Insurance terms and concepts

Broker

One that negotiates insurance contracts on behalf of the insured, thereby representing the client's interest, not the insurer's.

Joint Underwriting or Joint Reinsurance Pool

Participating insurers accept every eligible risk, and then may choose to reinsure some of those risks.

Rating Bureaus

1. Independent rating bureaus serve the insurance industry by gathering and analyzing statistical data for rate-making purposes. 2. Insurance Services Office (ISO) is the largest rating bureau in operation. It prepares policy forms and develops loss costs for property and casualty lines other than Workers' Compensation, Crop, and Bonds.

Insurable Interest

1. Insurable interest is the potential for financial hardship in the event of a loss. 2. In property insurance, property ownership is evidence of insurable interest. The insured must prove that there was an insurable interest at the time of loss in order to collect. In casualty insurance, insurable interest usually results from property rights, contract rights, and potential legal liability. 3. Insurable interest must exist in every enforceable contract. Note: One cannot sell his/her home, then burn it down, and expect to collect.

Insurer as Principal

1. Insurer as Principal - The insurer is the source of the authority in which the producer/agent must abide. a. When acting within the scope of authority, the insurer is responsible for all of the producer's/agent's acts. b. When the producer/agent exceeds the authority in the agency contract, the producer/agent may be in the position of being personally liable for his/her actions.

Loss Ratio and Expense Ratio

1. Loss Ratio - Loss ratio is determined by dividing paid losses plus loss reserves by total earned premiums. 2. Expense Ratio - Expense ratio is determined by dividing an insurer's total operating expenses by total earned premiums.

Direct Mail

1. A marketing system that does not use an agent. Policies are usually marketed directly from the insurer's home office. 2. The insurer offers its contracts to the public through direct mail campaigns, and newspaper, radio, television, and magazine advertising.

Exclusive Agent

1. A person under agreement to represent a single insurer, or a group of insurers, having common ownership. The insurer retains the rights to the business written by the agent. If the agent leaves the insurer, the book of business is kept by the insurer. 2. The insurer normally provides services to its exclusive agents, such as providing office space and clerical support, preparing contracts, mailing renewals, and handling claims.

Independent Agent

1. A person who enters into agency agreements with more than one insurer. 2. The agent has ownership of the business written. 3. The independent agent usually receives a higher rate of commission than an exclusive agent does, but the agent must finance his/her own agency. 4. The agent pays the cost of office space, clerical support, marketing, and for the collection of renewal information.

Elements of Insurable Risks

1. There must be a large number of homogeneous (like) units to make losses reasonably predictable. 2. The loss must be definite in terms of cause, time, place, and amount (calculable). 3. The loss must be accidental. 4. The loss must cause financial hardship. 5. The policy must exclude catastrophic perils, such as war, nuclear hazard, and illegal operations.

Peril

A cause of a potential loss. Please review Chapter One for further discussion.

Loss

A reduction in, decrease in, or disappearance of value.

Reduction (loss prevention)

Techniques for the prevention or reduction of potential loss, such as sprinkler systems, burglar alarms, pollution controls, and safety guards on machinery.

Facultative Agreements

Allow the ceding insurer and the reinsurance companies an opportunity to exchange advice about the underwriting of each case. This agreement is more time-consuming and may result in a higher premium. These agreements are strictly between the insurers; all inquiries and transactions by the consumer regarding the process are through the ceding or originating company

Annual Statement

Every insurer authorized to transact business in this state must file a financial report with the Department or Division annually. The financial report must be detailed so the Department or Division might see anything of financial concern.

admitted insurer

This is an insurance company that has met all the qualifications designed by the Department of Insurance and has received a certificate of authority from the DOI to transact insurance in this state.

Loss Cost Rating

A rating organization provides insurers with the portion of a rate that does not include provisions for expenses or profit. The expense and profit components to develop the final rate must be added by individual insurers based upon their projections. Loss cost rating is used on risks for which the insurer may not have enough data to develop the rate, other than for expenses and profit.

Law of Agency

A relationship between 2 parties where one (the producer/agent) may act on the behalf of the other (the principal) and bind the actions or words of the principal.

Open Competition

A state relies on competition between insurers to produce fair and adequate rates.

Identification and Analysis of Risk

A survey of the insured's operations, assets, and exposures that could give rise to losses, and their potential frequency and severity. Example: Physical inspections, flowcharts, etc.

Elimination (avoidance)

After potential areas of hazard have been identified, it may be found that some exposure to risk can be eliminated entirely.

