2. Insurance Planning. 14. Insurance Company Selection Flashcards
(38 cards)
Module Introduction
It is human nature to avoid the unknown, because charting familiar territory is always preferable to venturing on a voyage to nowhere. This mindset plays a vital role in the marketplace. A consumer always wants to make the best selection when he is making a purchase. In order to be able to do that, he has to have a fair idea of the options available to him, on the basis of which he can then make the best possible choice.
Unfortunately this is not true in the insurance market, where the average consumer is largely uninformed. This is the reason consumers often do not make good selections as far as insurance policies are concerned. When a policy is purchased, an uninformed consumer often can’t comprehend the legalese or financial jargon that sets the terms of the policy. Moreover, consumers are often not aware of the risks involved when buying insurance policies.
The state government steps in at this juncture, to insulate consumers from the vagaries and risks of the insurance market, as well as to protect them from unscrupulous and aggressive insurance companies.
The Insurance Company Selection module will explain the insurance market and its regulation in depth.
The online portion of this module takes the average student approximately three hours to complete.
Upon completion of this module you should be able to:
* Explain the insurance market
* Describe the choices for insurance consumers
* Discuss the historical perspective and the present need for regulations, and
* Outline the role of the state government to protect consumers.
Module Overview
The insurance market has three major players: the sellers, buyers and the regulators. Regulations affect both insurance buyers and sellers. For example, some laws compel individuals and business firms to purchase insurance while other regulations require sellers to provide insurance to specific groups.
To ensure that you have an understanding of insurance company selection, the following lessons will be covered in this module:
* Insurance Market
* Insurance Regulation
* State or Federal Regulation
Upon completion of this module, you will be able to:
* Explain the workings of the insurance market
* Explain the need for insurance market regulation
* Describe the historical background of insurance regulation
* List the ways by which the government can regulate insurers
* List the anomalies in the insurance industry despite regulation, and
* Explain why government regulation of insurance remains an issue today.
Section 1 – The Insurance Market
Insurance consumers are largely uninformed and often unable to understand the wording of insurance contracts. Insurance companies justify the complex language by saying that it protects them from litigation. Presently, efforts are under way to simplify insurance contracts to aid the consumer.
The consumer must decide on the company, agent, policy, amount and price of the policy he wants to buy. There are different rating firms to help choose the right insurance company. The five major rating firms in the U.S. are A.M. Best Company, Standard & Poors, Moody’s Investor’s Services, Duff & Phelps Credit Rating Company, and Weiss Research. But it is not a safe bet to rely only on these rating firms before selecting a company.
Other sources of information about insurance companies include insurance agents, state insurance regulators and customers. But each one of these sources is subject to bias, arising out of interest or experience.
To ensure that you have an understanding of the insurance market, the following topics will be covered in this lesson:
* The Insurance Consumer
* Consumer Choices
Upon completion of this lesson, you should be able to:
* Explain why the uninformed consumer cannot select the right insurance policy
* List the different financial ratings firms, and
* Discuss the problems associated with relying too much on rating firms.
Section 1 – The Insurance Market Summary & Practitioner Advice:
The main challenge for the insurance consumer is to buy the right policy. When the time comes for him to choose the insurance company, he may rely on one of the many rating firms available. However, the ratings firms use different scales to rate a company.
The Internet is a good and reliable source to help consumers make choices about insurance. Sources such as insurance agents, state insurance regulators and customers are not free from biases.
In this lesson, we have covered the following:
- An uninformed insurance consumer risks buying an unsuitable policy because he is not well prepared to choose the right company, agent, policy, and amount of protection.
- There are five main rating firms that rate insurance firms but all these rating firms use different scaling systems to rate a company.
- The insurance consumer makes the right choice if (s)he gathers relevant information from the Internet and makes a comparative study of the ratings of the various rating firms before choosing his company.
Practitioner Advice: While it can be confusing to compare an insurance company’s ratings from the different agencies, there are a few guidelines to follow.
