FIN 3100 Ch 5-9
How does the concept of actual cash value support the principle of indemnity?
The concept of actual cash value supports the principle of indemnity. In property insurance, the basic method for indemnifying the insured is based on the actual cash value of the damaged property at the time of loss.
Who owns the policy expirations or the renewal rights to the business under the independent agency system?
the agency owns the expirations or renewal rights to the business.
Explain the meaning of: Estoppel
the loss of a legal defense because of previous actions that are now inconsistent with that defense.15 If one person makes a statement of fact to another person who then reasonably relies on the statement to her or his detriment, the first person cannot later deny the statement was made.
Explain the meaning of: Waiver
the voluntary relinquishment of a known legal right. If the insurer voluntarily waives a legal right under the contract, it cannot later deny payment of a claim by the insured on the grounds that such a legal right was violated.
Explain the major arguments against repeal of the McCarran-Ferguson Act.
The insurance industry is already competitive. Small insurers may be harmed. Insurers may be prevented from developing common coverage forms.
Explain the major arguments for repeal of the McCarran-Ferguson Act.
The insurance industry no longer needs broad antitrust exemption. Federal regulation is needed because of the defects in state regulation.
Explain the meaning of an insurable interest.
states that the insured must be in a position to lose financially if a covered loss occurs.
Describe the basic characteristics of stock insurers.
A corporation that issues insurance and is owned by stockholders. The stockholders elect a board of directors who, in turn, appoint executive officers to manage the corporation. The board of directors has ultimate responsibility for the corporation's financial success. If the business is profitable, the company can declare dividends and pay them to stockholders; the value of the stock may also increase. Likewise, the value of the stock may decline if the business is unprofitable.
Explain the difference between a "retail" and "wholesale" intermediary and describe the two types of "wholesalers."
A managing general agent (MGA) is a specialized type of "wholesale" producer that, unlike "retail" producers, is vested with underwriting authority from an insurer. Surplus lines brokers are wholesalers and do not have contact with the applicant who is seeking coverage. The retail producer who initially produces the business handles all customer contact. The surplus lines broker gets involved only if a retail producer is unable to place business with an admitted insurer. At that point, the retail producer must then ask a surplus lines broker to find a market for the coverage
Explain the principle of indemnity.
states that the insurer agrees to pay no more than the actual amount of the loss; stated differently, the insured should not profit from a loss.
Identify the major types of mutual insurers.
Advance premium mutual: Mutual insurance company owned by the policyholders that does not issue assessable policies but charges premiums expected to be sufficient to pay all claims and expenses. Assessment mutual: Mutual insurance company that has the right to assess policyholders for losses and expenses. Fraternal insurer: Mutual insurance company that provides life and health insurance to members of a religious faith, ethnic group, or social organization.
Briefly describe the role of the following in adjusting claims:
Agents: often have authority to settle small first-party claims up to some maximum limit. The insured submits the claim directly to the agent, who has the authority to pay up to some specified amount. Staff claims representatives: are 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: An independent adjuster is an organization or individual that is not part of an insurance company and settles claims for a fee. Public adjusters: A public adjuster represents the insured rather than the insurance company and is paid a fee based on the amount of the claim settlement.
Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts.
Aleatory contract: is a contract where the values exchanged may not be equal but depend on an uncertain event. Unilateral contract: means that only one party makes a legally enforceable promise. Conditional contract: the insurer's obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. Personal contract: the contract is between the insured and the insurer. Contract of adhesion: means the insured must accept the entire contract, with all of its terms and conditions.
Identify the major sources of information available to underwriters.
Application Agent's report. Inspection report. Physical inspection. Physical examination.
