UNDERWRITING AND RATEMAKING

Why Underwriting? What is its purpose?

The purpose of underwriting is to develop and maintain a profitable book of business for the insurer.

How does underwriting help profitability?

Underwriting does so by serving these purposes:

1. Guarding against adverse selection, the tendency of people with the greatest probability of loss
to be the most likely to purchase insurance.
2. Ensuring adequate policyholders’ surplus: The insurer cannot write all the business in the world.
Its capacity is based on regulation and internal guidelines, and limited by the ratio of written
premiums to policyholders’ surplus, which is the excess of premiums over losses and expenses.
3. Enforcing underwriting guidelines: UW Guidelines specify the varying degrees of underwriting
authority (the scope of decisions the underwriter can make independently) granted to various
levels of underwriters, producers and MGAs.

What kind of underwriters exist?

Line and staff. Line Underwriters evaluate new submissions or renewals. They work directly with
producers and applicants. They are the ones in our process workflows typically engaged in mid-office
operations. Staff Underwriters manage the risk selection process. In other words they help make and
implement underwriting policy (product, pricing, guidelines, etc.), typically based out of headquarters.

What activities do Line Underwriters perform?

Being directly concerned with evaluating new submissions or renewals, they get to do the following:

1. Select Insureds: This is their day to day function- they do this by following criteria given to them
in the UW guidelines. In the process they avoid adverse selection, charge the right premiums for
a certain chance of loss. Importantly too, they ration the insurer’s available capacity to select
insured spreads across levels of loss exposures, ensuring an optimum spread across locations,
class/size of risk, LOB, etc.
2. Classify and price accounts: Line UWs classify accounts- this is the process of grouping accounts
with similar attributes so they can be priced appropriately. VJ and TJ are in their late 30s, safe
drivers, similar cars, in the same neighborhood, drive the same miles daily, etc.- they get to be in
a group and get similar pricing. Importantly too, they must submit such classification and rating
plans to state insurance department. In some LOBs, Line UWs may not have any discretionary
latitude in pricing. What the pricing, the Line UW must document the characteristics and the
debits and credits applied to pricing (discounts or the opposite). Part of compliance.
3. Recommend or provide coverage: Another day to day function. They decide what extend to
coverage to provide or to ask applicants to make changes to their own risk management in
order to qualify for some coverage. They may limit coverage based on their willingness to
underwrite types of risk.
 4. Manage a book of business: Typically, Line UWs are expected to manage a P/L for a book of
business written from a producer or a territory or a product/LOB.
5. Support producers and insureds: Though independent agents and customer service reps are the
front office, UWs support them to meet the needs of the insured. They are directly involved
with producers in making policy quotations.
6. Coordinate with marketing efforts: Line UWs sometimes have a bit of marketing responsibility.
Sometimes they are responsible for marketing the insurer and its products to the producers.
When they do this they are called production underwriters. Otherwise, carriers have special
agents or field reps to do this work.

What activities do Staff Underwriters perform?

Being involved with creating and implementing policy, they get to do the following:

1. Research the market: Decide whether to get into (or out of) a territory/product, ensure optimal
product mix in a book of business, set premium volume goals, etc. They do this along with
actuarial and marketing.
2. Formulate underwriting policy: This involves the carrier’s mission and goals delineated into
specific strategies. This will influence the contents of the books of business. Staff UWs work with
inputs from the rest of the organization to do this. They do this within the markets they serve,
like: the standard market (better than average accounts), the non-standard market (higher risk)
or the specialty market (unique needs like professional liability).
3. Revise underwriting guidelines: More detailed procedures, influenced by changes in the
Underwriting Policy
4. Evaluate loss experience: They research loss data and change the UW guidelines accordingly
5. Research and develop coverage forms: Coverage forms are used to construct an insurance
contract. Sometimes developed by external advisory orgs. Otherwise developed by Staff UWs in
consultation with actuarial and legal, considering court cases, regulation, consumer needs, etc.
6. Review and revise pricing plans: They develop prospective loss costs (loss trending based on loss
history)- this is also done by external advisories. Then they change rates/rating plans based on
their profit margins.
7. Arrange treaty reinsurance: Staff UWs must arrange for this. Sometimes the underwriting
guidelines restrict coverage based on limitations in treaty reinsurance. If higher limits are
purchased, higher the coverage. In Commercial Property, Staff UWs maintain a line
authorization guide- this controls coverage based on treaties. If facultative (individual loss
exposure) reinsurance is needed, either the Line UW or the Staff UW may arrange for this,
depending on the insurers’ procedures
8. Assist others with complex accounts: They could help Line UWs as consultants or referral
underwriters in complex or atypical cases.
9. Conduct underwriting audits: These ensure the Line UWs are following the UW guidelines,
adhering to proper UW authority, documenting pricing, etc. Also Staff UWs use statistical tools
to review product mixes, size of exposure, etc.
10. Participate in industry associations: National/State level; as well as residual market mechanisms
like the automobile joint underwriting associations or windstorm pools.
11. Conduct education and training: Of Line UWs, both during hiring and Continuing Ed.
What steps are there in the Underwriting Process?

1. Evaluate the submission. When the UW does this, she scopes out the loss exposures and
associated hazards. Four categories of hazards: physical hazards (weak auto body), moral
hazards (DUI history), morale hazards (careless attitude to driving) and legal hazards (liability
law in the state). To evaluate, UWs need to figure out (a) what info is relevant and needed, and
(b) get that info from producers, the application itself, inspection reports, government records,
financial rating (like credit rating), loss data (from loss runs), field marketing personnel, claims
files (when renewing existing policies). They also use tools or methods like predictive analytics
(predict future events), predictive modeling (make models of anticipated future events) and CAT
modeling (estimate losses from potential CAT events).
2. Develop Underwriting Alternatives. 3 basic alternatives- Accept, Reject or Counteroffer. Four
ways to do a counteroffer: (a) Ask for risk control measures (like install a sprinkler), (b) change
policy limits, rates or rating plans (experience rating plans- based on past experiences, schedule
rating plans- which rewards good behavior and penalizes the bad, or retrospective rating plans-
which adjust the premium based on ongoing loss experience in the current period), (c) amend
policy terms and conditions (change deductibles, exclude certain types of loss, etc), and (d) use
facultative reinsurance or agency reinsurance in which the UW asks the agent to divide the
coverage among many carriers).
3. Select an Underwriting Alternative. Things to consider: Does the UW have enough underwriting
authority to make a selection? Is there a wider case to approve than the requested coverage
(more business, other coverages, etc.)? Does it meet the mix-of-business goals? Producer
relationship building? Do regulatory restrictions prevent approval or privacy laws prevent info
that needs to be obtained?
4. Determine an appropriate premium. Ensure each loss exposure is properly classified so it can be
properly rated. For most personal lines as well as Workers Comp, classification automatically
becomes the rate.
5. Implement the Underwriting Decision. Communicate the decision, issue documents (Binder,
which is temporary until the policy is issued, and Certificate, a description of coverage) and
record info.
6. Monitor. Both policies (for activities) and books of business. For policies, look for big policy
changes, big losses, prepare for renewal as the date approaches, make risk/safety inspections
and do premium audits to keep a check on larger loss exposures than were contemplated. For
books of business, keep a tab on loss ratios in classes of business/policyholders, territories and
producers (for sales volume, retention, loss ratio).

How is underwriting regulated?

Each state has its own regulation. Two important examples of UW regulation are (a) prohibition of unfair
discrimination (such as denying coverage on the bases of geography- known as redlining), and (b)
restrictions on cancellation or non-renewal. Most states want carriers to notify policyholders in a
specific period before cancellation or non-renewal. In some cases states have prohibited cancelling
during the policy term.
States do Market Conduct Exams to evaluate carriers’ best practices in all functions, not just UW. Apart
from the above two, these exams cover failures to file rates or forms, improper account classification,
anticompetitive practices, inaccurate usage of classification or rating plans, etc.

How do you determine premium?

To get to premium, let’s explore 4 basic steps or factors: (1) Getting rating info from advisories; (2)
Getting rates approved by the states; (3) class rating; and (4) individual rating.

