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Kevin Glaser: Inside the Insurance Industry – Third edition

How Insurance Companies Work

Insurance companies are typically chartered as mutual or stock companies. A mutual company is owned by its policyholders (also referred to as “insureds”). A stock company is owned by its stockholders.

The main advantage of a mutual company from an insurance consumer’s perspective is the possibility of receiving a “refund” in the form of a policy dividend if the insurance company’s profit-making results are better than anticipated.

Such refunds may take the form of rate reductions or maintaining current insurance product pricing.

Insurance companies can also be distinguished by the type of product distribution method they use. The three main distribution methods are: through an independent agency, through an exclusive agency, or through a direct writer.

Agents who exclusively represent one insurance company may be considered independent contractors by the insurance company

For exclusive agencies, the marketing of insurance products is typically the responsibility of the insurance company, although exclusive agents can also mount their own marketing campaigns in order to gain name recognition in their communities.

Insurance agents have signed contracts to represent insurance companies and to sell the products offered by these insurance companies. As a result, legally, they have a dual fiduciary responsibility to both the insurance companies they represent and to the customers that buy the insurance policies that they sell.

Insurance brokers technically represent their customers, not insurance companies.

insurance companies pay contingent commissions not only to insurance brokers, but agents as well, on an annual basis, predicated upon their performance during the prior twelve-month period.

Loss ratio results – dollars paid out in claims divided by the amount of money paid for an insurance policy. Typically, a pure loss ratio of less than 50 % is desirable. Policy retention percentages – how many policies an insurance agent kept at the date the insurance renewed. A number higher than 80 % is decent.

Insurance Company Internal Department Functions

The major internal departments in insurance companies are: Marketing, Claims, Underwriting, Policy Services, Audit Department and Loss Control. Other support positions include: Legal, Actuary, Subrogation, Internal Audit, Product Development, Information Technology and Management.

If a person does not have a well – known public profile and wants to get into insurance sales, he or she must typically have somewhere between 100 to 1,000 leads to contact prior to starting an insurance sales career path because there is no consumer name recognition.

Contingent commissions are additional commission dollars that are paid to agencies when certain, contractually agreed – upon criteria are met.

In general, it is the duty of buyers of insurance to tell their insurance agent the coverage that they desire, as well as the limit of insurance that they want. The insurance buyer also has a duty to read the policy that they receive. Insurance sellers (agents) are responsible for making certain that what the customer ordered was delivered by the insurance company and often little else.

An insurance policy is nothing more (or less) than a contract.

The claims adjusters are the ones who interpret whether or not a claim that is presented is an event that is covered under the policy (contract) purchased.

Most insurance companies follow ISO (Insurance Services Office), which promulgates the vast majority of insurance policy coverage language used by insurance companies today.

Courts view the insurance contract as strictly enforceable because the insurance policy is a unilateral document (drafted by only one party — the insurance company) in which the policyholder has no input in the development of the contract (this is also known as a “contract of adhesion”). As a result, ambiguities are decided in favor of the insurance consumer.

Consumers remain confused about the insurance claims process for many different reasons. One reason is that a claim involves understanding policy language and things such as coverage provisions, limitations and exclusions. Another reason for consumer confusion is a lack of information about the process itself — and due to a great amount of misinformation that has been spread by friends, relatives, neighbors and others concerning insurance claims.

Underwriting is the analysis of the characteristics of a risk to decide if the risk is acceptable, unacceptable, or acceptable if certain requested conditions (changes) are met.

The underwriter typically has the power to make exceptions to the insurance company’s guidelines. Underwriters also possess pricing authority. One of the craziest things about the underwriting process is the archaic rating methodology that is used to price commercial lines (business insurance) policies.

A tremendous amount of effort and time is required to rate coverages that the insurance company provides.

Policy Services provides the internal assistance necessary for the insurance company to get their policies issued.

The main purpose of the Audit Department is to find out if there have been changes in a commercial policy since the last anniversary date.

Loss Control (also known as Loss Control Engineering or Safety Engineering) is a service offered by insurance companies to clients who meet certain criteria.

Other Insurance Company Support Positions

The Legal Department supports the Claims Department. It ultimately decides which claims should be fought (company position defended), which “outside” attorneys (independent, stand – alone law firms that represent insurance companies and their insureds) will be used in litigation support matters and at what point a settlement should be considered.

The purpose of those in the Actuarial Department is to statistically analyze the rate structure of insurance policies by line of business (i.e., commercial property, commercial general liability, commercial automobile, homeowners and personal automobile) to decide whether a rate increase or decrease is needed, and if so, by how much.

Insurance company expenses include claims paid, outstanding liabilities (known as “incurred but not reported” or “IBNR” within the industry) and other company expenses such as payroll, benefits, overhead and profit.