The Federal Insurance Office (FIO) has made a number of recommendations for modernizing insurance regulation. Briefly describe the FIO's recommendations for each of the following:
Areas for reform at the state level: Material solvency decisions. For material solvency oversight decisions of a discretionary nature, the states should develop a process that obligates the appropriate state regulator to first obtain the consent of regulators in other states. Consistency of solvency regulation. To improve the consistency of solvency regulation, the states should establish an independent review mechanism for the NAIC Financial Regulation Standards Accreditation Program. Transparency in transferring risk to reinsurance captives. States should develop uniform and transparent procedures for the transfer of risk to reinsurance captives. A captive is an insurer owned by a parent firm to insure its loss exposures, to reduce premiums, to provide easier access to a reinsurer, and to attain favorable tax advantages. Best practices standard. State-based solvency and capital adequacy procedures should converge toward best practices and uniform standards. The term best practices is defined as a method or technique that has consistently shown results superior to those achieved by other methods and can be used as a benchmark. Principles-based reserving. States should move forward with the implementation of principles-based reserving. This is a newer method for calculating policy reserves in life insurance. It is based on risk analysis and risk management techniques that reflect life insurance and annuity risks more accurately than the current rule based on the one-size-fits-all approach. The states should also develop uniform guidelines to monitor principles-based reserving. Corporate governance. States should develop corporate governance principles that impose character and fitness expectations on directors and officers appropriate to the size and complexity of the insurer. Group supervision. In the absence of direct federal authority over an insurance group-holding company, the states should continue to develop approaches to group supervision and address the shortcomings of single entity supervision. Supervisory colleges. State regulators should make group supervision more effective by continued attention to supervisory colleges. A supervisory college is defined as a meeting of insurance regulators or supervisors where the topic of discussion is regulatory oversight of one specific insurance group that writes significant amounts of insurance in other jurisdictions. State guaranty funds. States should adopt and implement uniform policyholder recovery rules so that policyholders receive the same maximum benefits from state guaranty funds regardless of where they reside. Areas for direct federal involvement in regulation: Mortgage insurers. Federal standards and supervision for mortgage insurers should be developed and implemented. Uniform treatment of reinsurers. To have national uniform treatment of reinsurers, the Treasury and United States Trade Representative should pursue a covered agreement for reinsurance collateral requirements based on the Credit for Reinsurance Model Law and Regulation drafted by the NAIC. Financial stability of large national and international insurers. The FIO should engage in supervisory colleges (defined earlier) to monitor the financial stability of large national and international insurers and identify issues or gaps in the regulation of such insurers. The National Association of Registered Agents and Brokers Reform Act of 2013 should be adopted, and the FIO should monitor its implementation. Auto insurance for military personnel. The FIO will continue to work with federal agencies, state regulators, and other parties to develop personal auto insurance policies for U.S. military personnel, enforceable across state lines. Rate regulation. The FIO will work with state regulators to establish pilot programs for rate regulation that seek to maximize the number of insurers offering personal lines products. Personal information. The FIO will study and report on the ways in which personal information is used for insurance pricing and coverage purposes. Native Americans. The FIO will consult with tribal leaders to identify alternatives to improve the accessibility and affordability of insurance on sovereign Native American and tribal lands. Collection of surplus lines taxes. The FIO will continue to monitor progress by the states on the implementation of provisions in the Dodd-Frank Act that require the states to simplify the collection of surplus lines taxes and decide whether federal action is warranted in the near term. Market conduct recommendations: ment, and similar activities. Regulators are concerned that certain industry practices or actions may have adverse and unfair financial effects on policyholders, beneficiaries, claimants, and insurance consumers. Examples include the sale of unsuitable insurance products; misrepresentation of coverage; excessive sales pressure; rates that are excessive, unfairly discriminatory, or not reflective of filed rates; denial of legitimate claims, rejection of applications not based on acceptable underwriting criteria; and improper termination of policies. In its report on modernizing the insurance industry, the FIO made the following recommendations concerning the regulation of the market conduct of insurers and agents: Marital status. States should assess whether marital status is an appropriate underwriting or rating consideration. Product approval. To improve the approval of products by the states, every state should participate in the Interstate Insurance Product Regulation Commission (IIPRC) and expand the products subject to approval. State regulators should streamline and improve the regulation of commercial lines and pursue the development of national standard forms and terms. Sales of annuities to suitable purchasers. To protect consumers in all parts of the United States, each state should adopt the Suitability in Annuities Transactions Model Regulation drafted by the NAIC. Market conduct regulation. States should reform market conduct examinations and oversight practices. State regulators should (1) perform market conduct examinations consistent with the NAIC Market Regulation Handbook, (2) seek information from other regulators before issuing a request to an insurer, (3) develop standards and procedures for market conduct examiners, and (4) develop a list of approved market conduct examiners based on objective standards. Rate regulation. States should monitor the impact of different rate regulation methods to identify regulatory practices that best promote competitive markets for personal lines insurance consumers. Risk classification. States should (1) develop standards for the appropriate use of data for the pricing of personal lines insurance, (2) study and report on the ways in which personal information is used for insurance rating and coverage purposes, and (3) extend regulatory oversight to vendors that provide insurance scores to insurers for products that use insurance scores in underwriting and rating. Insurance scores are used in auto insurance and are based on driving history, age, gender, zip code, marital status, and credit score.
Briefly explain the basic principles of underwriting.
Attain an underwriting profit. Select prospective insureds according to the company's underwriting standards. Provide equity among the policyholders.