Financial Rating Agencies

Agents are responsible for placing business with insurers that are financially sound. Several independent financial rating services provide ratings available to the public. 5 of the most popular services are A.M. Best, Standard's and Poor's, Moody Investment Services, Duff and Phelps Credit Rating, and the Weiss Insurance Ratings. Each service assigns rating codes to show strengths and weaknesses of each company rated.

non admitted insurer

An insurer not authorized to transact insurance in a particular state, either by failing to comply with that state's requirements, or by not seeking admission.

Direct Writer

An insurer that deals directly with the insured through a salaried representative or a captive agent, as opposed to an insurer that contracts with an agent.

Insurable Events

Any event, whether past or present, which may cause loss or damage to a person having an insurable interest, or any such event that may create a liability against him/her.

Moral Hazard

Dishonesty. Example: An insured burns down his/her house, or gives false information on an application.

Experience Rating

Rates are based on the actual losses during a specified period of the past.

Judgment Rating

Rates are based on the underwriter's judgment and experience.

Manual Rating

Rates contained in a manual published by the insurer or those of the rating organization of which it is a member.

File and Use

Rates must be filed with the state insurance regulatory authority (Department or Division of Insurance), and may be used as soon as they are filed.

Individual Rating

Rating used in cases where there are not enough similar insureds to support a class rate. Primarily used in commercial risks because of the number of variables involved.

Rehabilitation and Liquidation

Regardless of the regulations and controls, a few insurers find themselves in financial difficulty. When this happens, the Department or Division will step in and attempt to help the insurer become solvent again. Only as a last resort are insurers declared insolvent, and the liquidation process started.

Reserves

Reserves are accounting measurements of an insurer's future obligation to its policyholders.

Pure Risk

Risk for which there exists a possibility of loss or no loss. Example: The possibility of damage to property caused by fire, windstorm, explosion, etc. Note: Insurance is designed to provide protection against pure risk.

Speculative Risk

Risk for which there exists a possibility of loss, no loss, or gain. Example: Gambling.

Consultant

Some states do not recognize consultants or financial planners. In those states that do recognize them: a. They offer advice, counsel, and opinions of service in respect to the benefits, and the advantages or disadvantages of any insurance policy or contract. b. They are compensated by fee for service, commissions, or other legal considerations, and only one form of compensation may be paid per each completed consulting service.

Mandatory Rates

Some states require that mandatory rates be used for certain lines of insurance. These rates are set by state rating bureaus.

Retrospective Rating

The insured's premiums are adjusted at the end of the policy period based on a formula of debits or credits for losses that have occurred during that period.

Adverse Selection

The insuring of risks that are more prone to losses than average risks. Poorer risks, or less desirable insureds, tend to seek or continue insurance to a greater extent than better risks.

Contract law

The law the pertains to the formation and enforcment of contracts

Law of Large Numbers

This principle states that the larger the number of exposures considered, the more closely the losses reported will equal the underlying probability of loss. The principle applies to homogeneous groups, but not to individual risks.

Transfer

This risk management technique utilizes the purchase of insurance to transfer the uncertainty of loss to an insurance company from the insured or owner.

Surplus Lines

Those types of insurance that cannot be obtained from admitted insurers. Each state regulates the procurement of Surplus Lines Insurance (a.k.a. Excess Lines). a. The business must be transacted through a Surplus Lines Broker. b. The full amount or kind of insurance being obtained from the nonadmitted insurer must not be obtainable from an admitted insurer. c. The insurance must not be placed with a nonadmitted insurer solely to receive financial advantages that would not be available by placing the business with an admitted carrier.

Stock Insurance Company

a. A stock company is owned by stockholders (shareholders). b. Stockholders direct the company's operation by electing directors and officers. c. Shareholders receive taxable stock dividends (return of profit). d. Traditionally, stock insurers issued nonparticipating policies; however, today, in most jurisdictions, a stock insurer is free to issue participating policies.

Risk Retention Groups

a. A group-owned insurer who primarily assumes and spreads the liability-related risks of its members. b. They are an insurance company, licensed in at least one state, that are owned by their policyholders, who are also their shareholders. c. Although they only need to be licensed or chartered in one state, they may insure members of the group in other states. d. Membership is limited to risks with exposure to similar liability needs. Example: Theme parks, go-cart tracks, waterslides, etc.

