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Understanding the Insurance Industry: From Regulations to Operations

I. Purpose of Insurance RegulationA. Historical disagreement regarding the need for regulation

1. Regulation is necessary to maintain competition (the regulation of competition) (aka Antitrust) by preventing: a. Monopolies

b. Collusion

c. Unfair competition or non-competition in general

2. Regulation is needed to protect the consumer from improper treatment (the regulation of performance) if: a. Necessary where monopolies cannot be prevented

b. The purpose is to make the regulated industry as beneficial to the consumer as possible

c. Necessary to control prices to assure there are no excessive profits

B. How Much Regulation is Reasonable

Little/No Competition

Absolute Antitrust/ Limited Performance

RegulationAbsolute Antitrust/ Strict Performance

Regulation

Ample Competition

Almost no Antitrust / Limited Performance

Regulation

Limited Antitrust/Strict Performance

Regulation

Minimal Harm Major Harm

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“Limited”: There are regulations, but they do not govern every aspect of the operations or actions. The industry does have options within the regulations. Must comply with the intent of the regulation or standard

“Strict”: The industry is heavily regulated and must comply with the letter of the regulations, not just the intent.

C. Why is regulation of the insurance industry necessary?

1. Insurance is an integral part of the American economy (the majority view)

a. The public welfare is served by the availability of insurance

b. Insurers must be able to fulfill the promises of protection made to the public1) Pricing must adequately reflect future demands

2) Cost must reasonable for the consumer

3) Necessary coverages must be readily available

4) Promises made in the contract must be reasonable

2. To avoid competition that might be damaging to the industry and ultimately the public (the minority view)

a. Improper pricing

b. Promising too much

II. How we Arrived Here – Insurance’s Regulatory HistoryA. At the beginning of the insurance industry in America, insurance was

regulated at the state level

B. Paul v. Virginia (1869)

1. Insurance agent Samuel Paul violated Virginia law by selling insurance in the state without a Virginia license


2. After being arrested and fined, he sued stating that insurance was interstate commerce and thus subject to federal regulation not state regulation

3. US Supreme Court in 1869 ruled that insurance was not interstate commerce and was thus subject to state regulation

4. Remained the law of the land until 1944

C. United States v. South-Eastern Underwriters Association (1944)

1. Brought by the US Attorney General

2. Claimed that the SEUA was guilty of collusion

3. Supreme Court agreed and concluded that insurance was subject to the Sherman Act and could be regulated by Congress

4. This remains the common law today

5. This decision was modified by statutory law - the McCarran-Ferguson Act (Public Law 15)

III. Application of the Current Regulatory Stance Under McCarran-FergusonA. Introduced and passed in response to the SEUA decision

B. Signed into law on March 9, 1945


C. The act does not prevent the federal government from regulating the insurance industry. It simply gives states very broad authority to regulate the industry.

D. The federal government is allowed to enact regulations for the insurance industry if it chooses. But, the law must specifically relate to insurance for it to preempt state law. Now we have the Federal Insurance Office (FIO)

E. McCarran-Ferguson provides that states have the authority to regulate the “business of insurance.”

F. Sherman Act still applies to boycott, coercion or intimidation

G. To fall under state authority to regulate (and outside of the Sherman Act), the activity must meet the definition of the “business of insurance” (Union Labor Life Insurance v. Pireno (1982)) whether:

1. The practice has the effect of transferring or spreading a policy holder’s risk;

2. The practice is an integral part of the policy relationship between the insurer and the insured; and

3. The practice is limited to entities within the insurance industry

IV. Who Regulates NowA. State legislatures


1. Enacts laws governing the conduct of insurance carriers doing business within its boundaries

2. Laws relate to domestic, foreign and alien insurance carriers permitted to conduct business in the state (known as “admitted carriers”)

3. Laws relate to requirements placed on non-admitted carriers (White List)

B. State courts interpret policy language and apply them to specific situations (creating common laws)

C. Commissioner of Insurance (Director or Superintendent)1. Appointed or Elected (Only 11 states elect their commissioner: California,

Delaware, Georgia, Kansas, Louisiana, Mississippi, Montana, North Carolina, North Dakota, Oklahoma and Washington)

