Business Insurance
Types of Insurers
Chapter Three
There are various types of insurers. Each type provides a service. It is the job of the agent and buyer to determine if one type better suits the client’s needs than does another.
Insurance may be divided into several types. The broadest division is between government and private insurers.
At one
time the private insurance industry was separated into three branches in the
Most states allowed companies to write coverage only in one of these three branches. It was not a sensible system in the view of many. For example, automobile was split between fire insurers for physical damage and casualty insurers for liability. It seemed impractical to need two insurers to secure both types of coverage. Either type of insurer could write collision coverage.
It was not until
the 1940s and early 1950s that legislation was passed allowing for full
multiple-line underwriting for fire and casualty insurers. By 1955, when
Before multiple-line underwriting was allowed, homeowners and business owners had to have separate policies for fire insurance and liability insurance. Additionally, a separate policy was needed for theft insurance as well as many other types of coverage. This was not only inconvenient; it was also usually more costly for the insured. Multiple-line underwriting made it possible for insurance companies to design policy forms that cover the major property and liability exposures under one contract.
With multiple-line underwriting private insurance was reduced from three to two major branches:
Either life insurers or property-liability insurers may write health insurance. Most often we consider health insurance as part of life coverage, but that is not necessarily the case.
Life companies write three types of coverage: life insurance, annuities, and health insurance. As we know, life insurance is designed to insure the premature death of another. Life insurance provides money for the named survivors or heirs of the insured. It may also be purchased as a means of covering the expenses leading up to death and burial costs.
Annuities are the opposite of life insurance. Where life policies pay when a specified person dies, annuities are designed to pay that same person prior to their death. In effect, an annuity is a means of liquidating the estate by paying income for a specified time period or for the lifetime of the annuitant. Not all annuities are liquidated prior to death; statistically, the majority of annuities are not. Despite this fact, they were designed to do so. Annuities are used for many purposes. They have become a very popular means of saving for retirement and other life goals. In fact, many state lotteries use annuities to pay the winners.
Health insurance provides money to cover in full or part the costs of health care. Depending upon the policy, the individual receives reimbursement for the costs of doctor visits, hospitalization, prescription drugs, outpatient treatments, surgery, and many other items relating to illness and injury of the insured.
There are five types of coverage written by property and liability insurers:
Physical damage or loss coverage protects the insured against loss of or damage to owned property. This would include such things as direct loss from fire, windstorm, and theft. Loss of income and extra expense coverage provides protection for insureds from income loss and extra expenses incurred due to damage to their property or the property of others. Liability coverage protects the insured against third-party claims for bodily injury or property damage caused by negligence or imposed by statute or contract. This would include such things as automobile liability, workers’ compensation, and contractual liability insurance. Health insurance written by property-liability insurers is the same as that written by life insurers. Surety (often referred to as suretyship) allows parties to offer a financial guarantee of their honesty or their performance under a contract or agreement. Fidelity, construction, and bail bonds are examples of surety coverage.
Government Insurance
Either the state or federal government may write government insurance. Additionally, it may be either voluntary or compulsory, depending upon the insurance being discussed.
Voluntary means that an individual has the choice of participation. The federal government writes crop insurance, military personnel life insurance, bank-deposit insurance, savings-and-loan insurance, securities investor protection insurance, crime insurance, mortgage and property improvement loan insurance, Medicare insurance, insurance against foreign expropriation, and backup programs written in cooperation with private insurers for coverage against perils of flood and riot in qualified areas, and for writing of surety bonds for small minority contractors. In all cases, since it is voluntary, no one is required to participate in these policies. Several states also offer varying types of voluntary coverage. Again, since they are voluntary, no one is required to participate, although some types of bank loans would not be possible without proof of insurance (so, in that respect, they may be thought of as compulsory).
Compulsory means that participation is required. Compulsory government insurance is required of the masses and we usually call this type “social insurance.” It may be written by either the federal or state governments. The best-known government insurance program is Social Security, which provides income in retirement, following a qualified disability, and for qualified survivors of deceased covered workers.
