5-1

The Private Insurance Industry

Measured by any one of a number of standards, the insurance industry in the U.S. is significant.

1. 7,900 insurance companies (insurers)

2. 2.1 million persons employed

3. $3.1 trillion in assets

4. 13.6% of Gross National Product

5-2

Types of Company by Product

1. Life insurers • write life, annuities, and health insurance• about 2,000 companies in 1998

2. Property and Liability insurers• write property & casualty (including health)• about 3,900 companies in 1998

3. Health and Accident insurers• 400 monoline health insurers• 69 Blue Cross & Blue Shield organizations• 1,600 capitating providers (HMOs and PSOs)

5-3

Types of Insurers by Form of Ownership

1. Capital stock companies

2. Mutual companies

3. Reciprocals-attorney in fact

4. Lloyd's associations

5. Health Expense Associations

6. Government Insurers

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Capital Stock Insurers

1. Organized as profit-making ventures with stockholders who assume the risk that is transferred by insureds.

2. Premium charged by insurer is final--there is no form of contingent liability for policyholders.

3. Board of directors is elected by stockholders.

4. Earnings are distributed to stockholders as dividends on their stock.

5-5

Mutual Insurers

1. Owned by policyholders

2. Distinguishing characteristic is distribution of earnings. Money left after paying costs is returned to policyholders as a dividend.

3. Broadly speaking, mutuals are divided into three classes• pure assessment mutual

• advance premium with assessable policies

• advance premium nonassessable mutuals

5-6

Demutualization

In 1990s--a period of mergers and acquisitions --disadvantages of mutual form of organization became more apparent:

• limited mechanisms for accessing capital

• structure of mutuals not particularly flexible

• mutuals cannot use stock for acquisitions

• federal legislation to allow banks and insurers to affiliate requires a holding-company structure

5-7

Demutualization

A number of insurers have demutualized -- that is, converted from mutual to stock insurers (or in some cases to a modified proprietary form).

When demutualizing, a mutual insurer issues stock to policyholders, but also sells new stock.

• Policyholders have a choice between stock in the new company or cash.

• Some take stock and some take cash.

5-8

Mutual Holding Company Structure

Besides demutualization, some insurers have opted for a different approach, under state mutual insurance holding company laws.• Mutual converts to a stock insurer owned by a

holding company that is organized as a mutual.• Policyholders own mutual holding company

and their contractual rights as insureds remain in the stock insurance company.

• holding company can own subsidiaries, and raise capital by selling stock in subsidiaries.

• State laws generally require that voting control remain with the holding company.

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Reciprocal Insurers

1. Also called “interinsurance exchange”

2. Unincorporated aggregation of individuals, called subscribers, who exchange risks

3. Each member is both insured and insurer

4. In a mutual, policyholders assume liability collectively; in a reciprocal, subscribers assume liability severally

5. Administrator of the program is known as the attorney-in-fact

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Lloyd’s Associations

1. Lloyds of London

2. American Lloyds

5-11

Lloyd’s Associations

1. Named after London coffee house where modern marine insurance originated.

2. Lloyds does not write insurance, but is like the New York Stock Exchange, where buyers and sellers transact business.

3. Originally, insurance was written by over 30,000 “names,” with unlimited liability, usually as members of syndicates.

5-12

Reconstruction and Renewal Plan - 1995

Lloyds manner of operating changed after losses in 1980s led to suits against Lloyds by members

Reconstruction and Renewal Plan:

1. Settlement offer to members

2. Reinsurance of pre-1992 losses (Equitas)

3. Revision of financial standards at Lloyds

• corporate entities

• limited liability

• increased financial requirements

5-13

American Lloyds

American Lloyds are U.S. organizations whose operations are patterned after Lloyds of London.

5-14

Insurance Exchanges

States of Florida, Illinois, and New York enacted legislation authorizing “insurance exchanges” patterned after Lloyds in 1979.

Florida and New York exchanges encountered financial difficulty and failed.

Illinois exchange continues to operate successfully.

5-15

Health Expense Associations

1. Originally, Blue Cross and Blue Shield plans were formed to allow prepayment of hospital and physicians services respectively.