Subrogation Department personnel are known as the “bad boys” of the insurance company. They typically work as a part of the Claims Department and chase down individuals or companies that owe money to the insurance company.

Many times, outside collection agencies or attorneys are used for subrogation purposes where the potential of a large dollar recovery amount exists.

The Internal Audit Department reviews internal insurance company underwriting, claims and other Department activities to make sure the various Departments within the insurance company are acting within company guidelines.

Everyone at insurance companies keeps their eyes and ears open concerning their competition, but typically it is the Marketing Department that feeds competitive information back to their insurance company management. Once the information is received, the Marketing Department makes suggestions for change, if they feel it makes sense. Senior management from both Claims and Underwriting then either agree or disagree with the recommendation (s). If consensus is reached within the insurance company departments, the product idea moves forward through the Product Development team and a new product is born. The proposed product is then reviewed by other departments, such as the Legal and Information Technology Departments, prior to release.

Programming of new products by the Information Technology Department (IT) is an extremely important part of the introduction of new insurance company products.

In addition to providing programming for new products, the Information Technology Department is charged with maintenance of existing computer systems.

Insurance is a heavily regulated industry because it deals with the “public good”.

When a loss exceeds the limit of a primary insurance policy (the policy that pays first) the insurance company may be required to pay even more if an umbrella policy exists.

A Little Known Factor Affecting Insurance Companies

Most people don’t realize the many different areas that impact their insurance policies. One such area is reinsurance. Reinsurers insure the insurance company. Reinsurers pay for losses that occur under the specific contract that is signed between themselves and the insurance companies that they reinsure.

Insurance companies typically purchase reinsurance in one of the following methods: treaty, facultative or bordereau. Companies can use all of these methods at the same time. Treaty reinsurance is negotiated across the insurance company’s entire book of business according to agreed – upon criteria.

Facultative reinsurance is purchased on a case-by-case basis when a specific risk falls outside of values that are contained within the treaty reinsurance agreement.

Bordereau reinsurance is purchased when an insurance company wishes to reinsure a specific set of risks. An example of this type of reinsurance is when a book of business is purchased from another insurance carrier and the purchasing company wishes to limit its loss exposures associated with the new book of business by purchasing reinsurance.


One of the basic premises behind insurance is the Law of Large Numbers.

 “As more exposure units join the statistical group, losses become more predictable”.

In personal lines (automobile and homeowners) there are typically pricing “tiers” that customers may qualify for.

In commercial lines (businessowners, commercial property and general liability coverage) there is even more rate (price) flexibility.

The application of “credits”, pricing tools such as experience rating, loss costs and IRPM (internal rate premium modification), can be applied to reduce the “manual” rate developed. Underwriters use their judgment when applying IRPM.

External (Third Party) Resources

Public adjusters are claims adjusters who work directly with businesses and individuals rather than for insurance companies. Public adjusters are consumer advocates who intercede on behalf of the policyholder with their insurance company.

Insurance consultants provide professional insurance and risk management advice and services to clients, typically on a fee – only basis.

insurance is just one aspect of risk management — it is a risk transfer technique.

Insurance Litigation

Cases that involve supporting the plaintiffs usually occur after there has been a series of discussions between the insurance policyholder and the insurance company claims adjuster.

The term bad faith resulted from courts holding that there is an implied covenant of good faith and fair dealing in all contracts of insurance. This is because insurance contracts have special characteristics — including the fact that they are unilateral (drafted by only one party — the insurance company) and aleatory (the contract is based upon the insurance company’s promise to pay for a future unknown event).

How to Get the Best Insurance “Deal”

The main advantages of internet and direct sales methods are price and convenience. However, there are exclusive agents and independent agents who can sell at or below prices being offered over the internet or through the mail.

Risk Management

A good working definition of “risk management” is attributed to Robert J . Marshburn. He defines risk management as “the practice of protecting an organization from financial harm by identifying, analyzing and controlling risk at the lowest possible cost”.

The Future of Insurance

Insurance companies will continue to find ways to make their contracts easier to comprehend by people unfamiliar with insurance. More and more policies will be issued on a business owners (BOP) type of policy and fewer and fewer commercial package policies (CPP) will exist.

Alternative distribution channels will make considerable headway in future years. People will feel more and more comfortable buying over the internet and over the telephone. Insurance will continue to be viewed as a “commodity” by consumers and price will remain the number one key consideration in the average person’s decision to purchase an insurance policy. Coverages and relationship with the company and/or salespersons will become a more distant second and third place.

Insurance companies will attempt to have computer software do more and more of the decision making and will attempt to streamline their organizations in new ways in order to save money.