* Get the ratings for a number of years, (not just the last 2) and watch out for a downward trend.
* Look for excellent ratings for more than 5 years.
* Look for very high ratings from at least 2 of the 5 ratings services.
Which of the following must a consumer decide on, besides a company, when they want to buy a policy?
* Agent
* Policy
* Amount
* Price
* Location
Agent
Policy
Amount
Price
* The consumer must decide on the company, agent, policy, amount, and price of the policy he wants to buy.
* There are different rating firms that help consumers choose the right insurance company.
Dean Jones wants to buy an insurance policy. He makes his purchase decision based only on the insurer’s financial rating. Should Dean consider other information?
* Yes
* No
Yes
Section 2 – Insurance Regulation
Depending on one’s perspective, insurance regulation may be viewed as a form of governmental consumer protection or as government interference with transactions between insurance buyers and sellers. Some parties favor more governmental regulation of insurance while others favor less.
Insurance regulation arises from two separate sources, both working together: the law, and the administration of the law. A third important participant in the provision of insurance regulation is the courts, including state, federal, original jurisdiction and appellate courts.
To ensure that you have an understanding of insurance regulation, the following topics will be covered in this lesson:
* Defining Regulation
* Reasons for Insurance Regulation
* History of Insurance Regulation
Upon completion of this lesson, you should be able to:
* Define regulation in the insurance marketplace
* Explain the need for regulation in the insurance sector, and
* Trace the history of insurance regulation
What did the Armstrong Investigation (1905) reveal? (Select all that apply)
* Unethical fire insurance practices.
* Unjustifiable home-office expenses.
* Unethical business acquisition methods.
* Unethical political influence.
Unjustifiable home-office expenses.
Unethical business acquisition methods.
Unethical political influence.
* The Armstrong Investigation revealed abuses such as unethical business acquisition methods, unjustifiable home-office expenses, unethical political influence, and other problems.
The McCarran-Ferguson Act provides a limited exemption to the insurance industry from the federal antitrust laws. Which of the following Acts must apply to the business of insurance “to the extent that such business is not regulated by state law?” (Select all that apply)
* Sherman Act
* Investment Company Act of 1940
* Federal Trade Commission Act
* Clayton Act
Sherman Act
Federal Trade Commission Act
Clayton Act
* The McCarran-Ferguson Act a limited exemption to the insurance industry from the federal antitrust laws. The Act provides that the Sherman Act, the Clayton Act, and the Federal Trade Commission Act apply to the business of insurance “to the extent that such business is not regulated by state law.”
The Gramm-Leach-Bliley Act also established the concept of functional regulation of subsidiaries of financial holding companies and established the __ ____??____ __ as the umbrella supervisor.
* SEC
* Federal Reserve
* NAIC
* FINRA
Federal Reserve
* The Act established two new corporate vehicles for the conduct of financial service activities: the financial holding company & the financial subsidiary.
* In addition, the Federal Reserve was established as the umbrella supervisor.
Section 2 – Insurance Regulation Summary
Insurance market regulation helps protect the interest of the average consumer. Unlike other sectors, insurance is unique in that competition is no guarantee of price regulation. The only way to regulate price of an insurance policy is by ensuring insurer solvency.
The fact that insurance is regulated by the states is a legacy of U.S. insurance history, replete with acts and subsequent acts reversing the former.
The GLB act of 1999 was enacted to modernize the U.S. financial services market. The act got a major thrust due to the technological revolution.
In this lesson, we have covered the following:
- The need for regulation in the insurance market is to guarantee financially strong companies, prevent unfair treatment of consumers, provide fair contracts at fair prices.
- The history of insurance starting with the Paul vs Virginia case in 1869, which concluded that insurance was not interstate commerce, till the recent GLB Act of 1999, which seeks to modernize the insurance marketplace to give it a competitive edge over European counterparts.
- The great debate whether the state or the federal government should regulate insurance.
