
Non-Admitted Insurer: Insurance company not licensed to do business within a given state.
Participating: Insurance that pays dividends to policy holders, typically issued by a mutual insurance company.
Policy Dividend: A refund of part of the premium on a participating life insurance policy. Amount of payment is determined by subtracting the actual premium expense from the premium charged. The payment can be taken as cash, applied to a purchase an increment of paid-up insurance, left on deposit with the insurance company, or applied to purchase term insurance for one year.
Reciprocal Insurer: Reciprocal insurers are unincorporated groups of people providing insurance for one another through individual indemnity agreements.
Reinsurance: A contract where one insurer (the reinsurer) agrees to accept a portion of a risk from another insurer (the ceding company), which remains responsible for the coverage but can claim losses from the reinsurer for the reinsured part. Facultative reinsurance is negotiated individually for each risk, while automatic reinsurance is agreed in advance. Common forms include quota share agreements, where premiums and losses are shared by percentage, and excess loss agreements, where the reinsurer pays only losses above a set amount.
Reinsurer: Company assuming reinsurance risk.
State of Domicile: The state where a company’s home office is located.
Stock Insurance Company: Insurance business owned by stockholders.
Surplus Lines: The name given to insurance for which there is no market or insurance available through authorized carriers in the state where the risk arises or is located.
Unauthorized (Non-Admitted) Insurer: An insurer not licensed to sell insurance within a state. Also, Excess/Surplus Lines brokers and reinsurers do not need a certificate of authority and may be referred to as “unauthorized.”