Why is subrogation used?
subrogation prevents the insured from collecting twice for the same loss. subrogation is used to hold the negligent person responsible for the loss. subrogation helps to hold down insurance rates.
Explain the legal distinction between an agent and a broker.
Broker is 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.
Identify the major techniques that regulators use to monitor insurance company solvency.
Capital standards. Risk-based capital standards. Reserve requirements. Restrictions on investments. Annual financial statements. Field examinations. Field examinations. FAST system.
Identify the principal areas of insurance company operations that are regulated by the states.
Formation and licensing of insurers Solvency regulation Rate regulation Policy forms Sales practices and consumer protection Taxation of insurers Miscellaneous: Cybersecurity
Describe the shortcomings of state regulation.
Inadequate protection of consumers Improvements needed in handling complaints. Inadequate market conduct examinations. Insurance availability. Regulators overly responsive to the insurance industry.
The corporate structure of mutual insurers has changed over time. Briefly describe several trends that have had an impact on the corporate structure of mutual insurers.
Increase in company mergers: some insurers want to acquire a line of new insurance, enter a new area of business, or become larger and benefit from economies of scale. Demutualization: A term to describe the conversion of a mutual insurer into a stock insurer.
Briefly explain the reasons for reinsurance.
Increase underwriting capacity Stabilize profits Reduce the unearned premium reserve Provide protection against a catastrophic loss Enable an insurer to retire from a territory or class of business Obtain underwriting advice from the reinsurer
Describe briefly the following distribution systems in the marketing of property and casualty insurance.
Independent agency system: the independent agency is a business firm that usually represents several unrelated insurers. the agency owns the expirations or renewal rights to the business. the independent agent is compensated by commissions Exclusive agency system: the agent represents only one insurer or a group of insurers under common ownership. Direct writer: applied to an insurer whose sales representatives are employees (such as salaried representatives), and not independent contractors. a term applied to insurers that use the exclusive agency system for selling insurance products Direct response system: a direct response insurer sells directly to the public by television, telephone, mail, newspapers, and other media. primarily to sell personal lines of insurance, such as auto and homeowners insurance. Multiple distribution systems: To increase their profits, many property and casualty insurers use more than one distribution system to sell insurance.
Describe briefly the following distribution systems in the marketing of property and casualty insurance.
Independent agency system: the independent agency is a business firm that usually represents several unrelated insurers. the agency owns the expirations or renewal rights to the business. the independent agent is compensated by commissions that vary by line of insurance. Exclusive agency system: the agent represents only one insurer or a group of insurers under common ownership Direct writer: the term direct writer is applied to an insurer whose sales representatives are employees (such as salaried representatives), and not independent contractors. a term applied to insurers that use the exclusive agency system for selling insurance products Direct response system: Multiple distribution systems:
Briefly describe the following insurance company operations:
Information systems: Accounting: Legal services: Loss control:
Describe the basic features of mutual insurers.
Insurance corporation owned by the policyholders, who elect the board of directors. The board appoints managing executives, and the company may pay a dividend or give a rate reduction in advance to insureds.
How does rate making, or the pricing of insurance, differ from the pricing of other products?
Insurance pricing differs considerably from the pricing of other products. When other products are sold, the company generally knows in advance the costs of producing those products, so that prices can be established to cover all costs and yield a profit. However, the insurance company does not know in advance what its actual costs are going to be. 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. Of course, the insurer hopes that the premium it charges plus investment income will be sufficient to pay all claims and expenses and yield a profit.
Explain the principal methods for regulating insurance companies.
Legislation- All states have insurance laws that regulate the operations of insurers. These laws regulate (1) formation of insurance companies, (2) licensing of agents and brokers, (3) financial requirements for maintaining solvency, (4) insurance rates, (5) marketing, sales, and claim practices, (6) taxation, and (7) rehabilitation or liquidation of insurers. Also, laws have been passed to protect the rights of consumers, such as laws restricting the right of insurers to terminate insurance contracts and laws making insurance more widely available. Courts- State and federal courts periodically hand down decisions concerning the constitutionality of state insurance laws, the interpretation of policy clauses and provisions, and the legality of administrative actions by state insurance departments. As such, court decisions can affect the market conduct and operations of insurers in many important ways. State Insurance Departments- All states, the District of Columbia, and U.S. territories have a separate insurance department or bureau. An insurance commissioner, who is elected or appointed by the governor, has the responsibility to administer state insurance laws. Through administrative rulings, the state insurance commissioner wields considerable power over insurers doing business in the state. The insurance commissioner has the power to hold hearings, issue cease-and-desist orders, and revoke or suspend an insurer's or agent's license to do business.