- Failure to regulate the insurance market has led to abuses such as unethical business acquisition methods and exercise of undue political influence in the life insurance market.
- Merritt Committee Investigation and Armstrong Investigation found problems that led to new state regulations.
Who conducts the administration of a state’s insurance laws?
* Insurance agent
* Insurance Commissioner
* Federal official
* Federal judge
Insurance Commissioner
Promoting insurer solvency is the most important goal of insurance regulation.
* False
* True
True
What are the steps to regulate price in the insurance sector?
* Prior approval before pricing
* Open rate option
* Fixed rate
* Promotion of social goals while pricing
Prior approval before pricing
Open rate option
Promotion of social goals while pricing
The insurance marketplace is regulated by:
* IRS
* Federal government
* State government
* Stock Exchange
State government
* The Congress passed a law giving the states the power to regulate the insurance marketplace.
Section 3 – State or Federal Regulation
In the U.S., insurance is within the jurisdiction of the state. Each state has its own laws to regulate the insurance sector. However, the Appleton Rule, that the State of New York has adopted, is an exception. The individual states regulate the insurance marketplace by making some conditions binding on the insurer. This is done, keeping the benefit of the insured in mind. Provisions like maintaining the mandatory legal reserves and surplus requirements, unearned premium reserve, loss reserve and policy reserve requirements help the State protect the interest of the insured, by ensuring insurer solvency. With the help of the Insurance Regulatory Information System (IRIS) the state monitors insurance companies, to detect solvency problems, if any. In 1992, after the failure of three major life insurance players, the NAIC introduced a new risk-based capital (RBC) requirement for life insurance companies. The States do not allow insurance companies, especially life insurance companies, to take major risks as far as investments are concerned, so as not to jeopardize, the interest of the insureds.
To ensure that you have an understanding of insurance regulation, the following topics will be covered in this lesson:
* State Insurance Regulation
* Regulated Activities
* Audits and Solvency Testing
*
Upon completion of this lesson, you should be able to:
* Define insurance regulation
* Explain how different states maintain regulation
* Explain how the states detect solvency problems, and
* List limitations by the state on insurance firms on investments.
Which of these states have adopted the Appleton rule?
* California
* Texas
* New York
* Alaska
New York
* In 1939, New York made the Appleton rule part of its insurance code. The rule states that insurance companies doing any business in New York State must be in substantial compliance with all of New York’s rules in whatever state they do business.
* No other state has adopted the Appleton rule as part of its insurance code.
An insurer needs __ ____??____ __ that is in excess of assets over liabilities, as a cushion against poor underwriting results (more losses than predicted) and poor investment results (lower earnings than projected).
* surplus
* savings
* a separate account
* reserves
surplus
* An insurer needs surplus that is in excess of assets over liabilities, as a cushion against poor underwriting results (more losses than predicted) and poor investment results (lower earnings than projected).
Identify the items that would be considered non-admitted assets of an insurer. (Select all that apply)
* Supplies
* Equipment
* Office buildings
* Office furniture
Supplies
Equipment
Office furniture
* Examples of non-admitted assets include items such as office furniture, supplies, and equipment.
Consider two insurers similar in size. One company operates very conservatively while the other operates in an aggressive manner. Under previous rules, both insurers might have the same minimum capital requirement. Based on RBC rules, the aggressive insurer may have to maintain what percentage of capital and surplus relative to a conservative insurer.
* 100% more
* 150% more
* 150% less
* 50% more
150% more
* Under the previous rules, both insurers might have the same minimum capital requirement.
* Based on the RBC rules, the aggressive insurer would, perhaps, have to maintain 150% more capital and surplus than the conservative insurer.
Match the category of risk with the correct definition.
Asset Risk
Credit Risk
Underwriting Risk
Catastrophe Risk
* The potential that premiums or reinsurance will not be collected.
* The potential for default or decline in the market value of investments.
* The potential for a catastrophe to reduce profitability or capital.
* The potential that rates will be inadequate to cover future losses.