Reciprocal Insurance Company

a. A group-owned insurer whose main activity is risk sharing. b. A reciprocal insurer is unincorporated, and is an aggregation of individuals, firms, and business corporations, which exchange insurance on one another. Each member is known as a subscriber. c. The exchange of insurance is effected through an Attorney-In-Fact, who is appointed by the subscribersand empowered on their behalf to bind them to one another. d. Each subscriber assumes a part of the risk of all other subscribers, so, if premiums collected are insufficient to pay losses, an assessment of additional premium can be made.

Mutual Insurance Company

a. A mutual company is owned by its policyholders. Every policyholder is a member of the company. b. Policyholders choose a Board of Trustees or Directors to manage the company. c. Profits are returned to policyholders as nontaxable dividends (return of unused premium). d. Most mutual companies are nonassessable - they cannot charge members a pro rata share of loss and expense at the end of the policy period. e. Traditionally, mutual insurers issued participating policies; however, today, in most jurisdictions, a mutual insurer is free to issue nonparticipating policies.

Captive Insurance Company

a. An insurance company organized in instances when insurance cannot be purchased from commercial insurance companies for a business risk. In many instances, companies within an industry form a joint captive insurance company for such a reason. b. Captives retain substantial portions of each loss and then purchase reinsurance above these levels through the international reinsurance market at a more favorable premium, with higher limits of coverage. c. Captives provide an alternative funding mechanism when coverage breadth or capacity in traditional insurance markets does not meet the insured's needs, and can provide cost savings, cash flow benefits, and specialized loss prevention and claims services not otherwise available. d. Given capital and operating expense requirements, captives are generally of interest only when applicable premiums are substantial (i.e. $2,000,000). e. Investment returns can be obtained directly on the captive's invested capital. f. The company has its own manager and typically conducts a formal officers meeting annually.

Fraternal Benefits Societies

a. Fraternal societies are primarily social organizations that engage in charitable and benevolent activities that provide insurance, primarily life insurance, to its members. b. Membership is typically drawn from members of a given lodge, order, or society. c. They are usually organized on a nonprofit basis.

Lloyds

a. Lloyds is not considered an insurance company, but is a grouping of syndicates, each specializing in a particular risk. b. Lloyds provides a meeting place and clerical services to its syndicate members, who actually transact the business of insurance. c. Coverage provided is underwritten by a Syndicate Manager, who may also be known as an Attorney-In-Fact, or an Individual Proprietor. d. No corporations or other limitations on liability are permitted, so members expose their entire fortune on each risk they accept, therefore, making each individually liable. e. Lloyds of London and Lloyds of America are the presently known Lloyds.

Class Rating

group of insureds who have similar exposures and experience are charged the same rate.

Tort Law

law that pertains to injuries suffered by one party as a result of another parties actions. A tort is a civil wrong other than crime or breach of contract.

Risk Sharing Plan

nsurers agree to apportion among themselves those risks that are unable to obtain insurance through normal channels.

Prior Approval

nsurers cannot use rates until approved by the Department or Division of Insurance, or until a specific time has passed after the filing without being disapproved.

Physical Hazard

A physical condition that increases the probability of loss. Example: Flammable material stored near a furnace, or property located next to a dynamite factory.

Insurance Company Financial Structure

1. The Department or Division of Insurance regulates all insurers doing business in this state. Its major concern is providing protection against the insolvency of an insurer. 2. The Department or Division regulates the organization and ownership, capital and surplus requirements, reserves, accounting, investments, annual statements, rehabilitation of impaired insurers, and the liquidation of insurers when necessary. 3. The Department's or Division's main goal is the protection of the general public through the use of the following reports and regulations: a. Investments - Insurance regulations require that all investments be approved by the insurer's Board of Directors. Most investments are required to be invested in something that is fairly stable. b. Annual Statement - Every insurer authorized to transact business in this state must file a financial report with the Department or Division annually. The financial report must be detailed so the Department or Division might see anything of financial concern. c. Examination of Insurers - The Department or Division conducts examinations on every insurer in this state. The examination may be as often as the Department or Division deems necessary. d. Rehabilitation and Liquidation - Regardless of the regulations and controls, a few insurers find themselves in financial difficulty. When this happens, the Department or Division will step in and attempt to help the insurer become solvent again. Only as a last resort are insurers declared insolvent, and the liquidation process started. 4. The Department or Division may implement a rehabilitation plan if it determines that the insurer could be reorganized, consolidated, converted, reinsured, or merged. Under a rehabilitation order, the Department or Division maintains control of the insurance company until management can be turned over to private management after the problems have been solved. 5. Evaluating an insurer's surplus (excess assets, over liabilities) is very important. Any major change in surplus from year to year should be carefully scrutinized to determine the cause.