Advisories: Insurance rating systems are all based on estimated loss costs (losses + adjusting expenses).
Carriers can get loss cost info from advisories like ISO (Insurance Services Office, Inc.) for P&C, NCCI
)National Council on Compensation Insurance) for WC, AAIS (American Association of Insurance
Services) and the SFAA (Surety and Fidelity Association of America). They help in ratemaking and
developing forms specific to states. To get the final rate, the carrier will get basic rates, and will add
profits/contingencies; and then gets the final premium by multiplying the rate by the number of
exposure units. The advisories can get historical loss data from several carriers and get to the rate by the
law of large numbers (i.e., as the number of similar but independent exposure units increases, the
accuracy of predictions increases).

States: Basic rates are published in the advisory’s rating manual or stored in the carrier’s rating system.
They are also filed with the state insurance department when required. The department may accept,
reject or modify them.

Class Rates: Class rating considers the average probability of loss for large business with similar risks.
Used for commercial properties, different types of workers in WC coverage (clerical vs construction),
etc.

Individual (or Specific) Rates: Used when individuals can’t be readily assigned a class. Example: a large
unique factory building. UWs could use the building materials for determining loss cost, also number
and types of fire extinguishers, local fire department’s capabilities, etc.; and assign weighted points,
which determine the rate when there is none published. The UW needs to rely on her judgment in this
case- known as judgment rating.

CLAIMS

What kind of professionals settle claims?

Different types: a claim representative (a generic name for all who adjust claims, except public
adjustors) could be staff claim reps, claims supervisors, independent adjustors, TPA employees and
sometimes producers. Public adjustors also settle claims by representing the interests of the insureds.

Staff claim reps could work from the office or could be field (or outside) claim reps who investigate the
scene of a loss, have meetings with lawyers, insureds, etc. Staff claim reps tend to work from branch
offices than the home office or HQ. Independent adjustors are contractors hired sometimes for all
claims work, sometimes when the carrier doesn’t have enough branches, sometimes when staff claim
reps are too busy to handle all the work, or sometimes when special skills are needed. Sometimes
producers have the mandate to make claim payments, called drafts, upto a limited amount. Public
adjustors are hired by insureds if the claim is complex or if there are challenges with the settlement.
They are paid a percentage of the settlement. Some states govern the services they can provide.

What are quality measures for the claims function?

3 typical measures: (a) Best Pracs, (b) Claim Audits and (c) CSAT.

Best Practices in this context simply means the internal procedures for claims. They are based on legal
requirements often- example: ‘a claim should be acknowledged in 24 hours within receipt for a specific
product’. This is not just an SLA, but law.

A Claim Audit is done by examining the number of open cases to closed claim files, performed by branch
office or home office claims staff. To evaluate they will look at many factors- both quantitative and
qualitative. Quantitative audit factors- examples: timeliness (of reports, reserving, payments), number
of claim files monthly (opened, closed, reopened), subro recovery percentage, accuracy of data entry,
percentage going to litigation, percentage entering trial, average claim settlement by claim type, etc.
Qualitative audit factors- examples: realistic reserving, follow up on subro opportunity, good negotiation
skills, thorough investigation, accurate evaluation of insured’s liability, etc.

CSAT- claim supervisors review correspondence sent on claim reps- complaints or compliments.

What are the steps in the claims handling process?

1. Acknowledge and Assign the claim (AA). Claim is assigned to a licensed claim rep by the carrier.
She contacts the insured to acknowledge, get info on the loss and explain the claim process and
instruction to prevent further losses. If needed, she will set up a time to investigate and inspect.
2. Identify the policy and set reserves (IR- Identify and Reserve). First check the policy to ensure
claim is covered under the terms. If it is not, the rep could notify the insured thru either a non-
waiver agreement (a signed agreement that during the course of the investigation neither the
carrier nor the insured waives rights under the policy) or a reservation of rights letter (letter
stating that the carrier may later deny the claim if the facts warrant it). Second, the rep
establishes case (loss) reserves- typically it happens early in the process. A Claim Information
System helps with this- there be a type of reserve for physical damage, another for bodily injury,
etc. Some systems require separate reserves for each claim. Others include expense reserves for
some LAE. Example: A car hits a guard rail. The claim rep acknowledges this, verifies coverage,
gets info, etc., and sets a reserve for $1500- this should be an accurate reserve as it is easy to
estimate a single car collision loss with no bodily injury or liability. After the claim is paid the
reserve comes down to $0. Liability claims are far tougher due to complexity, witness testimony,
long period, etc- so the final payment may exceed the original reserve.
3. Contact the insured or her representative. Explained in Step 1, but it could happen after the
initial acknowledgement as well. Claims rep may also contact a public adjustor or third parties if
they are claimants. Also they will share a blank proof of loss form for property damage and any
documents for evidence the insured can provide the carrier.
 4. Investigate. Three things to remember here: (a) Claims handling guidelines help the rep
understand the type of investigation, methods, what info to get, when to stop investigating- i.e.
when she will have sufficient info, etc.; (b) get perishable info first and contact third party
claimants early in the process; (c) pursue subrogation rights if a negligent third party was at
fault.
5. Document. Throughout the life of the claim, document, document, document. There are 3
types: (a) diary systems (a calendar to table claim steps, review dates, etc., as reps handle
multiple cases daily- also called pending system or suspense system), (b) file status notes (an
activity log that documents investigations, reviews, decisions, comments on all parties, etc.), and
(c) file reports (activity reports which are more detailed- they could be external or internal).
External file reports go to state departments, producers and others- they are sent by reps and
have info on details of the loss, like the paid amount, amount in the outstanding reserve, etc.
Internal file reports could be preliminary reports (reps acknowledge receipt of FNOL to the
carrier, claim activity, suggest reserves, coverage issues, request assistance, etc.), status reports
(report on similar details as claim handling is in progress) and summarized reports (detailed
template with subheadings, filed in 30 days of acknowledgment). Also- though this happens
when the claim is closed, the rep must create a final Closing Report, which contains
recommendations for subrogation, advice to underwriters, etc. This report could be used by
supervisor to appraise the rep’s performance.
6. Determine the cost of loss, liability and the loss amount. Claim reps find the cause of loss, apply
statutory and case law to find liabilities. To cover the loss, the rep considers options to repair,
replace, settle any business income lost, pay for treating bodily injury, including residual and
lasting effects of injury and the pain and suffering it has caused.
7. Conclude the claim. 3 options: (a) pay (all eligible named parties), (b) deny (may need approval
from a claim supervisor, and need to send a denial letter as soon as possible, usually by certified
mail) or (c) resolve the dispute (either litigation or alternate dispute resolution- ADR). Litigation
could happen any time during the claim lifecycle. ADRs include Mediation (use a neutral outside
party to examine and recommend), Arbitration (same as mediation, but the decision is binding),
Appraisals (when the loss is covered by the amount of owed is disputed), Mini-Trials (an
abbreviated version of a trial before a panel or an advisor) and Summary Jury Trials (same as a
Mini-Trial, but contains witness testimony and presented to a panel of mock jurors).

How does the claim rep verify coverage when she is assigned the case?

The rep is looking for two types of verification- first, verify the policy is covered, second- verify the claim
cover the loss (whole or in part). To verify the policy is covered, she follows 3 steps: (a) check it is in
effect as on FNOL date, (b) check if the claim date is within the policy period, (c) check if the damage is
insured under policy. To verify the claim covers the loss, she follows 4 steps: (a) check if the
insureds/claimants have insurable interest (when the interest in the policy may cause financial damage
to the insured/claimant in the event of the insured loss, and the interest is not unduly remote), (b) check
if the damaged property/part thereof is covered, (c) check if the cause of loss is covered, and (d) check if
any additional coverages, endorsements, limitations or deductibles apply.
How does a rep determine the amount of loss?

Best Pracs: This could be the tough part in many cases. There are methods to do this. Keep an inventory
of items lost. Is the loss involved is a business, check any valuation info in the company’s financial
records. Also for loss business income, check financial records for historical date.

Valuation Basis: For properties, check if the policy itself specifies how to value the property, in the case
of property damage. All property policies have a valuation provision- typically there 3 methods: ACV
(Actual Cash Value- the cost to replace the property with another property of like kind and quality less
depreciation), Replacement Cost (same as ACV without depreciation) and Agreed Value (specified in the
policy declarations on the maximum amount to be paid in the event of loss- this value is based on
appraisal, and used for antiques, fine arts, etc.).