- Asset Risk: The potential for default or decline in the market value of investments.
- Credit Risk: The potential that premiums or reinsurance will not be collected.
- Underwriting Risk: The potential that rates will be inadequate to cover future losses.
- Catastrophe Risk: The potential for a catastrophe to reduce profitability or capital.
Practitioner Advice
Describe Guaranty Funds
Practitioner Advice: States prohibit insurers or agents from implying that Guaranty Funds make financial strength of the carrier a non-issue. Discussion of these Funds should be avoided and only when the consumer specifically mentions them. To remain compliant and to avoid any chance of misunderstanding, an agent should stress the importance of insurer stability and direct consumer Guaranty Fund questions to the State’s insurance department.
All states have solvency laws and guaranty funds to protect insureds from losses caused by insolvent insurers. State regulators are likely to intervene in an insurer’s independent operations when the company’s surplus accounts reach an unacceptably low level, or if the company’s conduct appears to be jeopardizing the policy owner’s interests. Regulators call the first phase of intervention conservatorship, rehabilitation, or receivership.
If this phase fails to correct the problems, regulators can order the next level of intervention: liquidation. In the case of small insurers, the state may try to rehabilitate the company, find a solvent insurer to assume the business, or liquidate the company using the guaranty fund. The failure of both large and small insurers can require policy owners to give up some contractual rights including access to their funds for stated periods. In some cases involving life insurance companies, policy owners received lower investment returns than called for in contracts issued by failed insurers.
The money to finance the state guaranty funds comes from assessments on all insurers doing business in a particular state. Thus, there is a transfer of funds from solvent insurers to support the insureds of insolvent insurers. The fairness and logic of such a transfer are subject to criticism, since the most likely transfer is from insureds purchasing coverage from insurers charging adequate (higher) premiums to insureds of companies charging inadequate (lower) premiums The 1989 NAIC Guaranty Fund Model Act provides some national uniformity among the various state regulations.
Critics note that insureds having already paid a higher price now must pay more to support those insureds who, voluntarily, chose to purchase insurance at a lower price.
State regulators are likely to intervene in an insurer’s independent operations when the company’s surplus accounts reach an unacceptably low level, or if the company’s conduct appears to be jeopardizing the policy owner’s interests.
Practitioner Advice: States prohibit insurers or agents from implying that Guaranty Funds make financial strength of the carrier a non-issue. Discussion of these Funds should be avoided and only when the consumer specifically mentions them. To remain compliant and to avoid any chance of misunderstanding, an agent should stress the importance of insurer stability and direct consumer Guaranty Fund questions to the State’s insurance department.
Section 3 – State or Federal Regulation Summary
In the U.S., administration of insurance regulation is left to the states. While imposing regulation, the individual state keeps the interest of the insured in mind. To make sure that the insured does not get a raw deal, the state monitors the activities of the insurers. If, at any point in time, the state feels that a solvency problem may arise, it can intervene even in the internal matters of the insurer.
The state forbids the insurers from dabbling too much in speculative investment. This is done to lower the risks of insolvency. The new RBC requirement, binding on the insurer, further eliminates the this risk.
In this lesson, we have covered the following:
- Insurance regulation is monitored by the states as a result, all 50 states can have their own, different set of regulations.
- The states regulate the insurance market by ensuring that problems of insolvency do not hamper the interest of the insured.
- The states enforce the regulations by making certain stipulations and closely monitoring the insurers to ensure that these are not violated.
- In order to minimize the chances for insolvency the states forbid insurers from making risky investments.
- Rate regulations produce insurance rates that are fair and adequate and not unfairly discriminatory.
Which of these states have adopted the Appleton rule?
* California
* Texas
* New York
* Alaska
New York
* In 1939, New York made the Appleton rule part of its insurance code. The rule states that insurance companies doing any business in New York State must be in substantial compliance with all of New York’s rules in whatever state they do business.
* No other state has adopted the Appleton rule as part of its insurance code.