Periodically,
Some states underwrite workers’ compensation insurance while others use private insurers. Several states operate monopolistic state funds for workers’ compensation, so no private insurance is allowed. The states typically make these plans compulsory. Workers’ compensation is required in most states, even when private insurers are allowed to compete for the business, in some cases with the state itself.
Some states have made automobile liability insurance compulsory. This does not mean that the state provides such insurance; merely that drivers are required to purchase the coverage in order to legally drive their vehicle.
Along with stock insurers, mutual companies also assume liabilities in their corporate capacity. Unlike stock insurers, which are operated for the sole benefit of their stockholders, mutual companies are controlled by their policyholders. However, just as many stockholders do not actively participate, neither do policyholders. Therefore, the so-called “control” may be more theoretical than real.
There was originally much doubt as to whether or not a mutual company could survive. It was thought that policyholders were less likely to successfully operate a corporation. In fact, mutual companies have enjoyed a great deal of success, although that success may be more of a tribute to the company managers than to their policyholders. Few purchasers of insurance are interested in running the insurance company. They are more interested in the premium rate, the claims history, and the benefits they will receive. Few care what type of organization the insurer is.
Most mutuals write insurance under the “assessment plan.” Assessment mutuals usually confine their business to specific types of property in limited areas and do not compete in the broad marketplace. Many mutual companies do not employ insurance agents, writing business instead directly out of the home office for the benefit of local residents.
Non-assessable mutuals operate similar to stock companies. They utilize agencies or direct writing systems. This type of mutual company is growing in numbers. Under most state laws a mutual insurer may issue non-assessable policies provided it has a surplus over all liabilities equal to the capital and surplus required of stock insurers writing the same class of business. Even though there are fewer non-assessable mutuals than there are assessment mutuals, the non-assessable write the majority of business.
Assessment mutuals are most active in the fire insurance field and operate principally in one of two ways:
Under assessments, insurance may be furnished on the deposit of a cash premium. There is also an agreement that in case losses and expenses exceed income, the balance is to be collected through the assessments levied on the members (the insureds). The maximum assessment liability for both assessment and nonassessment mutuals for members is usually fixed by the laws of each individual state or by the charter and bylaws of the insurer. State law dominates, if different than the charters and bylaws.
So, who sets up mutual insurers? In theory, nearly anyone can. From a practical standpoint, it tends to be organized by a group with a similar goal. Often this is done by farmers or by property owners in towns and small cities in order to secure insurance at the lowest possible cost. How does one begin such an undertaking? Usually arranging insurance for the original founding members starts the business. After officers have been elected and the organization legally perfected, the business is entrusted to the care of an elected secretary. Since this is a new, startup business the officers (including the secretary) may have other jobs that support them financially. In fact, the officers may even be volunteers, working for the insurance business without pay. This keeps expenses down. Limitation on the risks and amounts to be accepted is usually left to the discretion of the board of directors or an executive committee.
Depending upon who is speaking, the fact that mutuals operate in restricted districts is either an advantage or a disadvantage. It all depends upon one’s viewpoint. Due to their local nature, mutual insurers eliminate much of the moral hazard normally associated with insurance. When a company is small and owned by the policyholders there is likely to be a conscious effort to minimize risks that would possibly end up in a claim (costing the company money). Members know each other. This makes it easier to avoid over-insuring. It also makes fraudulent claims very difficult to achieve. Since the company is small and local, policyholders tend to have a higher moral code when dealing with their neighbors and business associates. It is much easier to feel a large, distant insurance company has lots of money to give in questionable claims.