2. Makes rating and form determinations

3. May have other duties

D. National Association of Insurance Commissioners (NAIC)

1. Not a regulatory body

2. Founded in 1871

3. Establishes minimum standards and model laws individual states can enact or not

4. Awards accreditation to states that comply

V. What States Regulate Now


A. Licensing of insurers

1. Controls the formation of companies

2. Decides which carriers can do business in the state

3. Monitors financial soundness (capital and surplus) in relation to code

B. Examination of insurance carriers

1. Annual reports required of every admitted carrier

2. Physically examines and inspects domestic carriers at least once every three to five years

C. Insolvencies

1. Uses the NAIC-developed Insurance Regulatory Information System (IRIS) to analyze selected audit ratios

2. Deviations from “normal” ratios prompts close scrutiny of the insurer

3. If there is an insolvency or potential insolvencya. The first choice is rehabilitation

1) Reinsurance

2) Merger

b. The second (and less desirable) option is liquidation

D. Rates

1. Adequate


2. Not excessive

3. Not unfairly discriminatory

4. Four common approaches to rate regulation (often used in combination)a. Prior-Approval

b. Open Competition

c. File and Use

d. Use and File

e. Flex Rating

E. Reserves

1. Earned premiums

2. Unearned premium reserves

3. Loss reservesa. Reported not yet paid

b. Incurred but not reported (IBNR)

F. Investments

G. Forms

H. Agent qualifications


I. Unfair trade practices

1. Misrepresent pertinent facts or insurance policy provisions relating to coverages applying to a loss;

2. Fail to acknowledge and act reasonably promptly upon notice of a claim arising under an insurance policy;

3. Fail to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies;

4. Refuse to pay claims without conducting a reasonable investigation based upon all available information;

5. Fail to affirm or deny coverage of a claim within a reasonable time after proof-of-loss statements have been completed and submitted;

6. Fail to attempt in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear;

7. Compel the insured to institute litigation to recover amounts due under an insurance policy by offering substantially less than the amounts ultimately recovered in actions brought by such insured;

8. Attempt to settle a claim for less than the amount to which a reasonable man would have believed he was entitled;

9. Attempt to settle claims on the basis of an application which was altered without notice to, or knowledge or consent of, the insured;

10. Make claims payments to insureds or beneficiaries unless accompanied by a statement setting forth the coverage under which the payments are being made;

11. Make known to insureds or claimants a policy of appealing from arbitration awards in favor of insureds or claimants for the purpose of (in order to) compelling the insureds or claimants to accept settlements or compromises less than the amount awarded in arbitration;

12. Delay the investigation or payment of claims by requiring an insured claimant, or the physician, of [or] either, to submit a preliminary claim


report and then requiring the subsequent submission of formal proof-of-loss forms, both of which submissions contain substantially the same information;

13. Fail to promptly settle claims where liability has become reasonably clear under one portion of the insurance policy in order to influence settlements under other portions of the insurance coverage;

14. Refuse, fail or unreasonably delay a settlement offer under applicable first-

party coverage on the basis that other coverage may be available or that third parties are responsible for the damages suffered, except as may be specifically provided in the policy; and

15. Fail to promptly provide the policyholder a reasonable explanation of the basis in the policy, in relation to the facts or applicable law, for the insurer's denial of a claim or refusal to offer a compromise settlement.

VI. Three Distinctive Types (Styles) of InsuranceA. Private Insurance

B. Social Insurance

C. Public Guarantee Insurance

VII. Private InsuranceA. Three broad categories of private insurance

1. Property and Liability (or Casualty)

2. Life Insurance

3. Accident & Health


B. Property & Liability (Casualty)

1. Ocean and Inland (Marine Insurance)a. Marine is the oldest branch of modern insurance

b. Lloyds of London - ship owners met with investors to “insure” against the “perils of the sea”

c. Ocean Marine: To cover the perils of the sea and may include while being

moved on land depending on the policy and the contractual requirements (FOB, FAS). “Blue Water” coverage.

d. Inland Marine: Designed to cover mobile property on land and transported on “brown water.” Also covers “instrumentalities of transportation.”