In the case of Replacement Cost, the claim is generally paid only after the item has been replaced. In the
case of AVC, it is usually paid upfront, and then the insured has 180 days to provide notice of the
replacement cost.

What is the depreciation timeframe is over? Even then an item could have some functional value. Reps
need to use judgment. Some methods to compute value involve checking square footage in case of a
property, type and quality of materials used, and construction cost per square foot.

After the claim payment, what could the rep do to limit costs?

Pursue (a) subrogation or (b) salvage rights in case of a total loss (all is lost or destroyed) or a
constructive total loss (when the loss can’t be repaired without exceeding the pre-loss value less the
salvage value). If a damaged car is valued at $10,000, the repairs cost $9000 and the salvage value is
$1500, it would be considered a constructive total loss. The insurer finds it cheaper to pay the ACV of
$10,000, less the salvage value of $1500, bringing the total spend to $8500, instead of paying $9000 in
repairs.

What else is important to remember in the case of liability claims?

Besides the steps followed in claims benefiting the insured, liability claims have additional steps to
watch for: (a) find out whose fault it was/how the loss occurred/is the insured is responsible to pay; (b)
speak to the third party or a representative to get their side of the story, (c) interview witnesses and
study the scene to reconstruct it. The injured party has the option of going to court, the carrier typically
settles out of court due to the expense involved in litigation. Claims paid out for liability claims are called
Damages. Legal liability may involve 2 types of damages- Compensatory Damages (payment for actual
harm done) and Punitive Damages (court-awarded payment as punishment for reckless, malicious or
deceitful act- it may not be related to any harm done). Compensatory Damages could be of 2 types:
Special Damages (specific, out of pocket expenses- such as for hospital expenses, ambulance,
prescription, etc. - easy to compute) and General Damages (compensation for pain and distress- like
disfigurement, loss of the ability to bear children, etc.- the rep may look for past cases and supervisors
for guidance).
What else is important to remember in the case of Property Catastrophe claims?

In two words, speed and creativity. Regulators and insureds expect claims to be settles quickly,
regardless of the volume of claims, so carriers have to prepare. Detailed Contingency plans are made
and given to all associates. These plans have (a) each one’s roles and responsibilities, (b) keep
organization focused on CAT Claims than anything else, and (c) identify challenges, weakness, etc. A
carrier could do other things, such as increase claim settlement authority of associates, including
producers, get CAT claim reps from other regions, make advance payments to policyholders for living
expenses, settle immediately all property valuation in the policyholder’s favor, etc. Sometimes claim
checks are payable to both policyholders and mortgagees. But mortgagees may withhold signature until
repairs are done, but repairs can be done only with the claim check. So the carrier may need to help out
claimants. A sample of the challenges in a CAT situation: (a) Staffing problems (get staff from other
areas, independent adjustors), (b) Evacuating the carrier’s premises (secure premises and get alternative
premises), (c) Communications down (get wireless communication, arrange for public broadcast), (d)
Transportation blocked (identify alternative routes and services), etc.

What is Good Faith claims handling?

Claim reps must pay valid claims- this is the essence of good faith claims handling. Or to put it another
way, they must avoid acting bad faith, which means the unreasonable or unfounded (not necessarily
fraudulent) refusal to pay a claim. More bad faith claims (for breaching implied good faith and fair
dealing) happen in insurance than any other industry. This is because the insurer get to write the policy
contract and also does the investigation, claim decision, etc.- so it has more “bargaining power”. Courts
typically favor the insureds for this reason.

To prove bad faith, courts determine a standard of conduct. Some courts use a negligence standard (also
called due care) to award compensatory damages, but they may award punitive damages only in case of
gross misconduct (not gross negligence and willful misconduct- these are different).

Good Faith handling includes these behaviors: (a) Good investigation (thorough, accurate and timely),
(b) Documentation (complete, accurate), (c) fair evaluation (based on facts, not opinions; compliance
with statutory time limits), (d) good faith negotiation (respond to lawyer requests with evidence,
documentation, etc., use arbitration to prevent bad faith behavior, etc.), (e) follow laws relating to fair
claims practices, (f) use competent legal advice (from lawyers without competing interests), etc.

RISK MANAGEMENT

What is the difference between Traditional and Enterprise Risk Management?

Risk Management is the function that deals with the uncertainty of economic outcomes (risk). It is a
dedicated function in large organizations. A risk management program deals with resources and
activities to protect an organization from the adverse effects of accidental losses. Traditional Risk
Management deals with “pure risk” (a chance of loss or nor loss, but no chance of gain). To do this it
focuses on managing safety, purchasing insurance and controlling financial recovery from losses
generated by hazard risk (BCP/DR). Enterprise-wide Risk Management (ERM) deals with all risk- i.e. both
pure risk and speculative risk (also business risk) in which there is a chance of gain or loss (interest rate
hedging/currency risk). An ERM approach integrates these efforts at the enterprise level rather than at a
BU level.

What is the Risk Management process?

See the following steps- check the taxonomy. Remember the acronyms ILE, ALE, ESIM:

1. Identify Loss Exposures (ILE)

2. Analyze Loss Exposures (ALE)
3. Explore Risk Management Techniques: (ESIM- Explore, Select, Implement, Monitor)
a. Risk Control
i. Avoidance
ii. Loss Prevention
iii. Loss Reduction
iv. Separation
v. Duplication
b. Risk Financing
i. Retention
ii. Non Insurance Transfer
iii. Insurance
4. Select Risk Management Technique: (ESIM- Explore, Select, Implement, Monitor)
5. Implement Risk Management Technique: (ESIM- Explore, Select, Implement, Monitor)
6. Monitor Risk Management Technique: (ESIM- Explore, Select, Implement, Monitor)

Now, the details:

1. Identify Loss Exposures: Develop a thorough list of accidental losses. 3 ways to do this: (a) Do a
physical inspection (locations, operations, maintenance routines, safety practices, etc). (b) Do a
Loss Exposure Survey- discuss this with managers and peers. This covers the same topics in a
survey format.(c) Analyze Loss History.

2. Analyze Loss Exposures: Find 2 things about each item in the above list of loss exposures: (a)
Loss Frequency, (b) Loss Severity

3. Explore Risk Management Techniques: At this stage just understand the techniques. Two
categories: Risk Control and Risk Financing.
a. Risk Control Techniques- Make losses more predictable, or less frequent or less severe.
i. Avoidance: This means avoiding any possibility of loss by disposing off an
existing loss exposure or deciding not to assume a loss exposure. Example: A
 family decides not to buy a boat, and avoids any loss exposures from boat
ownership.
ii. Loss Prevention: Reduces loss frequencies (number of losses). Example: A
business installs bars on windows to prevent burglaries.
iii. Loss Reduction: Prevents severity of losses (dollars). Example: A business installs
a sprinkler system to reduce fire damage loss severity. Underwriters frequently
request inspection reports from the carrier’s risk control department.
iv. Separation: Lowers loss severity by isolating loss exposures. Example: A business
buys multiple small warehouses instead of a single big one to lower the effects
of a single loss.
v. Duplication: Lowers loss frequency by keeping spares, backups, copies in a
reserve. Example: A taxi firm buys duplicate vehicles to keep all drivers on the
road even if one regular car needs repair.
b. Risk Financing Techniques: A way to pay for or transfer the cost of losses.
i. Retention: Retains all or some loss exposure (even if unintentionally due to
inadequate identification of exposure). Example: A taxi firm does not buy
collision coverage but sets aside its own funds to cover losses.
ii. Non Insurance Transfer: Transfers financial consequences to a third party (not
insurance). Example: Landlord transfer to tenant any liability exposures- a “hold
harmless” agreement.
iii. Insurance: Transfers the above to an insurer in exchange for a premium.

4. Select Risk Management Technique(s): Based on financial criteria and guidelines: (a) Financial
Criteria: Low risk tends to reduce profitability as well. A company may decide that it doesn’t
want any retained loss exposures to affect annual earning by more than 5 cents per share of
stock. If the company has 100 million shares outstanding, this means a $5 Million dollar
retention limit for all exposures. (b) Informal Guidelines: First guideline, Do not retain more than
you can afford to lose. Second, Do not retain large exposures to retain a little premium. If an
exposure has low frequency but high severity, go ahead and insure it because it is unpredictable
but will cost relatively less premium. Third, Do not spend a lot of money for a little protection.
For exposures with high frequency and low severity, retention is probably best. Fourth, Do not
consider insurance a substitute for risk control. If collision frequency is high, simply buying more
insurance or reducing the deductible will not actually solve the collision problem. Help solve the
problem by loss prevention or loss reduction.