There
is a down side to this. Writing insurance on a restricted number of risks
also constitutes an element of danger since it loses sight of the unrelenting
application of the law of averages. Writes the authors
of Property and Liability Insurance: “So long as the loss record of the
locality is sufficiently low and uniform, a small mutual may prosper, but on
the advent of several losses at about the same time, there may be
trouble. The system of assessments providing for such contingencies,
while fine in theory, may at times fail because of the
difficulty or impossibility of collecting the assessments.”[1]
Such insurers are not always required by state or other regulating authorities
to maintain surplus funds. Even so, there is an obvious tendency shown to
keep a sizable ratio of surplus to coverage. In addition, history has
shown the companies tend to use scientific valuation of liabilities, which
helps to keep mutuals in business. Many of these companies have done far
more right than their counterparts that issue stocks. In fact, the oldest
insurance company in the
While laws vary, some states discourage mutuals from operating in large cities. There may even be laws forbidding it. States do so because they recognize the necessity for the mutual insurers to protect their insured members against catastrophic losses. Operating in large cities may have the tendency to increase the likelihood of catastrophic losses since buildings are side-by-side and face additional types of threat. Some states merely limit the mutuals’ activity to insuring the less hazardous risks of dwellings, farm buildings, and stores within given districts. In nearly every state, the amount of insurance written must be backed by specifically stated amounts of cash premium (often 25 percent).
When a mutual company manages to spread over one or more states, it is referred to as a state mutual company. A mutual insurer this big has more risk. It no longer is made up of neighbors and friends who know each other. When this advantage disappears so does much of the protection from fraud and misrepresentation. The moral hazard increases. The company may also now have to rely upon agents for soliciting business. The selections of risk is now removed from the home office and placed on the judgment of their agents (who may or may not have the company’s best interest in mind).
For the consumer’s protection, a number of states have passed laws with special reference to the organization and operation of such mutual insurers. The number of applications for insurance that must be in hand before the company is considered “viable” is usually much larger for state mutuals than it is for local mutual insurers. The class of business that may be accepted by state mutuals is carefully limited in certain states, whereas in others a limit is placed on the amount of insurance that may be written on any one type of risk. State mutual companies find that the services they are allowed to render as a whole are limited.
Mutual insurers may operate similarly to a stock company if they wish to. If they choose to, they will charge an advance-premium intended to be sufficient to enable them to meet all of their disbursements for losses and expenses while accumulating a surplus. If the mutual insurer happens to earn a profit, the directors of the mutual insurer may announce a dividend, which is paid to all their policyholders. Again, the policyholders are the owners. On the other hand, if the insurer suffers a loss and has not qualified to issue non-assessable policies, the policyholders could be assessed, usually an additional premium. This would not usually happen, however, since the surplus would be used to offset the loss. The right to assess another premium is an element of strength, though. It means that the company is not limited to using the surplus, since it has the right to assess an extra premium from its members. Mutuals can shift to the non-assessable plan when they have accumulated sufficient surplus to qualify under the applicable state laws.
Many mutual insurers only issue non-assessable policies. Under these policies, the policyowners cannot be asked to pay anything in addition to their initial premiums if adverse experience happens. These companies usually follow the business methods of stock companies and maintain large surpluses to cover claims. Their premiums are typically higher because they operate like a stock company would. Although non-assessable mutuals are numerically smaller, they write more business than do the assessment mutuals.
It is common for mutual companies to convert to stock insurers. Between 1930 and 1995 approximately 70 mutual property-liability insurers did so. While there are many varying reasons for doing so, some of the reasons include:
There is no doubt that it is more difficult for a small or even middle-sized company to operate amid the giants of the industry.
Reciprocal exchange or inter-insurer (also called inter-insurance) associations is a type of cooperative insurance. All policyholders insure each other. Therefore, each policyholder cooperatively insures the next. Each policyholder is also an insurer, as contracts are exchanged on a reciprocal basis.
It must be noted that the reciprocal exchange is not a mutual insurer in the legal sense. That’s because the individual policyholders assume their liability as individuals, not as a responsibility of the group as a whole. Reciprocals are not incorporated either, as a mutual company typically is. Rather reciprocals are formed under separate laws as associations.
