Exam 2 Flashcards
Balance Sheet
A summary of the company’s overall financial position as of a given financial statement date
Structure of Balance Sheet
Assets = Liabilities + Surplus meaning assets are on the left side and liabilities and surplus on the right side
Income Statement
Reflects the activities of a company for a certain time period, a span of time
Three major components of Income Statement
Profit (or Loss) = Revenues - (Losses/Benefits and Expenses)
Reserve
The amount of money that an insurance company must set aside to pay future obligations to the policyholders. Typically the largest liability for most insurance companies
Two major liabilities for a P&C insurance company
Loss reserves and unearned premium reserves
Loss Reserves
Claims incurred (that have happened) but are not yet paid. An estimated amount for:
- Claims reported and adjusted, but not yet paid
- Claims reported and filed, but not yet adjusted
- Claims incurred but not yet reported to the company
Case Reserve
A loss reserve established for each individual claim when it is reported but not yet adjusted. It is typical to set this for individual claims (but not group claims). Methods for calculating include:
- Judgment Method
- Average Value Method
- Tabular Value Method
Incurred-but-not-reported (IBNR) Reserve
Reserve set for claims that have been incurred but have not been reported to the company yet
- Used for losses that occur close to year-end
- Policyholders report the claim in the new year even though it occurred in the prior year
- Must be estimated because the exact amount is unknown
Unearned Premium Reserves
Premiums received, but not yet earned
Surplus
The difference between an insurance company’s assets and liabilities
What is surplus initially set by?
Capital paid by stockholders (stock company) and excess premiums paid by policyholders (mutual company)
How can surplus be distributed?
Through dividends which decrease surplus. Companies have to make sure they maintain enough surplus to run the business when deciding on the size of dividends
Reporting Losses
The insurance company has an obligation to pay the claim when a loss occurs. Takes time for the claim to be reported and for the insurance company to decide who is at fault and how much should be paid
Reasons for Insurance Regulations
- Maintain Insurer Solvency
- Compensate for inadequate consumer knowledge
- Ensure reasonable rates that are neither excessive nor inadequate
Commerce Clause
Federal government has authority to regulate interstate commerce
10th Amendment
Powers not explicitly given to the federal government are reserved for the states
Paul vs. Virginia (1868)
Supreme court ruled insurance was not interstate commerce, and that the states (not federal government) had right to regulate the insurance. The reversal of this threw the industry in turmoil.
South-Eastern Underwriters Association (1944)
When the supreme court reversed itself and said insurance is interstate commerce when conducted across state lines
Sherman Anti-trust law
- Prohibit business activities deemed to be anti-competitive
- Prevent “per se” violations: any agreement to boycott, coerce, or intimidate
- Prohibit price fixing
McCarran-Ferguson Act (1945)
Continued regulation and taxation of the insurance industry by the states are in the public interest
- Federal antitrust laws apply to the insurance only to the extent that the insurance industry is not regulated by state law
- Stated that insurance is commerce
- Insurers/rating bureaus are exempt from federal antitrust law, provided activities are subject to state law, and do not involve boycott, coercion, or intimidation
- States respond by formalizing state-level laws and regulations
Three principal methods used to regulate insurers
- Legislation - through both state and federal laws
- Court decisions - Interpreting policy provisions
- State insurance departments
- Most active for day-to-day regulation
- Implements laws, helps draft regulations
Four basic aspects of National Association of Insurance Commissioners (NAIC)
- Voluntary participation by state insurance departments
- Its goal is to encourage greater uniformity, cooperation, and coordination of laws and regulations
- It produces model laws & regulations that individual states can adopt which will be uniform across the country
- The NAIC has no authority on its own beyond what state’s give it. States can choose to modify or ignore the model laws and regulations
Areas of State Insurance Regulation
- Formation & Licensing of Insurers
- Solvency
- Rate Regulation
- Policy Forms (Approval)
- Sales Practices/Consumer Protection
- Taxation
- Miscellaneous: Cybersecurity
Types of Licenses for Insurance Companies
- Domestic: Located within the state
- Foreign: Out-of-state insurer that is chartered by another state, but licensed to operate in the state
- Alien: Insurer that is chartered by a foreign country, but is licensed to operate in the state
Solvency
Reserves, Surplus, Risk Based Capital. The assets must be sufficient to offset liabilities
Admitted Assets
Assets that an insurer is allowed to show on its statutory balance sheet in determining its financial condition
- Assets that can easily be converted into cash
- Financial assets and real estate are admitted
- Furniture and equipment is not admitted
Risk-Based Capital (RBC)
Insurers holding a certain amount of capital, depending on the riskiness of their investments and insurance operations
RBC Categories
- Asset Risk (C1): Higher capital for riskier assets
- Insurance Risk (C2): Covers severely adverse claims
- Interest/Market Risk (C3): Covers large swings in interest rates or stock prices
- Business Risk (C4): Management error, such as poor strategy decisions, operational risks
- Affiliate Risk (C0): Covers risks of affiliate insurance of affiliate insurance companies that an insurance owns
Actionable Levels of RBC