5. Implement Risk Management Technique: Four decisions: (a) Decide what should be done (new
sprinkler system/what it costs/which model/etc.); (b) Who should be responsible; (c)
Communicate risk management info to all concerned parties; (d) allocate the cost of the risk
management program (BCP/DR for which BU)

6. Monitor Risk Management Technique: Monitor results and revise if needed. This also means
returning to the first two steps (identify and analyze new loss exposures)
LOSS EXPOSURES

What are the different types of loss exposures?

(1) Property Loss Exposures, (2) Liability Loss Exposures, (3) Personnel Loss Exposures, and (4) Net
Income Loss Exposures.

In Property Loss, what types of assets are exposed?

An asset is any item with value. Basic types of property are Real Property and Personal Property. But
these are subdivided into other types. They could be land, buildings (including plumbing, wiring, HVAC,
etc.), personal property (contents) in the buildings, money and securities (separate from personal
property as they have special challenges- highly susceptible to theft and can be easily destroyed in a
fire), vehicles (personal auto or commercial auto including fire trucks, etc., mobile, RV) and watercraft,
and property in transit (vehicles carried on trucks, gasoline in a tanker truck).

What is a Peril? Is it different from a Hazard? How does peril happen? What are its consequences?

Peril is the cause of a loss. For property losses, it could happen from fire, lightning, flood, hail,
windstorm, theft, etc. A peril could leave a property in an altered state (life fire) or affect its usability
(collision) or its access to the owner (theft). A hazard is not a cause of loss- it increases the frequency or
severity of a loss. Careless campfires are a fire hazard, not a peril. A uncontrollable fire is a peril.

From the Insurance POV, Peril’s consequences are financial because the asset reduces in value when
peril affects it. 3 types of parties are affected by it: Property owners, Secured Lenders (like a mortgage
holder) and Property Holders (Bailees are parties temporarily possessing but not owning a property, and
responsible for its safekeeping- Drycleaners, repair shops, etc often fall in this category. This agreement
is called a Bailment). The financial consequence could be valued in terms of ACV, Replacement Cost or
Agreed Value.

Before we get into Legal Liability, what are the sources of Law in the US?

1. Constitution- this itself and all the decisions affecting it made by the Supreme Court form
Constitutional Law.
2. Legislative bodies- federal, state or local bodies could have a law passed- it’s called a statute.
Such laws are called statutory laws.
3. Court decisions in particular cases- Called Common Law or Case Law- they establish a precedent.

What is the difference between Criminal Law and Civil Law? What is a Tort?

Criminal Law deals with wrongs against society and cases under this could be prosecuted by the
government. Civil Law protects rights and provides remedies for breach of duties owed to others. It
protects contract rights. A tort is also a wrongful act (not prosecuted by the government, so not
criminal) except a breach of contract, that invades a legally protected right. In other words, it is a civil
law case which is not a breach of contract. It could be of 3 types: (a) Negligence- like a DUI accident, (b)
Intentional Tort- causing harm, like assault, battery, libel, slander, invasion of privacy or false arrest, or
(c) Strict Liability (or Absolute Liability)- like owning a wild animal or doing dangerous stuff like blasting
operations. Tort Law is a branch of civil law that doesn’t deal with breaches of contract. It is largely
based on common law, but sometimes made into statutes. Its main concern is to find out who is
responsible for injury or damage.

For Legal Liability, what is the basis for a legal right of recovery?

A legal right of recovery could be based on:

1. Torts: Negligence, Intentional Tort or Strict Liability

2. Contracts: Liability assumed under contract (landlord’s transfer to tenant via a “hold harmless
agreement”) or a Breach of Warranty (breach of promises made by a seller, like a hair dryer will
work as attested, but ends up damaging hair)
3. Statutes (from statutory law): No-fault auto laws or Workers Compensation laws (when the
employer has to pay specified benefits in case of injury regardless of who is at fault, but cannot
be sued by the employee for workplace injury).

Returning to Torts, could you detail out the 3 types?

A tortfeasor could potentially commit 3 types of torts:

1. Negligence: Failure to act in a prudent manner. DUI accident. Proving Negligence needs 4
elements of proof: (1) Defendant owed a legal duty of care to Plaintiff. (2) She breached that
duty of care. (3) Defendant’s act was the proximate cause (without it Plaintiff would not have
suffered, and its natural effect was the injury) of Plaintiff’s injury. (4) Plaintiff suffered injury
2. Intentional Tort: Deliberate acts that cause harm. Assault. (threat of force for harm) Battery
(harmful physical contact). Libel (defamation in print). Slander (oral defamation). False Arrest
(like a store employee detaining in error a customer for shoplifting). Invasion of Privacy.
3. Strict Liability: Inherently dangerous activities.

In addition to the tortfeasor, vicarious liability could also be held by other parties, especially
subordinates in a business when they act on behalf of the employer. In such cases, both employer and
employee are liable, jointly and severally.

What are the assets exposed to Liability Loss?

Any asset could be exposed but most commonly, plaintiffs claim money. Defendants liable to pay could
give money or sell real or personal properties to convert into money. Plaintiffs could also claim income
that the Defendant may receive in the future, but doesn’t have now.

What could cause liability losses?

Auto/vehicle/watercraft accident, accident on premises, accidents from personal activities (injury in

golf), business operations (roofing contractor falls and sustains injury), completed operations (after an
electrical wiring job, faulty wiring leads to injury), products (a pharma drug causes dangerous side
effects after several years), advertising (using models’ profiles or others’ trademarks without
permission), pollution (cleanup costs and expense to relocate or rehabilitate people), liquor (person is
DUI after a host serves liquor), professional activities (medical malpractice, errors and omissions for
insurance professionals).

What are the financial consequences of liability losses?

 1. Damages.
2. Defense Costs
3. Damage to reputation

For Personnel Loss Exposures, what assets are exposed?

Every personnel is a person of value, but some key employees are considered especially valuable to the
business. Assets exposed could be (a) individuals, (b) groups, or (c) owners/officers/managers.

What causes Personnel Losses?

Death, Disability, Resignation/Layoff/Firing, Retirement/Kidnapping

What are the financial consequences of Personnel Losses?

Loss of value from the employee’s contributions, replacement costs, loss from any negative publicity,
loss caused by low morale.

For Net Income Loss Exposures, what assets are exposed?

Only 1- the future stream of Net Income (revenue minus expenses and income tax). If expenses increase
or revenue earning is stalled, net income decreases. A factory fire may not only affect property, liability
or personnel losses, but net income as well.

What causes Net Income Losses?

A Net Income Loss is not a direct loss, but an indirect loss, which arises from a direct loss. So a Net
Income Loss could happen as a result of Property, Personnel or Liability Losses. Additionally, it could
arise from Business Risks, inherent to a business operation. Such risks could be: (a) Loss of goodwill (to
maintain this many organizations pay for losses for which they may not be responsible), (b) Failure to
perform (Ford Explorer with Firestone recall in 2001), or (c) Missed opportunities.

What are the financial consequences of Net Income Losses?

Decrease in revenues, Increase in expenses, or a combination of these two.

INSURANCE POLICIES

What are the 4 essential elements of a contract?

1. Agreement (offer and acceptance) - There must be mutual assent. One offers, another accepts.
In insurance when an applicant submits an application, it is an offer to buy insurance. The UW
accepts and sets a premium which is accepted by the insured. At this point the insurer has
accepted the offer. An underwriter could make several counteroffers till they arrive at
acceptance.
2. Capacity to contract. Parties must be sane, not under the influence of drugs or alcohol, must not
be a minor. In Insurance, the carrier must be licensed to do business in a state.
 3. Consideration. Something of value exchanged. In this case a promise to pay Premium in
exchange for a promise to pay Claims.
4. Legal purpose. Should not be against the law or public policy (like a bribe). Property insurance
on illegal drugs would be invalid. Or if the insured’s wrongful conduct causes the operation of
the contract to violate public policy- like in the case of arson.

What are the distinguishing features of Insurance Policies?