The funds held by a reciprocal are the sum total of individual credits held for the account of individual subscribers. These subscribers are required over a period of years to accumulate reserves representing a multiple ranging from two to five annual premiums before underwriting earnings, if any, are returned in cash. A separate account is maintained for each subscriber. Out of this is paid only his individual share of each loss and expense. Beyond that, the reciprocal usually can levy an assessment up to a multiple of premiums paid, such as ten times, but the liability of each subscriber is definitely limited. Reciprocal insurance is quite distinctly an American development.[2]
In its
pure form, reciprocals are still operating in the
The majority of business is written by reciprocals that are not performing in the pure form. These companies deviate in a number of ways. The companies are mutual in the sense that all the other members insure each policyholder. The members are represented by an attorney-in-fact who has been given the power to manage the affairs of the organization, subject only to such restrictions as may be stated within the terms of the powers of attorney or the organization. The liability of each insured is fixed.
Like all things, reciprocals can be either good or bad, depending upon the situation. Opponents of this type of organization point out:
Those that favor reciprocals state the following advantages:
The bulk of reciprocal insurance is written by inter-insurance associations whose characteristics have been modified to some extent. The modifications often include the lack of separate accounts that are maintained for the members. There may be no proration of expenses or losses by the insured. Additionally, no individual may have any claim to any portion of surplus funds. Surplus funds become the property of the organization. Most of the reciprocal companies issue non-assessable policies. Those that do not typically limit maximum possible assessments to no more than one annual premium.
When the characteristics of a reciprocal change so, too, do the avenues of marketing. Some write automobile, life, and other lines in addition to fire insurance. This significantly changes the description of the marketing company.
Underwriting is a major element in the insurance business. Whether it is for a life insurance policy, a fire policy, or a long-term care policy, the underwriting often determines how the company continues and whether or not they show a profit.
Stock and mutual insurers might organize into underwriting groups for the purpose of insuring special classes of property along with their normal insurance business. Although there can be many reasons why they do so, it is often to insure a unique or especially hazardous type of risk. It may also be done when there is a heavy concentration of values involved, or specialized services are required.
Some types of risks require the use of syndicates, who handle the insurance of aviation and marine risks, cotton and oil properties, and other similar risks. Syndicates are distinguished by the management of the group, which makes all underwriting decisions within the framework established by the board, independent of individual member-insurer influence. The participants accept their share of all the lines that are written by the group office.
Some mutual companies were organized with a special purpose in mind. Typically these organizations limit their insurance protection to a specific type of business, such as lumber, logging, grain or milling, or drug manufacturers. At one time these were known as class mutuals. They wrote insurance only for a specified occupation or class in which they had specialized knowledge. Often the objective was lower premiums or certain forms of coverage. Today these specialized companies are known as factory mutuals and they now tend to write much broader coverage.
Factory mutuals began in 1835 and emphasized loss prevention through a cooperative effort of the policyholder and the company. The factory mutuals supplied inspection services and engineering advice, backed up by a comprehensive research program.
Today’s factory mutuals have broadened the type of risk they cover to include commercial property, public and educational institutions, and large-scale housing units. To be eligible a property must be of substantial construction, properly designed to minimize hazards pertaining to its class, equipped with automatic sprinklers (where applicable), and with high-grade management.
The
factory mutual system consists of: three mutual companies, one wholly owned
stock insurance subsidiary, and the Factory Mutual Engineering
Corporation. The Factory Mutual Engineering Corporation provides
inspection, adjustment, appraisal, and plan service for all the
companies. Working closely with the Factory Mutual Research Corporation,
it carries on basic research into the physics and chemistry of combustion and
heat transfer, and the
Factory
mutuals require their insured members to pay a large deposit premium, which is
several times the yearly cost. At the end of the policy period,
deductions are made for substantial loss operation services, other expenses and
actual losses paid, and the balance is returned to the insured. There are
no agents for the company; contracts are written using special
representatives. These representatives are stationed at branch offices
throughout the
Factory mutual companies are characterized by their large deposit premiums, insurance for large and high-grade industrial and institutional properties, and an emphasis on loss prevention. Factory mutual forms provide coverage (at a single rate) for fire, windstorm, explosion, sprinkler leakage, riot, civil commotion, malicious mischief, sonic boom, vehicle and aircraft damage, radioactive contamination, and volcanic eruption and molten material. Boiler and Machinery Insurance, in the same amount as the other property insurance, is also underwritten by Factory Mutuals.