Most companies have RBC ratios of 300%-400%
- 100%-124%: Red Flag
- 75%-99%: Company Action Level
- 50%-74%: Regulatory Action Level
- 35%-49%: Authorized Control Level
- <35%: Mandatory Control Level
Investment Regulations
- Prevent insurers from making unsound investments that could threaten the company’s solvency and harm the policy owners
- Laws generally place a limit on the proportion of assets in a specific category, such as real estate or stocks
- Many states limit the amount of surplus a participating life insurer can accumulate, rather than pay as dividends. Generational equity is a factor here
Forms of Rate Regulation for Property and Casualty
- Prior approval law
- Modified prior approval law
- File-and-use law
- Use-and-file law
- Flex-rating law
- State-made rates
- No filing required
Policy Form Approval
State insurance commissioners have the authority to approve or disapprove new policy forms before the contracts are sold to the public. Purpose is to protect the public from misleading, deceptive, and unfair provisions
Sales Practices
Regulated by laws concerning the licensing of agents and brokers. They prohibit a variety of unfair trade practices, such as misrepresentation, twisting, and rebating
Twisting
Inducement of a policy owner to drop an existing policy and replace it with a new one that provides little or no economic benefit to the client
Rebating
The practice of giving an individual a premium reduction or some other financial advantage not stated in the policy as an inducement to purchase the policy
Complaint Division
State insurance departments typically have this for handling consumer complaints which typically involve claims. Information is provided to consumers on insurance department websites and in brochures
Taxation
Insurers pay numerous local, state, and federal taxes such as premium and income taxes
Cybersecurity
NAIC adopted insurance data security Model Act in October 2017 which requires insurers to protect data from theft, ransom, and malicious tampering
Federal Regulation
- Would provide uniformity in state regulations
- More effective for international insurance agreements
- More effective in the handling systemic risk
- Would enable insurers to become more efficient
Arguments for State Regulation & Shortcomings of Federal
- More responsive to local insurance needs
- Federal regulation could lead to a dual system of regulation and increase costs
- Poor quality of federal regulation, ex. banking
- Reasonable uniformity of laws can be achieved by the model laws of the NAIC
- Facilitates experimentation and innovation
- Unknown consequences of federal regulation
What are the unknown consequences of federal regulation?
- Already understand state regulation
- Fed further from people, so harder to change flawed law
What does Modernizing Insurance Regulation look like?
Critics believe the current regulatory system is broken, and lax regulatory oversight at both the state and federal levels contributed to the financial meltdown in 2008/2009
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)
Contained numerous provisions to reform the financial services industry. Created the Financial Stability Oversight Council (FSOC) to identify and treat systemic risk and the Federal Insurance Office (FIO)
Indemnity
The insurer agrees to pay no more than the actual amount of the loss
Principle of Insurable Interest
The insured must be in a position to lose financially if a covered loss occurs. Its purpose is to prevent gambling, reduce moral hazard, and measure the amount of the insured’s loss
What can support an insurable interest for P&C?
- Ownership of property
- Potential legal liability
- Serving as a secured creditor
- Contractual Rights
How can an insurable interest for life insurance be supported?
- Your own life
- Life of another person
When must insurable interest exist?
- Property insurance: at the time of the loss
- Life insurance: only at the inception of the policy
Subrogation
Substitution of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance
Utmost Good Faith
A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on other contracts
What are the three legal doctrines that support utmost good faith?
- Representations
- Concealment
- Warranty
Representations
Statements made by the applicant for insurance. A contract is voidable if the representation is material, false, and relied on by the insurer. Still applies if the misrepresentation is innocent
Material
Means that if the insurer knew the true facts, the policy would not have been issued, or would have been issued on different terms
Reliance
The insurer relies on the misrepresentation in issuing the policy at a specified premium
Concealment
Is intentional failure of the applicant for insurance to reveal a material fact to the insurer
Warranty
A statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects
Basic Parts of an Insurance Contract
- Declarations: Statements providing information about what is to be insured (P&C). Life contracts have similar
- Definitions: Insured is typically referred to as “you”
- Insuring Agreements: What is the promise being made?
- Exclusions: What is not intended to be covered like perils, losses, and property
- Conditions: Limits on the promises; duties of insured. If you fail to pay the premium, insurer can cancel coverage
- Miscellaneous: Cancellation, grace period
Types of Coverage
- Named perils
- Open-perils, or special coverage
Endorsement
Written provision that adds to, deletes from, or modifies the provisions in the original contract
Rider
Provision that amends or changes the original policy
Contractual Provisions that limit coverage
- Deductibles
- Coinsurance - P&C and Health
- Policy Limits
- Exclusions
Why limit coverage?
- Moral/Attitudinal Hazard
- Adverse Selection
- Administrative Costs
Policy Limit
The maximum amount that the insurer will pay. Apply on a per occurrence or aggregate basis