1. Contract of indemnity. The purpose is to indemnify the insured who has suffered a loss.
Insurance policies follow the principle of indemnity (benefit should be no greater than the loss
suffered by the injured- i.e. the insured should not profit from the loss). Also the contract
usually allows for subrogation recovery rights. In addition, the insured must have insurable
interest- i.e. she cannot buy insurance unless she is in a position to suffer loss from the insured
event. An exception to the rule of indemnity is when the insurance policy is a valued policy- that
is, when the claim amount is specified, regardless of the value of the loss.
2. Contract of utmost good faith. Complete honesty and disclosure needed. The parties are
released if there is any concealment or misrepresentation of material fact (a fact that would
affect the insurer’s decision to provide/maintain insurance or settle a claim).
3. Contract involving fortuitous events and the exchange of unequal amounts. Insurance covers
loss exposures that are uncertain (fortuitous) and involves the exchange of frequently unequal
amounts (premiums or claims).
4. Contract of adhesion. Contracts are written by the insurer on pre-printed forms developed by
itself or an insurance advisory organization, and the insured cannot change anything in it. The
insured has no choice but to adhere to it, hence the word adhesion.
5. Conditional contract. It is a contract that obligates one or more parties only under certain
conditions.
6. Nontransferable contract. Cannot be assigned to any other party than the insured.

How is an Insurance Policy structured?

A policy is derived from an insurance form. A form may be preprinted (for policies that meet the needs
of several policyholders) or a manuscript form (drafted according to terms agreed between the insurer
and the insured). A preprinted form may be standard forms published by an advisory organization, or a
non-standard form developed by the carrier. Manuscript forms may be drafted to meet unique needs,
common in liability coverages for certain professions.

A policy may be either self-contained (single document, like a personal auto policy) or modular
(combination of different agreements, some of which may not be common to a large number of
policyholders).

An example for a modular policy is the ISO Commercial Package Policy (CPP). It has several modules for
different LOBs. But it has common elements across the different LOB components as well- such as a
common “policy conditions” module and a common “declarations” page. The unique elements for the
components, called “coverage parts” (they contain policy provision for that particular coverage, whether
in a CPP or a monoline policy) are: another declarations page specific to the coverage part (this is in
addition to the common declarations page), one or more coverage forms, and applicable endorsements
and in some cases, a general provisions form. See the following diagram showing a CPP for 3 LOBs
covered (Commercial Property, Inland Marine and Farm):

What are the different documents in the Policy?

A Declarations page is like an exec summary - contains details on the insured and the subject of the
insurance. Identifies parties to the contract, names, addresses, premium, etc. They also provide a short
summary of the coverage provided under the policy

Policy Provisions clarify details of the coverage. The coverage forms, cause of loss forms, etc. are all part
of this. Policy provisions relating to the specific line of business in a monoline or CPP policy are grouped
under the term ‘coverage part’.

Policy provisions come in 6 categories: (1) Declarations, (2) Definitions, (3) Insuring Agreements-
statements containing the carrier’s promise to make payment under described conditions, (4) Conditions,
(5) Exclusions, and (6) Miscellaneous provisions- wide variety of provisions that may alter the policy.

What are other related documents to the Policy?

Application- Documented request for coverage; has info about the insured and loss exposures.

Endorsement- Amends the policy form (homeowners endorsement including home business coverage)

Insurer’s bylaws- Example: Attachment to Policy, by mutual carriers, giving insureds corporate rights

Relevant Statutory Terms- Incorporates a statute in the policy by reference. (WC or no-fault auto laws)

Endorsements or Policy Forms may sometimes have info that qualifies as Declarations, in the form of
scheduled coverage (insurance for property/assets specifically listed- i.e. scheduled – on a policy, with a
limit of liability for each item). Example: a homeowner wants antiques covered with limits for each item.

What are the Policy Provisions found in Property Policies?

Covered Property: What is covered. Exclusions and Limitations. In Homeowners, the home is called a
dwelling and attached structures are also covered. Home and the attached structures together are
called ‘residence premises’. A detached garage is not covered and has to be covered separately. For
commercial property, the building is covered, but attached structures like antennas, pools, etc. are
covered separately. Installed fixtures, machinery, etc. are covered. Personal property can be insured in
the same policy but considered separate coverage items. Commercial property insurance refers to the
contents of the building as ‘business personal property’ which includes personal property of the insured
which are described in the declarations page. Property policies of all types tend to list items which are
not covered (like autos in a homeowner’s policy), this way it becomes clear what in fact is covered. HO
policies cover even guest’s personal property. Commercial property policies limit (not exclude) coverage
for personal effects of employees or guests. Personal auto policies cover damage to borrowed autos.

Covered Locations: Buildings are covered in a fixed location, but stuff like doors or window screens if
they are stored or moved elsewhere are also covered. HO policies cover personal property anywhere in
the world. Commercial property policies don’t cover personal effects outside 100 ft of the building.
Property moved out can be insured- such policies are called floaters. Floaters can be used to cover
satellites sent into space. Auto policies cover within the US, PR and Canada.

Covered Causes of Loss: A cause of loss could be storm, theft, etc., but many policies list them- such
policies are called named peril policies. Some policies cover any cause of loss, unless specifically
excluded- such policies are called special form or open peril policies. The difference between named
peril and open peril policies is the burden of proof. For named peril, insured must prove the cause of
loss was named, for open peril, there is no such burden unless the insurer proves it was caused by an
excluded peril. Named Peril policies could be Basic Form (has 1 dozen basic perils) or Broad Form (adds
more perils to basic form) policies. Open peril policies are also called Special Form. Similar to this, for
Auto Physical Damage, there are 3 coverages: Collision Coverage, Other than Collision (OTC) Coverage,
and Specified Causes of Loss Coverage.

Excluded Causes of Loss: In Property, there are typically several. Loss from war or nuclear hazard - too
expensive to pay claim, so excluded. Earthquake, flood- typically excluded but can be separately insured.
Loss from inherent vice and latent defects, wear and tear.

Covered Financial Consequences: Could be (a) Reduction in Property Value due to damage (called a
Direct Loss), (b) Lost Income (covers lost business income, or rental income if part of a home is rented
out; called Indirect Loss or Time Element Loss) and/or (c) Extra Expenses (expenses other than ordinary
expenses that a business bears to mitigate the effects of an interruption due to damage; for
homeowners ALE- Additional Living Expenses- are a type of Extra Expense).

Covered Parties: Parties with insurable interest could include owners, secured lenders (generally listed
in Declarations as a loss payee, users of property, other holders of property (bailees), etc.

Amounts of Recovery: This is covered by policy provisions relating to (a) Policy Limits, (b) Valuation
provisions, (c) Settlement options, (d) Deductibles, (e) Insurance-to-value provisions (insurers encourage
insureds to cover up to the value of the covered property, in case of a total loss- if it is underinsured,
they place provisions that encourage insureds to get this total coverage- example: coinsurance, which
specifies how much they are insured up to), (f) “Other insurance” provisions (if there is more than 1
insurance policy covering the same item, the amount paid by each policy depends on allocation
procedures specified in the Other Insurance provisions).

What are the Policy Provisions found in Liability Policies?

Covered Activity: Coverage involves the insured, the insurer and the third party. Some policies list the
activities covered, like auto liability policies. Others cover all activities not excluded- like CGL. CGL
typically excludes auto liability, workers comp, aircraft liability, etc., which are better served by other
liability policies.

Covered Types of Injury or Damage: Bodily Injury, Property Damage, Personal/Advertising Injury (libel,
slander, etc.)

Excluded Loss Exposures: Uninsurable losses like war, loss from illegal acts like distributing illegal drugs,
duplicate coverage from other liability policies, unnecessary coverage (like racing exclusions in auto),
specialized coverages (like HO policies excluding coverage for professional services provided by doctors),
exposures making premiums unreasonable (some pollution coverage, no one can cover everything)

Covered Costs: Damages and Defense Costs. Damages could be compensatory or punitive. If a claim is
settled out of court, both parties sign a Release, which releases both parties from further obligation.
Other covered costs include Medical Payments (like in a HO policy which pays necessary medical
expenses without a lawsuit, or in Auto Liability Policies) and Supplementary Payments (miscellaneous
expenses like bail bonds, appeal bonds, loss of insured’s earning due to appearing at trials, prejudgment
interest and postjudgment interest). Prejudgment Interest is interest accruing on damages before the
judgment is rendered. Postjudgment is after the judgment.