Underwriting

1. The selection of risk is the primary function of the underwriter. 2. The underwriter must protect the insurer against adverse selection by selecting risks that fall into the normal range of expected losses. 3. When evaluating a risk, an underwriter examines: a. The nature of the risk. b. What hazards are present. c. What outside factors might affect the risk. d. What past losses have occurred. Note: Underwriters like to select insureds whose actual losses will be similar to expected losses. 4. The underwriter must also charge an adequate premium for the risk based on the same factors used in evaluating the risk. Example: In most states an underwriter may take into account whether the primary operator of a vehicle is male or female. 5. Rates are considered inadequate when they do not sustain projected losses and expenses. 6. Producers engage in field underwriting, which not only saves the insurer time and expense in rejecting unacceptable risks, but also improves the producer's book of business, making it more profitable.

Reinsurance (Risk Sharing)

A device used by insurers to transfer or share in a risk. This process disperses the probability of a large loss and in turn provides coverage for a possibly otherwise uninsurable risk. There are at least 2 insurers involved, the insurer originating the application (ceding company), and the insurer or companies who share in the risk (reinsurance insurers). The agreement of reinsurance is strictly between the 2 insurance companies and will be classified as either an Automatic or Facultative Agreement

Residual Markets

A market designed for those risks unable to find coverage in the ordinary market.

Schedule Rating

A method of rating property and liability risks by using charges and credits to modify a class rate based on the nature of the particular risk that is being rated.

Merit Rating

An approach that rewards an insured who takes measures to decrease the probability of loss occurring by the institution of safety programs, loss control programs, etc.

Producers/Agents

An individual appointed by an insurance company to represent the company and to present policies on its behalf. a. Responsibilities to the Insurer 1) The producer/agent is responsible for presenting, modifying, affecting, accepting the performance of, or terminating the business contracts of the insurer. 2) Producers/Agents have a fiduciary duty to the insurer when handling premium funds in an account separate from personal funds. 3) After submitting an application, the producer/agent should report any material facts that may affect the underwriting of a policy to the insurer. 4) The producer/agent is not required to emphasize profitable policies. b. Authority 1) Express - The power that is expressed (written) in the producer's/agent's contract. Example: Binding authority. 2) Implied - The authority that the public assumes the producer/agent has. The active authority when conducting the insurance business, such as filling out applications, providing quotes, and accepting premiums for the insurer. 3) Apparent - The authority created when a producer/agent exceeds the authority expressed in his/her contract, and the insurer does nothing to counter the public impression that such authority exists. Example: The producer/agent accepting premiums on lapsed policies. c. Responsibilities to the Applicant/Insured 1) The producer/agent has the responsibility to seek and gain knowledge, not just initially, but on an ongoing basis throughout his/her professional career. The sale and servicing of insurance is a professional endeavor and requires in depth knowledge of policy coverages, provisions, limits, and risk evaluation. Only with this knowledge can one serve the best interests and needs of the applicant/insured. 2) As the producer/agent serves in a fiduciary capacity to the insurer, his/her applicants and insureds rely upon them to forward premiums and to secure the coverages that address their exposures. The failure of a producer/agent to do so is a violation of trust and professional expectation, even though the producer/agent technically is a representative of the insurer.

Sharing

Investments of a large number of people may be pooled by use of a corporation or partnership. Note: Insurers avoid great numbers in concentrated areas to "spread the risk."

Morale Hazard

Indifference to loss, or the failure to take proper care to protect property from loss. Example: Leaving one's house or vehicle unlocked.

Insurance

Insurance is the substitution of a small certain expense for a large uncertain loss. It also transfers the risk, protects against uncertainty, shares the loss, and reduces anxiety.

Risk Sharing Plan

Insurers agree to apportion among themselves those risks that are unable to obtain insurance through normal channels.

Retention (self-insurance)

It may be economically practical for an insured not to insure each exposure to loss, but instead insure only those risks that threaten the financial stability of the business.

Examination of Insurers

The Department or Division conducts examinations on every insurer in this state. The examination may be as often as the Department or Division deems necessary.

Automatic Agreements

The ceding company must transfer the amount of insurance in excess of the retention level immediately and automatically upon receipt of the premium. The transfer is automatic in accordance with the reinsurance agreement.

Risk Management

The determination of what types of protection are required to meet an insured's needs. The steps involved in risk management are as follows:

Exposure

The extent to which one may be affected by a peril.