Explain the basic characteristics of Lloyd's Corporation.
Lloyd's technically is not an insurance company; rather, it is a group of members (corporations, individuals, and limited partnerships) who underwrite insurance in syndicates. the insurance is written by the various syndicates that belong to Lloyd's. new individual members, or Names, who belong to the various syndicates now have limited legal liability. corporations with limited legal liability and limited liability partnerships are also members of Lloyd's. members must also meet stringent financial requirements. Individual members are high net worth individuals. Lloyd's is licensed only in a small number of jurisdictions in the United States.
Explain why the insurance industry is regulated.
Maintain insurer solvency Compensate for inadequate consumer knowledge Ensure reasonable rates Make insurance available
Explain the basic objectives in the settlement of claims.
The first objective in settling claims is to verify that a covered loss has occurred. The second objective is to pay the claim fairly and promptly. third objective in claims settlement is to provide personal assistance to the insured after a covered loss occurs.
Define the meaning of underwriting.
The first principle is that 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. equity among the policyholders.
Explain the following legal doctrines:
Misrepresentation: A representation that is false The legal significance of a misrepresentation is that the insurance contract is voidable at the insurer's option if the misrepresentation is (1) material, (2) false, and (3) relied on by the insurer. Concealment: is intentional failure of the applicant for insurance to reveal a material fact to the insurer. Concealment is the same thing as nondisclosure; that is, the applicant for insurance deliberately withholds material information from the insurer. The legal effect of a material concealment is the same as a misrepresentation—the contract is voidable at the insurer's option. Warranty: is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects.
Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation:
Paul v. Virginia: affirmed the right of the states to regulate insurance. South-Eastern Underwriters Association Case: the Supreme Court ruled that insurance was commerce and therefore it was interstate commerce when conducted across state lines. McCarran-Ferguson Act: states that continued regulation and taxation of the insurance industry by the states are in the public interest. It also states that federal antitrust laws apply to insurance only to the extent that the insurance industry is not regulated by state law. Gramm-Leach-Bliley Act (also known as the Financial Modernization Act of 1999): The legislation changed federal law that earlier prevented banks, insurers, and investment firms from competing fully in other financial markets outside their core area.
Describe briefly the following distribution systems in the marketing of life insurance.
Personal selling systems: A distribution system in which commissioned agents solicit and sell life insurance products to prospective insureds. 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. Commercial banks are becoming increasingly important in the marketing of fixed and variable annuities, and to a lesser degree, life insurance. In addition, other financial institutions and investment firms, such as Charles Schwab, Fidelity Investments, and the Vanguard Group, also make life insurance products and annuities available to their clients. 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. Other distribution systems: Worksite Marketing Stock Brokers Financial Planners Group Insurance
Briefly describe the major types of rating laws.
Prior-Approval Law Under a prior-approval law, insurance rates must be filed and approved by the state insurance department before they can be used. Modified Prior-Approval Law Under a modified prior-approval law, if the rate change is based solely on loss experience, the insurer must file the rates with the state insurance department, and the rates may be used immediately (i.e., file-and-use). File-and-Use Law Under a file-and-use law, insurers are required only to file the rates with the state insurance department, and the rates can be used immediately. Use-and-File Law A variation of file-and-use is a use-and-file law. Under this law, insurers can put into effect immediately any rate changes, but the rates must be filed with the regulatory authorities within a certain period after first being used, such as 15 to 60 days. Flex-Rating Law Under a flex-rating law, prior approval of rates is required only if the rate increase or decrease exceeds a specified range. State-Made Rates A few states prescribed state-made rates that apply to a small number of specialized lines. The state determines the rates, forms, and classifications that insurers must follow. No Filing Required Under the no filing required system, insurers are not required to file their rates with the state insurance department. However, insurers may be required to furnish rate schedules and supporting data to state officials.
Explain the major arguments in support of state regulation of the insurance industry.
Quicker response to local insurance problems. Increased costs from dual regulation. Poor quality of federal regulation. Promotion of uniform laws by NAIC. Greater opportunity for innovation. Unknown consequences of federal regulation.