Every agent would like to think they are superior in their profession. The truth is, few agents and brokers actually have the expertise needed in business insurance. It takes an individual or company that deals with businesses as a primary source of clientele. Just as doctors specialize, agents and brokers specialize.
There are thousands of agents willing to sell a product to anyone willing to buy it. There are only a few agents who know how to specialize a product to the needs of the client. Insurers market in a variety of ways, but most of them use agents, especially when it comes to business insurance. Each state has thousands of licensed agents and brokers representing hundreds of commercial insurance companies.
Although there is a distinct difference between an agent and a broker most consumers think they are synonymous and interchangeable. The only direct writers are those companies that do not use agents at all, but rather sell directly through the mail or through association programs. However, captive agents and independent agents are the two groups most likely to be involved in marketing business insurance. Captive agents sometimes represent themselves as direct writers, but this is not technically true since an agent is involved.
We have sometimes heard that an independent agent is more likely to be able to assist the consumer when claims are disputed, since they represent the client rather than the insurer. In reality it is unlikely that any agent, captive or independent, has much clout to move a claim forward. It is true that an independent agent can still write business with other companies if he or she is having a dispute with one of the insurers they have licensed with. However, it is unlikely that any one agent has enough business with the insurer to truly make any difference in a claim dispute. Most disputed claims go to arbitration or litigation whether the agent agrees or disagrees with the insurer’s stance on claim payment.
Captive agents are likely to have a contract that mandates their alliance to the company rather than the client. Even so, claims that are disputed will not be settled by the agent, captive or otherwise. The state statutes will determine some, but most will be settled between the policyholder and insurer, independent of the agent.
For the policyholder, the bigger issue should be the stability of the writing agency (second, of course, to the stability of the insurer chosen). While the insurer might assign a replacement agency if the agency closes, most policyholders want to know whom they are dealing with.
One determining factor might be the size of the agency, although that does not necessarily guarantee financial stability. Some businesses may want to select a specific agent that they feel secure with, whether that happens to be a one-man or one-woman operation or a large agency they are employed by.
A necessary consideration is the availability of products for the type of business being insured. The size of the business being insured can determine the type of insurance product needed. It is necessary, therefore, to know the size of the business prior to setting up a meeting between owner and agent. This is true not only for the business owner but for the agent as well. There is no point in wasting each other’s time if the agent is unable to deliver what the business wants to buy.
National insurance brokerages are the largest of the independent agencies. These brokerages usually have multiple offices and are located in the majority of the states. They may even have affiliations overseas.
Next in size is the medium to large-size independent agencies. While there may be some variances, these agencies usually write a significant amount of commercial business. The large-size agencies place business with fifty or more insurance companies and is fully automated. Sometimes they have special arrangements with insurers that benefit the business owner. This might include such things as the ability to bind the coverage or the ability to commit the insurer to insure the risk. Larger companies tend to be fully computerized tying directly to systems in some insurers.
From our point of view one of the most important factors is the expertise of the agent. As we said, too many agents attempt to advise in areas they are not qualified for. The Buyer’s Guide to Business Insurance by Don Bury and Larry Heischman states: “The insurance industry has tried to encourage its members to involve themselves in continuing education programs to show a commitment to the industry and to professionalism.” Unfortunately, state mandated education has not necessarily yielded educated agents. It has been our experience that those who wish to be educated will be with or without state mandates. Those who are not interested in broadening their knowledge will not do so, even when legally required to.
Some agents pursue special designations in insurance. Some are harder to achieve than others, but all of them demonstrate an interest on the part of the agent in higher education. Since the difficulty in achieving these designations varies we do not wish to make any comment on which one is best. It is our view that any additional education is worthwhile, though some are certainly better than others.
“Parts” pertain to the sections of education that must be completed in order to obtain the specified professional designation. Agents may obtain additional information from the groups that offer this education. There may be additional designations besides those listed here. Each will require some amount of education.
Thank you,
United Insurance Educators, Inc.
End of Chapter Three