2. Fire” Insurance (more appropriately – “Property Insurance”)a. Triggered by the Great Fire of London in 1666

b. The oldest fire insurance company in the US was started by Benjamin Franklin, the Philadelphia Contributorship for the Insurance of Houses from Loss by Fire (pioneer in required loss control measures)

c. Has moved from a named peril (fire, lightning and removal) form to an “open peril” coverage (loss is covered unless specifically excluded)

3. Casualty linesa. Liability: coverage for legal liability to a third party

b. Automobile: provides liability, med pay, physical damage and UM & UIM

c. Workers’ Compensation (Should be classed separately)

d. Equipment Breakdown (Boiler & Machinery)

e. Burglary, Robbery and Theft: May require crime forms or even bonds. The proper form is based on who took the property, who owned the property and the type of property taken.


f. Plate Glass: No longer necessary except maybe tenant coverage (CP 14 70 being remove 9/1/17) (There is a “Broken or Cracked Glass Exclusion” endorsement (CP 10 52))

g. Title Insurance: Protects against financial loss arising out of a defective title

h. Credit Insurance: Provides protection to manufacturers and wholesalers unable to collect money owed by customers. Does not cover “normal” bad debt, only excessive bad debt.

i. Fidelity and Surety Bonds

4. Workers’ Compensation (sometimes considered a form of “Social Insurance”)a. Covers the medical and indemnity costs associated with injuries arising out

of and in the course and scope of employment.

b. Statutorily required in every state (with various triggers)

c. Benefits are prescribed by statute

d. Benefits are provided as the “Sole Remedy”

e. Three “market” methods: 1) Fully private; 2) Competitive State Funds; 3) Monopolistic States (Nevada, Ohio, Washington, Wyoming)

f. Germany instituted the first workers’ compensation program in 1884

g. England followed in 1897

h. The first workers’ compensation laws in America were struck down as unconstitutional and violation of “due process”

i. The first workers’ compensation law to survive challenge was Wisconsin in 1911

5. Fidelity and Surety Bondsa. Fidelity – regarding honesty. Surety – “Guarantee” the ability to perform a

specified task


b. Bonds and insurance differs

c. Three parties to a bond: Principal (obligor); Obligee; and Surety

d. The surety can collect from the principal if there is a payment made

e. Three “C’s” of bonding: Character; Capacity; and Capital

f. The MCS-90 is also a bond-like form

C. Life Insurance: Provides protection against the financial burden caused by a premature death. Certain products assist when the individual lives well beyond their earning capacity (“superannuation”).

1. Temporary / Term coverage

2. Permanent coverage: Whole Life or Universal Life

3. Annuities

D. Accident & Health: Insures against the financial consequences associated with sickness or bodily injury (hospital bills, doctors, medicine, etc.)

VIII. Social InsuranceA. Redistribution from those who “have” and are not necessarily in need to

those who are in need and may not have enough.

B. For those facing a “Fundamental Risk”


C. Often times these programs combine welfare with traits of the insurance mechanism. The social “adequacy” of the benefits does not always match the individual’s contribution to the program.

D. Six “conditions” for Social Insurance (rather than “welfare”)

1. Participation is compulsory

2. Benefits paid are somewhat based on contributions rather than solely a demonstrated need

3. Benefit calculation is prescribed by law

4. Benefits paid out may not track contributions paid in if the beneficiary’s need is greater than “average”

5. There exists a definite plan for financing future benefits

6. The cost of the plan is borne by contributions made by individuals, employers or both

E. Federal programs

1. Old-Age, Survivors’ and Disability Insurance (OASDI): Also known as Social Security. Provides life insurance, disability and survivor benefits.

2. Medicare: Provides health insurance to citizens 65 years and older. Part A is compulsory hospitalization. Part B is voluntary medical insurance. Part of the social security system.