Briefly explain the following types of reinsurance methods for sharing losses:
Quota-share treaty: A reinsurance arrangement in which the ceding company and reinsurer agree to share premiums and losses based on some proportion. The ceding company's retention is stated as a percentage rather than as a dollar amount. Surplus-share treaty: A reinsurance arrangement in which the reinsurer agrees to accept insurance in excess of the ceding company retention limit, up to some maximum limit. The primary insurer and reinsurer share losses and premiums based on the fraction of total insurance retained by each party. However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the acquisition expenses. Excess-of-loss reinsurance: A reinsurance arrangement in which the reinsurer pays for part or all of the loss that exceeds the ceding company's retention limit up to some maximum level. Reinsurance pool: Pool for placing high-risk automobile drivers that arranges for an insurer to accept all applicants for insurance. Underwriting losses are shared by all auto insurers in the state.
Describe the steps involved in the settlement of a claim.
The insured provides prompt notice of loss. The insurer investigates the claim with the cooperation of the insured. The insured provides a proof of loss if required. The insurer makes a decision about paying the claim.
Briefly describe the sales and marketing activities of insurers.
The professional producer identifies potential insureds, analyzes their loss exposures, and recommends solutions to manage the risks that they face. After the sale, the agent has the responsibility of providing follow-up service to clients, keeping their risk management programs up to date. Finally, a professional producer abides by a code of ethics.
Explain the general rules of agency that govern the actions of agents and their relationship to insureds.
There is no presumption of an agency relationship. An agent must have authority to represent the principal. A principal is responsible for the acts of agents acting within the scope of their authority. Limitations can be placed on the powers of agents.
List the four requirements that must be met to form a valid insurance contract.
To be legally enforceable, an insurance contract must meet four basic requirements: offer and acceptance, exchange of consideration, competent parties, and legal purpose.
Why is an insurable interest required in every insurance contract?
To prevent gambling To reduce moral hazard To measure the amount of the insured's loss in property insurance
Explain the following actions by agents that are prohibited by state law:
Twisting: the inducement of a policyholder to drop an existing policy and replace it with a new one that provides little or no economic benefit to the client. Rebating: is giving an individual a premium reduction or some other financial advantage not stated in the policy as an inducement to purchase the policy.
Explain the major arguments for federal regulation of the insurance industry.
Uniform state laws and regulations. More effective negotiations of international insurance agreements. More effective treatment of systemic risk. Greater efficiency of insurers.
What is a valued policy law?
a law that exists in some states that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law.
What is a valued policy? Why is it used?
a policy that pays the face amount of insurance if a total loss occurs. Valued policies typically are used to insure antiques, fine arts, rare paintings, and family heirlooms. Because of difficulty in determining the actual value of the property at the time of loss, the insured and insurer both agree on the value of the property when the policy is first issued.
Identify three sources of authority that enable an agent to bind the principal.
agency agreement, which is an agreement between the agent and the principal that specifies the rights and duties of each party. implied authority, which refers to the authority of the agent to perform all incidental acts necessary to fulfill the purposes of the agency agreement. apparent authority. Under agency law, apparent authority can be defined as an agent who has the authority to act on behalf of the principal when actions or expressions by the principal to a third party lead a reasonable third party to believe that the principal authorized the agent to act.
What is the meaning of 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.
Explain the meaning of "securitization of risk."
an insurable risk is transferred to the capital markets through the creation of a financial instrument that is often called an insurance-linked security (ILS).
Describe the basic characteristics of a reciprocal exchange.
an unincorporated organization in which insurance is exchanged among the members An attorney-in-fact (that is, a person who is authorized to perform business-related transactions on behalf of someone else) manages the reciprocal. The attorney-in-fact is usually a corporation that the subscribers authorize to seek new members, pay losses, collect premiums, handle reinsurance arrangements, invest the funds, and perform other administrative duties. However, the attorney-in-fact is not personally liable for the payment of claims and is not the insurer. The reciprocal exchange is the insurer. Most reciprocals are relatively small and account for only a small percentage of the total property and casualty insurance premiums written. In addition,
Explain the principle of subrogation.
substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance.7 Stated differently, the insurance company is entitled to recover from a negligent third party any loss payments made to the insured.
Distinguish between facultative reinsurance and treaty reinsurance.
facultative reinsurance is an optional, case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit. treaty reinsurance is 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.
What is a replacement cost policy?
pays you the cost of replacing the damaged property with an item of a similar brand and quality
How is actual cash value calculated?
replacement cost less depreciation.
What is a mass-merchandising plan in property and liability insurance?
selling individually underwritten, property and casualty coverages to members of a group; popular products include auto and homeowners insurance. Policies are individually underwritten and applicants must meet the insurer's underwriting standards. Rate discounts may be given to reflect the producer's lower commission scale and savings in administrative expenses. In addition, employees typically pay for the insurance by payroll deduction. Finally, employers do not usually contribute to the plans; any employer contributions result in taxable income to the employees.