Covered Time Period: In an Occurrence-basis Policy, coverage is for an injury or damage that occurs
within the policy period, but the claim could be made after the policy period as well. In a Claims-Made
Policy, the claim has to be made within the policy period, and the injury or damage must have occurred
between two specific dates- the start date is called the Retroactive Date. Medical Malpractice, liability
for hazardous products are all typically claims-made.

Covered Parties: A liability policy gives broad protection to the insured. Others are generally named- like
family members, relatives, etc.- in a HO policy. CGL policies also name the covered parties and their
relationship to the insured- like employees, real estate managers, newly acquired organizations, etc.

Amounts of Recovery: There are Policy Limits (Each Person Limits, Each Occurrence Limits, Aggregate
Limits- maximum total payment for all occurrences, Split Limits- separate limits for bodily injury and
property damage liability, Single Limits- combined total for 1 occurrence), Defense Cost Provisions (Most
policies do not limit, others limit it within policy limits) and “Other Insurance” Provisions (like in Property
Policies, there is usually a formula to allocate payment).

MARKETING

Who are the marketing personnel the carrier depends on?

Producers place insurance business with insurers- they represent either insurers or insureds or both. An
Agent has an Agency Relationship with the insurer, the Principal, which authorizes the agent to act on its
behalf. The Agency Contract/Agreement details the scope of this authority. Typically they have no
expiration date, but describes how it can be terminated.

Talk about some important info in an Agency Agreement.

Legal Responsibilities (of Agent and Principal): Examples: the contract explicitly describes the agent’s
right to make coverage effective and any limitations on that right. It talks about how she is to handle
funds including when to remit premiums to the carrier. The contract usually gives her the right to
employ subagents. It specifies the duty of the carrier to pay commissions and other specified
compensation for selling or renewing a policy. Also to indemnify the agent for any losses or damages
which were not her fault. The agent’s authorized actions also obligate the carrier to third parties as if the
carrier were acting alone.

Scope of Authority: Could be Actual or Apparent. Actual Authority could be express or implied- it is
conferred to the agent in the contract. Express Authority is specified. Implied Authority is implicitly
conferred by custom, usage or the principal’s conduct indicating intention to confer it. Binding Authority
is a type of express authority- by it the agent can effect coverage on the carrier’s behalf. They do this by
issuing Binders, which temporarily provide coverage until the policy is issued. Apparent Authority is a
third party’s reasonable belief that the agent has authority to act on the principal’s behalf (based on
appearances or assumptions). Example: Paul tells agent Ann to not sell for credit above $200, but she
sells for $250 because in that industry, Paul’s request is unusual- every other seller does it. Ann had
apparent authority to do this, and a 3rd party who bought on credit need not give his goods back- Paul
cannot deny the apparent authority.

Talk about Insurance Distribution Systems.

3 main types: (a) Independent Agency and Brokerage Marketing System, (b) Exclusive Agency, and (c
Direct Writer.

Independent agents have the right to do business with its customers even by placing them with another
carrier. They have ownership of the agency expiration list (the record of the agency’s present
policyholders and the dates their policies expire). Independent agents and brokers are compensated in 2
ways: Percent Commissions (on new and renewal business) and Contingent or Profit-Sharing Commission
based on volume or Loss Ratio goals. Some have draft authority to settle small, first party losses.
Independent agents could group together into networks called independent agency networks, to gain
advantages of national reach. Another type of independent agent is a Managing General Agent (MGA)-
they could represent a single carrier or multiple. They are usually authorized to sell in a specific
geographical area. Typically used to sell specialty insurance.

Brokers could be sometimes national or regional, representing commercial insurance accounts. In

addition to sales, they may also have risk management, claims administration, actuarial and appraisal
capabilities. They get negotiated fees in addition to commissions, subject to state regulation. Most
agents and brokers can only place business with licensed (admitted) insurers in a state. In some states
Surplus Lines Brokers (or agents) can place business with a non-admitted broker- after a reasonable
effort to place it with an admitted carrier. The agents and brokers who can do this must be licensed in
that state, though- and they need to show proof they contact a minimum number- often 2 or 3-
admitted carriers to place business with first. Some state departments maintain a list of surplus
coverages they can place without this burden of proof. Some states maintain lists of eligible surplus lines
carriers, and unlisted carriers cannot do business at all.
Exclusive Agents are captive agents who can only place business with a particular carrier, compensated
on commissions. The focus is on new business, not loss ratio. They get reduced commissions on
renewals. They don’t own the agency expiration lists, though some carriers grant limited ownership.

Direct writers are direct employees of the carrier. They are compensated by salary, commission or both.
Sometimes a customer may want coverage not provided by the carrier, so the direct writer may contact
an agent representing another carrier, acting like a broker. The agents share the commission- this is
called brokered business.

What are the distribution channels?

Internet, Contact Centers, Direct Response, Group Marketing, Trade Associations and Financial
Institutions. In Group Marketing, Affinity Marketing targets customer based on profession, hobbies, etc.,
Worksite Marketing (payroll deduction) targets employers, and Trade Groups sponsor an insurer in
approaching a customer group and then takes a part of the profits. Producers’ Trade Associations like
IIABA (Independent Insurance Agents and Brokers of America), National Association of Professional
Insurance Agents (PIA), American Association of MGAs, etc. help in education, lobbying, etc. They help in
placing business. Banks and financial institutions also are channels. A mixed marketing system uses one
or more of all these.

What are the functions of Insurance Producers?

Mainly prospecting and sales, but it could include these- (a) Prospecting, (b) Risk management review-
the method of determining a customer’s needs (Example: A loss run report from an insured can help the
agent understand their claims history; a Workers Compensation loss run can reveal lag times in
reporting, resulting in higher costs), (c) Sales, (d) Policy issuance, (e) Premium collection- agents using
the agency bill process send invoices to customers, collect premiums, then send net premiums to
carriers after deducting commission- usually used for larger commercial policies, others use the direct
bill process, in which the carrier collects the premium and sends commission to the agent, (f) Customer
Service (respond to billing queries from customers, get loss reports/credit scores, etc., do customer
account reviews, answer customer queries on coverage, talk to premium auditors and risk control
associates), (g) Claim handling (sometimes they have authority to settle small claims, otherwise, they
may direct calls to claim departments, or issue claim kits to customers) and (h) Consulting to insureds
(paid in fees, but some states prohibit agents from getting both commissions and fees in the case of the
same client).

Agents who use the Agency Billing process can transmit premiums to the carrier in 3 ways: (a) Item
Basis- the agent pays only when they collect or when it is due, (b) Statement Basis- the insurer sends a
statement to the agent showing premiums that are due, and the agent must pay, or (c) Account Current
Basis- the agent periodically sends premiums that are due and sends payment after deducting
commissions- most commonly each month; the agent must pay even if the customers have not paid.

How do states regulate Insurance marketing?

1. Licensing producers- Just like state DOIs regulate carriers, they also regulate producers, claim
reps and other insurance personnel. Some states have separate licenses for agents, brokers and
solicitors (generally employees of agents or brokers, working as CSRs, and cannot bind
 coverage). In other states, solicitors must get an agent’s license. To get a license, an agent
passes an exam on insurance practices, coverages, laws and regulations. Some states require a
minimum number of hours of classroom study. In some states a recognized professional
designation program is enough and no tests required. Licenses have a specific term0 1 or 2
years, to be renewed by paying a fee. Most states also need to do CE courses.

2. Licensing Insurers and Personnel- Carriers are licensed state by state in order to sell a particular
line in the state. Personnel like claim reps also need licenses in some states. This also involves an
exam, background check etc. Public adjustors are generally required to be licensed. Consultants
also need to be licensed, separate for P&C and Life/Health.

3. Compensation- (a) Commission- both agents and brokers receive commissions from insurers
(brokers sometimes also from agents). Rates may be low (2% for WC) or high (30% for bonds). In
small agencies with only one agent, the entire commission goes to her. In large ones, a portion
goes to the producer who made the sale, rest goes to meet office expenses. Commissions are
earned at the point of sale, but if the policy is canceled or the premium returned to the insured
for some reason, the agent repays the commission back. (b) Contingent Commissions-
Supplemental payouts to producers who exceed expectations (on volume/profitability/growth).
Could be as high as 10% of total agency revenues. This has been under scrutiny, because
producers are not looking at the insured’s best interests. In 2004, NY AG Elliot Spitzer accused a
broker of doing just this and directing business to carriers due to excessive contingent
commissions and kickbacks. Other states had similar scandals so laws have been passed to make
producers disclose info to clients on compensation.