2. Now include Health Maintenance Organizations which provide a wide range of health care services in return for an annual membership fee.

3. Physician-Hospital Organizations (AKA Provider-Sponsored Organizations) are provider-owned delivery systems being formed in many areas.

5-16

Health Expense Associations

1. Terminology in this area is changing due to the various proposals for reform in health care delivery system.

2. Physician Hospital Organizations (PHOs) also sometimes called Integrated Delivery Systems (IDS).

3. Medicare reforms in the Balanced Budget Act of 1997 introduced the term “Provider Sponsored Organization” (PSO).

5-17

Government Insurers Defined

1. Direct provision by the government

2. Government reinsurance

3. Does not include self-insurance of government exposures

5-18

Reasons for Government Insurance

1. Fundamental risks that require compulsion and lack equity

2. Hazard considered too great by private insurance

3. Adverse selection against private insurers

4. Tools of social change by government

5. Mistaken notion that government can repeal the law of averages

5-19

Federal Private (Voluntary) Programs

1. War Risk Insurance (WW I, WW II) 2. Nuclear Energy Liability (1957-1975) 3. Federal Riot Reinsurance Program (1968-1983) 4. Post Office Insurance coverages 5. Federal Crop Insurance 6. Mortgage Loan Insurance (FHA, VA) 7. National Flood Insurance Program 8. Federal Crime Insurance Program (1971-1996) 9. SBA surety bonds10. Federal Fidelity Bonding Program11. Export-Import bank12. Overseas Private Investor Corporation13. Servicemen's and Veteran’s Life Insurance

5-20

State Private (Voluntary) Programs

1. State workers compensation programs

2. Wisconsin State Life Insurance Fund

3. Title insurance funds

4. Maryland State Automobile Insurance Fund

5-21

The Agent

The agent is the central figure in the marketing process.

• The relationship between agents and the companies they represent varies.

• Through a process of evolution, several marketing forms have evolved.

• Each has as its goal efficiency in distribution and service.

5-22

Distinction Between Agent and Broker

Agent:an individual authorized by an insurer to create, modify, and terminate contracts of insurance.

Broker:a representative of the insured who solicits business from insurance buyers but who is compensated by the insurer.

The agent can “bind” an insurer to a risk.A broker does not have binding authority.

5-23

Consultants and Financial Planners

In addition to agents and brokers, there is a growing number of risk management consultants who offer services on a fee basis.

In the personal lines field, there has been rapid growth in the personal financial planning field.

5-24

Life Insurance Distribution Systems

1. General Agents

2. Branch Office System

3. Personal Producing General Agent

5-25

General Agent System

1. General agent is empowered by insurer to operate in a given territory and to appoint subagents.

2. G.A. receives an overriding commission on business produced by subagents, out of which it pays expenses.

3. Most general agents receive some additional financial support from the insurer.

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Branch Office System

1. Branch office manager is an employee of the insurance company.

2. Expenses of branch office are paid by insurer, since branch office is simply an extension of the home office.

3. Branch manager may receive additional compensation based on production of agents supervised.

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Personal Producing General Agent

1. PPGAs are usually agents with a record of successful production.

2. Operate under contracts that give them greater compensation than other agents.

3. PPGAs pay their own expenses, including office and clerical.

4. PPGAs have authority to appoint subagents, but usually concentrate on personal production.

5-28

Property & Liability Distribution Systems

1. American Agency System• Agency represents multiple companies• Agent is said to “own the expirations”

2. Direct Writing System operates through • exclusive agents (State Farm)• captive agents (Allstate)

3. Direct response distribution• mass media advertising• direct mail

5-29

Corporate Combinations in Insurance

Insurance company groups or fleets

Originally formed in monoline era to combine property and casualty coverages

About 290 groups, comprising 1,100 insurers, write about 90% of property and liability coverage

5-30

Corporate Combinations in Insurance

Underwriting syndicates

1. Associated Factory Mutual Insurance Companies

2. Industrial Risk Insurers

3. Improved Risk Mutuals

4. Nuclear Energy Pools

5-31

Cooperation in the Insurance Industry

1. Rating organizations

2. Distressed and residual risk pools

3. Educational organizations

4. Public relations organizations

5. Insurance trade associations

6. Reinsurance organizations

5-32

Rating Organizations (Advisory Organizations)