3. Railroad Retirement, Disability and Unemployment Program

4. National Flood Insurance Program (Privatization talks)


5. Federal Crop Insurance

6. Terrorism Reinsurance (Terrorism Risk Insurance Program Reauthorization Act)

7. National Health Insurance (??)

F. State-based Programs

1. Unemployment Insurance Programs

2. Workers’ Compensation – depending on the state laws

3. Compulsory Temporary Disability Funds (California, Hawaii, New Jersey, New York, Rhode Island and Puerto Rico)

IX. Public Guarantee Insurance ProgramsA. Government programs insuring the assets of or guaranteeing the

protection of individuals who have placed their trust in or reliance on private institutions or industries

B. Federal programs

1. Federal Deposit Insurance Corporation (FDIC): Public corporation created by the Federal government to insure bank deposits against bank failures.

a. Currently $250,000 per depositor (until 12/31/2013 – returns to $100,000)

b. Certain retirement accounts (like IRA’s) are $250,000 permanently

2. National Credit Union Administration (NCUA): Same purpose as FDIC and same limit of protection


3. Security Investor Protection Corporation (SIPC): Does not bail out investors or “insure” the performance of their investments – only gets involved when money is owed or missing, not when an investment goes bad.

a. The SIPC replaces missing stocks and other securities when possible. Replaces when stolen by a broker.

b. Replaces up to $500,000 ($100,000 for cash claims)

4. Pension Benefit Guarantee Corporation (PBGC) a. Established by the Employee Retirement Income Security Act of 1974

(ERISA)

b. Protects private pension plans unable to meet their commitments (due to non-funding or underfunding)

c. Guarantees the retired employees will receive their promised benefits

d. Operating at a $79.4 BILLION deficit as of 11/16/16

e. 22,000 single-employer plans and 1,400 multi-employer plans under administration.

C. State programState Insurer Insolvency Funds: designed to protect policyholders should the carrier providing coverage become insolvent. These funds generally operate on an assessment basis.

X. How These Fields are SimilarA. All use some form of pooling

B. Loss is transferred from the individual to the group


C. Specific contributions made by the participant (premium or tax)

D. Individual substitutes a small certain cost for a large uncertain loss

XI. Major Functions of Insurance CarriersA. Ratemaking

B. New Business Production

C. Underwriting

D. Loss Adjustment

E. Investment

F. Miscellaneous

1. Engineering/Loss Control

2. Legal counsel

3. Accounting

XII. RatemakingA. An “Insurance Rate” is the cost per unit of protection


B. Property and Liability rates are based on loss statistics and trending (predictions)

C. Must meet certain statutory requirements

1. Adequate

2. Not excessive

3. Not unfairly discriminatory

D. Must balance long-term stability with the ability to respond to changes

E. Final insurance rates (called “gross rates”) have two parts:

1. The “Loss Cost” – the amount necessary to cover expected losses a. Expected Loss Ratio; or

b. The “Pure Premium”

2. Expense loading (aka “expense ratio”) – the amount to cover carrier expenses and enjoy an underwriting profita. Production costs (underwriting, commissions, etc.)

b. Administration costs (service, reinsurance, adjustment, etc.)

c. Underwriting profit

F. Approaches to Applying Rates


1. Class Rating – Same rate applies to all members with similar exposures and characteristics

2. “Specific” Ratesa. Judgment rating – The gross rate is developed on an individual basis applying

experience rather than statistical data (as there may be no credible data available) b. Schedule rating – A schedule of debits and credits (IRPM) is applied to the rate for

an “average” insured to develop a gross rate specific to the subject insured. Applies COPE data.

c. Experience rating – The average rate is lowered or raised based on the historical loss experience of the insured (i.e. Work Comp Experience Mods)

d. Retrospective rating – Final rates are calculated after the end of the policy period based on the loss experience during the insured period. Calculations are done at regular intervals until all claims are closed. Premiums are subject to a minimum and maximum.

G. Rates are adjusted regularly

1. Based on updated loss data and predictions about the future

2. A credibility factor is applied to raw loss data based on the facts surrounding the period being reviewed

3. Trending is also used when adjusting rates (claims payments, costs, etc.)

XIII. ProductionA. Either through agents or employees

B. Distribution methods

1. Independent agents (commissioned; non-employees; own the renewals)

2. Direct writers (salaried employees of the company)


3. Exclusive / Captive agents (independent contractors restricted to one admitted carrier; the insurance carrier owns the renewals)

C. The carrier may have marketing representatives to act as the liaison between the carrier and the agent

1. Appoint agents

2. Monitor agents

3. Cancel contracts

4. Field underwriting

XIV. UnderwritingA. The process of selecting and classifying risks acceptable to the insurance

carrier

B. Underwriters must understand the nature of the risks they are being asked to insure by gathering information for the underwriting process

1. The application

2. Information attained from the agent

3. Background investigations (MVR, loss runs, etc.) and credit checks

4. Physical examination or inspections using own personnel or a third-party inspection service.

C. Assure an adequate spread of risk (but cannot “redline”)


D. Avoid the “Adverse Selection” spiralE. Monitor the insured to assure it is advantageous for the carrier to remain

on the risk or do changes need to be made (endorsements, deductibles, loss control, etc.)