4. Unfair Trade Practices- States prohibit misrepresentation/false advertising, Tie-In sales (in Texas,
DOI warned against bundling Auto and H.O. as some carriers refused to sell or renew Auto
without H.O.), Rebating (agents cannot a part of the premium/commission to policyholder),
other deceptive practices like making false statements about another carrier’s financial
condition.

What are the different licensing standards for insurers?

1. Domestic Insurers- If an Illinois domestic insurer gets a Michigan license, it is a foreign insurer in
MI. The IL license (domestic) has not expiration date. Domestic insurers must meet conditions
for non-insurance corporations as well. To get a license, an insurer applies for a charter.
2. Foreign Insurer- To get this license, satisfy that the insurer has met the requirement in the home
state, and also satisfy financial criteria- like capital and surplus thresholds.
3. Alien Insurer- Satisfy a domestic insurer’s criteria, maintain a branch office in the state, have on
deposit in the US the minimum capital and surplus required.
4. Nonadmitted Insurer- Permitted to place business via a licensed specialty producer if admitted
insurers cannot place. The specialty producer must generally be a resident of the state.
Nonadmitted carriers must file a financial statement to satisfy the insurance commissioner and
provide any supporting documents/transactions, obtain a certificate of compliance from its
home state/country, and if an alien insurer, have capital and surplus on deposit as mentioned.
 5. Risk Retention Group- formed under state “captive insurance” laws. Generally low capital and
surplus requirements. If licensed in one state as commercial liability insurer, it can write
business in other states without licensing by filing some appropriate notice and registration
forms in the nonchartering states. They need to pay premium taxes in those states though.

FINANCIAL PERFORMANCE

Describe types of Insurance income.

Gross Written Premiums: Total of premiums charged in a financial year (policy period); Net Written
Premiums: Gross Earned Premiums: Written premium that applies to the policy period that has already
occurred. Gross UnEarned Premiums: Written premium that has not been applied in the policy period.
Direct Premiums Written = Premiums written by the carrier. Assumed Premiums Written: Premiums
originally written by another carrier, assumed by the carrier in a reinsurance contract. Ceded Premiums
Written: Premiums written by the carrier ceded to another carrier in reinsurance. Net Premiums
Written: Gross Premiums (Direct and Assumed), less Ceded Premiums.

Underwriting Income = Earned Premium – Paid Losses – Paid Loss Adjustment Expenses (amount
incurred to adjust and settle claims)

Investment Income = Income earned from investing funds; Net Investment Income = Investment Income
– Investment Expenses

Overall Gain or Loss from Operations = Net Investment Income + Gain or Loss from UW

Describe types of Insurance expenses and losses.

Paid vs Incurred Loss (Expenses): Any expense or loss that occurred during a policy period is incurred. If a
part of them have been paid, they are paid losses or expenses. Another way to put it: Incurred Losses =
Paid Losses + Loss Reserves (as a reserve is set aside for any loss that is reported).

Incurred but not Reported Losses (IBNR): Losses that have occurred but not yet been reported to the
insurer.

Loss Adjustment Expenses: Expenses to investigate, adjust or settle claims, Acquisition Expenses: the
part of underwriting expenses spent on acquiring new business; General Expenses: administrative,
technology and other indirect operating expenses; Premium tax, license and fees: Another type of UW
expense (states levy Premium tax, get money from licensing carriers); Dividend: Paid to policyholders
from the profits in a mutual company

Investment Activity Expenses: Considered a separate line item as it does not relate to insurance specific
expenses.

What are the types of Assets and Liabilities in an Insurance Balance Sheet?

Assets: Admitted (assets meeting minimum standards of liquidity, per Statutory Accounting Principles)
and Nonadmitted (like office furniture, which are not very liquid).
Liabilities: Loss Reserve (estimate of incurred losses not yet settled) and Loss Expense Reserve (estimate
of LAE for incurred losses not yet settled); Unearned Premium Reserve (equal to unearned premiums,
which are considered a liability); Other Liabilities.

Policyholders’ Surplus: Under Statutory Accounting Principles (SAP), Total Admitted Assets – Liabilities.

What are some important Insurance Financial ratios?

Loss Ratio = Incurred Losses and LAE / Earned Premiums

Expense Ratio = Incurred Underwriting Expenses/ Written Premiums

Combined Ratio = Loss Ratio + Expense Ratio

Investment Income Ratio = Net Investment Income/ Earned Premiums

Overall Operating Ratio = Combined Ratio – Investment Income Ratio

INSURANCE REGULATION

What types of private insurance companies exist?

Stock: Objective- to turn a profit to stockholders.

Mutual: Objective- profit and service for their members, via dividends as a percent of premium. Some
charge an assessment (additional premium) after the policy goes into effect, maybe after a CAT.

Reciprocal Insurance Exchange (Interinsurance Exchange): each member of this is an insurer and an
insured. Members are called subscribers, not experts at running insurance operations, so they contract a
manager/org called an attorney-in-fact. Their agreement with the AIF is called a subscription agreement-
the AIF collects premiums, underwrites business, markets business, handles claims, etc.

Lloyd’s: An unincorporated insurance/reinsurance marketplace like a stock exchange. Members are

investors in Lloyds. Each investor, called a Name, belongs to a syndicate of investors.

Captives: A subsidiary formed to insure loss exposure of parent companies or affiliates. No acquisition
costs. The parent benefits from the investments made by the captive using premiums paid by the
parent. Good cash flow technique. For offshore captives, no premium taxes!

Reinsurance Companies: transfer of insurance risk from insurer to another via a contract.

Why do Government Insurance Programs exist? What are some examples?

 Fill unmet needs in the private insurance market- like the Terrorist Risk Insurance Program
(TRIP). Sold through private insurers, reinsured by the Federal Government.
  Facilitate compulsory insurance purchases- Workers Comp, Personal Auto Liability, etc.
 Provide efficiency in the market and convenience to insureds- National Flood Insurance Program
(NFIP)- the Federal Government partners with private carriers and producers to sell the
insurance and pay claims. If the losses and LAE are above premium and investment income, the
Government reimburses the carriers.
 Achieve collateral social purposes- Federal Crop Insurance. Government subsidizes and reinsures
private insurers who sell this and also sometimes sell their own crop insurance for certain perils.
The Federal Crop Insurance covers perils like drought, disease, insects, excess rainfall and hail.

What are some P&C Insurance programs offered by state governments?

Fair Access to Insurance Requirements (FAIR) Plans: Basic property insurance for owners who can’t get
private coverage due to location or any other reason. Works through normal channels of distribution.
How the government and private carriers work together on this varies by state.

Workers Comp: offered by private carriers and by the government (as competitor, residual market or
exclusive insurer)

Beach and Windstorm: offered in states where private carriers may not offer to some owners. Works
through normal channels of distribution. How the government and private carriers work together on this
varies by state.

Residual Auto: Works through normal channels of distribution. How the government and private carriers
work together on this varies by state.

Why does the Government regulate Insurance?

Protect Consumers: the regulators do this by reviewing insurance forms (policy language, coverage
standards) to ensure they benefit consumers, and by ensuring insurance availability.

Maintain insurer solvency: premiums are paid in advance, so the regulator wants to make sure claims
are paid when due- this would be in danger if the carrier becomes insolvent. Also since carriers holds
large amounts of dollars, they want to safeguard the funds.

Prevent destructive competition: rates are regulated to prevent insurers driving each other to insolvency
by cutting rates.

What types of insurance licensing exist?