1. Formerly called “rating bureaus”

2. Operate in property and liability field

3. Gather loss statistics and publish trended loss costs

4. Major Advisory Organizations include

ISO Insurance Services Office

AAIS American Association of Insurance Services

NCCI National Council on Compensation Insurance

5-33

Distressed and Residual Risk Pools

1. Automobile assigned risk plans

2. Workers compensation assigned-risk pools

3. Medical malpractice pools

4. FAIR plans

5. Beach and windstorm pools

6. State health insurance plans

5-34

Other Cooperative Organizations

1. Educational organizationsAmerican CollegeAmerican Institute of P & L UnderwritersInsurance Institute of AmericaInsurance Company Education Directors

2. Insurance trade associationsAmerican Council of Life InsuranceHealth Insurance Association of AmericaAmerican Insurance AssociationAlliance of American InsurersNational Association of Independent InsurersAgents Associations

3. Reinsurance organizations

5-35

Competition in the Insurance Industry

Competition within insurance industry is intense. The competition occurs in two areas:

1. Price

2. Quality

5-36

Price Competition

1. Price competition occurs primarily at the company level, where prices are set.

2. Agents compete on basis of price in selecting the companies they will represent.

3. Price of insurance is a function of costs.

4. To the extent an insurer can reduce its costs below those of competitors, it can offer a lower priced product.

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Costs Common to All Insurers

1. Losses and loss adjustment expense

2. Acquisition expense

3. Administrative expense (company overhead)

4. Taxes

5. Profit and contingencies

5-38

Quality Competition

1. Insurers compete on basis of quality by offering broader forms of coverage and prompt claim service.

2. Most quality competition occurs at the agency level where the level of service can differ significantly.

3. Service provided by the agent consists principally of advice on coverages, companies, costs, and claims.

5-39

Is the Industry Really Competitive?

The 1980’s witnessed a fierce debate over the question of whether the industry is competitive.

Protagonists in the debate were

• insurance industry and a group of informed economists on one side

• insurance industry critics on the other side

5-40

Hallmarks of a Competitive Industry

Economists traditionally focus on market structure and market conduct to judge the competitiveness of an industry.

• market structure includes the number of competitors and concentration (percent of market controlled by largest firms)

• conduct is reflected by ease of entry into the market and changes in market share over time

5-41

Insurance Industry Market Structure

1. Numerous competitors in each of the three major sectors of the insurance industry.

2. No firm controls as much as 10% of the market.

3. Number of competitors has grown over time, indicating freedom of entry into the market.

4. Major shifts in market share have occurred.

5-42

Life Insurance Industry Structure

1. Number of insurers1967 1,715 insurers1987 2,343 insurers1995 1,695 insurers

about 1,600 life insurers discontinued operations between 1967 and 1995 which means roughly 1,500 new companies.

2. Market share

mutual insurers controlled 70% of market in 1970, only about 40% in 1997

5-43

Property & Liability Industry Structure

1. Number of insurers

• 1970 2,720 insurers

• 1990 3,900 insurers

• 900 operate in all states and write about 90% of total premiums.

2. Market share

• direct writers, which wrote 8% of total premiums in 1945, increased their share to 45% by 1997

5-44

Evidence of Intensity of Competition

1. Industry is highly cyclical, indicating inability to control output, prices, or profits.

2. Profits in recent years have consistently been below those for most industries.

3. Growing number of insurer insolvencies attest to the intensity of price competition.

5-45

Cash-Flow Underwriting

For past 30 years, property and liability insurers have broken even or lost money on underwriting, but make a profit from investment income.

Dependence on premiums for investable funds led to phenomenon called cash-flow underwriting.

In cash-flow underwriting, insurers price insurance to compete for investable funds.

Cash-flow underwriting is a form of leveraged investment that has benefited insurers.

5-46

Insurer Insolvencies

Year Life Insurers P & L Insurers 1984 11 271985 9 521986 14 321987 20 251988 19 421989 42 521990 41 431991 58 471992 32 591993 22 241994 11 221995 3 101996 6 91997 2 24