XV. Loss AdjustmentA. May be the only contact an insured ever has with the insurance carrier

B. Payment when a loss occurs is the reason insureds buy coverage

C. Adjusters decide:

1. If a loss occurred

2. If the loss is covered by the policy

3. The amount of the loss (to be paid)

D. Types of adjusters

1. Company adjusters – Employees of the insurance company

2. Adjustment bureaus and independent adjusters – Provide adjustment services (generally for a fee) in areas where the insurance carrier does not have staff adjusters.

3. Public adjusters – Work on the insured’s behalf in the adjustment process (not the carriers)


E. Loss Adjustment and Settlement

1. Loss notification either directly to the company or the agent

2. The loss/claim is investigated

3. The insured files a proof of loss within a specified amount of time

4. Adjuster pays or deniesa. Pays if there is no question regarding the claim, coverage or the amount

b. May deny based on:1) The lack of an actual claim

2) The lack of coverage for the incident or occurrence causing the damage

3) The amount of loss is in dispute

5. May require arbitration or court involvement

XVI. Who Helps the Insurance CarriersA. Advisory rating organizations compile loss information from member

companies to develop and file “loss costs” on behalf of those carriers. Some member carriers may use these “loss costs” as a basis to develop their own filed rates.

B. Some of these advisory organizations also create and file policy forms and endorsements on behalf of their member companies.

C. Rating bureaus1. Insurance Services Office (ISO)


2. American Association of Insurance Services (AAIS)

3. National Council on Compensation Insurance (NCCI)

4. Other notable rating bureausa. Surety Association of America - Fidelity and Surety Bonds

b. Automobile Insurance Plans Services Office (AIPSO) – Residual auto market

c. Mutual Services Office – Small local and regional P&C carriers in the Northeast

d. Underwriters Rating Board – Small urban P&C insurers

5. State-specific Property Rate bureaus – Hawaii, Idaho, Louisiana, Mississippi, North Carolina, Texas and Washington

6. State-specific Work Comp bureaus – California, Delaware, Indiana, Massachusetts, Michigan, Minnesota, New Jersey, New York, North Carolina, Pennsylvania, Texas and Wisconsin

XVII. Coverage for High-Risk InsuredsA. Auto residual markets (“Facility Auto,” “Assigned Risk”)

B. Workers’ Compensation Assigned Risk

C. FAIR Plans (Fair Access to Insurance Requirements)

D. Beach Plans and Wind Pools


XVIII.Underwriting Syndicates Insurers Can JoinA. Factory Mutuals (FM Global, IRI) – for highly protected risks (HPR’s).

Founded as early as 1838

B. American Nuclear Insurers (1957) – Approximately 60 carriers and 30 reinsurers participate

C. United States Aircraft Insurance Group (1928) – Four carriers participate

D. American Hull Insurance Syndicate (1920) – Approximately 5 carriers participate

XIX. Property & Casualty Industry Trade AssociationsA. Insurance Carrier Associations

1. American Insurance Association

2. Property Casualty Insurers Association of America – Formed my merger of National Association of Independent Insurers and Alliance of Mutual Insurers in 2004

3. National Association of Mutual Insurance Companies (NAMIC)

B. Insurance Agent Groups/Associations

1. Independent Insurance Agents and Brokers of America (IIABA) – The Big “I”


2. National Association of Professional Insurance Agents (NAPIA)

Historically, membership in one or the other was based on the type of carrier(s) represented

3. Council of Insurance Agents and Brokers (CIAB)

C. Miscellaneous Associations

1. Risk and Insurance Management Society (RIMS)

2. Public Risk and Insurance Management Association (PRIMA)

3. University Risk Management and Insurance Association (URMIA)

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