Domestic Insurer: Must meet conditions in the state of domicile as well as the conditions imposed on
regular corporations. An applicant applies for a “corporate charter” and submits info relating to (a) form
of ownership; (b) names/addresses of individual incorporators; (c) name of the corporation and
territories/types of insurance it plans to sell; (d) insurer’s total financing- authorized capital,
policyholders’ surplus. Minimum requirements apply only to surplus- most states require mutual carriers
to have as much surplus as the stock companies have capital and surplus together. Minimums vary by
state and according to types of insurance written.
Foreign or Alien Insurer: A foreign insurer licensed to operate in a particular state is domiciled in another
state in the US; an alien insurer is domiciled outside the US but licensed to operate in the particular
state. To be licensed, a foreign insurer must show that it met the criteria of its domicile state, and also
the minimum requirements imposed on domestic insurers. Alien insurers also must satisfy the criteria
imposed on domestic insurers, but they must establish a branch office in any US state and have funds on
deposit in the US equal to the minimum capital and surplus required.

Admitted vs Non-Admitted: Admitted insurers are licensed to do business in a state, whether as

domestic, foreign or alien. A non-admitted may be an alien insurer or a carrier licensed in other states,
but not licensed in the particular state. Non-admitted insurers are frequently called surplus lines
insurers- they can only sell through a licensed surplus lines producer. The non-admitted insurer must
still meet the regulatory requirements of an admitted insurer but these do not usually include
restrictions on policy forms or rates.

Producers and Claim Reps: Must be licensed as discussed.

How do states regulate rates and forms?

Rates: States want to make sure rates are (a) adequate, (b) not excessive, and (c) not unfairly
discriminatory. They do this in different ways:

Mandatory rate law: mandatory rates are set by a state agency or rating bureau.

Prior Approval Law: Rates/supporting rules to be filed with the state and approved before any use.

File and Use Law: Rates/rules to be filed before use, but need not wait until approval.

Use and File Law: rates/rules to be filed within a specific period after they are put into use.

Flex Rating Law: prior approval needed only if new rates go beyond a percentage of old rates.

Open Competition: called no-file law. No need to file or get any approval.

Forms: 2 objectives- (1) policies must be clear and readable- need to pass a readability test, (2) no
unfair/unreasonable policy provisions. Some state legislatures enact laws to control the structure and
content of forms, sometimes mandating the use of a specific form for a product. For example, Workers
Comp in many states often has standard policies prescribed by states for on the job injuries.

Exemptions: some insurers, like surplus lines insurers are not subject to rate or form regulation. Also
coverage for inland marine, ocean marine and aviation are also exempt, as they are difficult-to-place
risks. Commercial lines- except WC and Commercial Property- are deregulated for large sophisticated
purchasers. But the definition for the size of the business varies for exemption- in some cases, aggregate
premium (from the purchaser) of $500,000; in other states $25,000 or anything in between.

Explain Market Conduct and Solvency Regulation.

Market Conduct regulation focuses on how carriers treat customers in 4 areas of operation- sales,
underwriting, claims and bad-faith actions. Most states have laws to do this, called Unfair Trade
Practices Laws. In sales and underwriting, embezzling premiums, in claims making low settlement offers
or not providing reasonable explanations for denial or misrepresenting policy provisions, etc., are all
violations and may result in fines, suspension/revocation of licenses or other punishments. Regulatory
exams reveal some abuses but others are revealed when the customer lodges a complaint with the
consumer complaints division of the state department. They may hold formal hearings/investigate.

Solvency regulation is done through Solvency Surveillance- a process to verify that carriers’ financial
conditions will enable them to meet financial obligations and remain in business. They do this by:

a. Establishing financial requirements

b. Conduct on-site field examinations to ensure regulatory compliance- Once every 3 to 5 years. A
team of state examiners will review claims, UW, marketing and accounting procedures, with
emphasis on the financial condition.
c. Review annual financial statements in the NAIC (National Association of Insurance
Commissioners) prescribed format, with info on premiums, expenses, losses, investments,
reserves, etc.
d. Administer IRIS (Insurance Regulatory Information System). IRIS helps identify insurers with
financial problems. This is an information and early warning system operated by the NAIC. It
takes data from financial statements and develops ratios that test for capital adequacy,
underwriting leverage, etc. If a carrier is determined to be insolvent, the state places it in
receivership. If it cannot be rehabilitated, it is liquidated according to the state’s insurance code.
At that the state’s guaranty fund kicks in- this is a fund set up by the state to pay unpaid claims
of insolvent insurers, generally funded by assessments collected from all licensed insurers.

How do states regulate the surplus lines market?

Surplus lines exist due to these 5 factors: (a) unusual or unique loss exposures, (b) nonstandard business
for which poor loss experience is not adequately controlled by underwriting requirements, (c) need for
high coverage limits- like a manufacturer of hazardous chemicals, (d) loss exposures that need new
forms/new type of coverage, (e) need for unusually broad coverage- for example, standard CGL forms
exclude coverage for pollution liability. Producers turn to surplus lines insurers for this.

Some states maintain lists of non-admitted insurers which are approved or not approved. Most states
require them to place business through specially licensed surplus lines producers. If a producer who is
not licensed that way wants to insure a customer with a surplus lines insurer, she must arrange for that
license to handle the transaction. Also, before a particular risk can be “exported” to such an insurer the
surplus lines licensee must document that she searched diligently for coverage in the standard
(admitted) market. After placing the business with a surplus lines insurer, the licensee must collect the
premium tax ad remit it to the home state.

UNDERSTANDING INSURANCE

Explain these terms: Loss Exposure, Exposure Unit.

A loss exposure is any condition that presents a possibility of loss, whether or not the loss occurs.

An exposure unit is a fundamental unit for loss exposure. For example: A single family home for
Homeowners Insurance, that fits certain criteria for a rate- like location, square footage, etc.
 How does Insurance work as a risk transfer system?

It transfers the costs of losses- to the carrier

It shares the costs of losses- among all insureds. The law of large numbers states that the accuracy of
predictions about future outcomes (losses) increases as the number of exposure units increases.

What are the characteristics of an ideally insurable loss exposure?

There are 6: (a) the risk must be pure, not speculative (there must be no chance of gain, only loss); (b)
fortuitous losses (occurring by chance) from the insured’s standpoint; (c) loss must be definite and
measurable; (d) large number of similar exposure units; (e) loss must be independent and not
catastrophic; (f) affordable.

What are the benefits of insurance?

Insurance helps in 8 ways- (a) pay for losses, (b) manage cash flow uncertainty, (c) comply with legal
requirements, (d) control risk, (e) free up/efficient use of insured’s resources, (f) support for the
insured’s credit; (g) source of investment funds for insurers; (h) reduce social burden.

What are the costs of insurance?

Four costs: (a) Premium paid by insureds, (b) operating costs of insurers, (c) increased losses and (d)
opportunity costs (capital and labor used in the insurance industry could be used elsewhere).

Define some common insurance types.

Personal Auto Policy (PAP)
Personal Liability
Comprehensive coverage
Personal watercraft
Umbrella liability
PERSONAL LINES
Covers loss from ownership, maintenance or use of personal automobiles
Covers damage + defense expenses for bodily injury or property damage
from a covered occurrence
Auto insurance for all perils except collision or overturn
Covers personal watercraft loss from ownership, use, maintenance
Liability policy that provides excess coverage above underlying policies
and may provide coverage not available in the underlying policies, subject
to a self-insured retention. For clients with unique exposure units, like a
horse or a swimming pool. Limit is 1-2 million typically.

LIFE-HEALTH
Term Life Life insurance for a specified term, with no cash value
Life insurance that lasts through life with a definite death benefit in the
Permanent Life form of a cash value
Pays for extended medical care or custodial care in a hospital, nursing
Long Term Care home or a home
Pays the insured for a fixed period or for life in exchange for a specific
Annuity premium

COMMERCIAL LINES
Commercial Package Policy Coverage for two or more LOBs b combining ISO’s commercial lines
(CPP) coverage parts.
Commercial Auto
Business owners Policy (BOP)
Auto Physical
Commercial Property
Ocean Marine
Inland Marine
Commercial Crime Insurance
CGL
Professional Liability
Workers Compensation
Auto insurance for a business or nonprofit
Covers most P&C exposures of small and medium businesses
Coverage for damage to an auto that can include both collision and
comprehensive coverages.
Covers commercial buildings and contents
Covers ocean vessels, cargo, related liabilities
Covers land transportation equipment
Covers both money/securities and non-money property against theft and
other crimes
Covers common liability exposures of a business operation
Covers professionals for liabilities from rendering or failing to render
services
Coverage for benefits an employer is obligated to pay under WC laws