Actuarial Notes

Types of Insurers

Study guide: Exam DISC-RM

Types of Insurers are the ways insurers are classified: by their legal form of ownership, by their place of incorporation, by their licensing status in a jurisdiction, and by the system they use to distribute their policies. Each classification says something different: ownership tells who supplies the capital and keeps the profit, domicile tells who regulates the insurer's solvency, licensing tells which rules and protections apply to its policies, and distribution tells how it reaches customers. One insurer belongs to a class on every dimension at once.

\text{Policyholder's net cost} = \text{Premium} - \text{Dividend}

\text{Status in state } s = \begin{cases} \text{domestic} & \text{incorporated in } s \\ \text{foreign} & \text{in another state} \\ \text{alien} & \text{in another country} \end{cases}

  • Symbols: The first relationship is why ownership matters to the buyer. A participating policy from a mutual, or from a stock insurer that issues them, may return a policyholder dividend out of favourable results, which lowers the policyholder's net cost. The dividend is not guaranteed. The second classifies one insurer relative to a state s; the same insurer is domestic in its home state and foreign in every other U.S. state.
  • Stock insurers: A stock insurer is a corporation owned by shareholders, who supply its capital and receive its profit as stock dividends and growth in the share price. A board elected by the shareholders runs it. Stock insurers can raise capital by issuing shares, which makes it easier to grow or recover after large losses.
  • Mutual insurers: A mutual insurer is owned by its policyholders, who elect the board and may share in its results through policyholder dividends. It has no shares to sell, so it builds surplus mainly from retained earnings. Some mutuals have converted to stock insurers (demutualization), or formed a mutual holding company that can own stock subsidiaries, to gain access to capital.
  • Reciprocal exchanges: In a reciprocal exchange, the members, called subscribers, insure one another. An attorney-in-fact, often a corporation, manages the exchange for a fee, usually a percentage of premium, and handles underwriting, claims and investments.
  • Lloyd's: Lloyd's of London is a marketplace, not an insurer. Members, both individual Names and corporations, supply the capital through syndicates, each run by a managing agent, and the syndicates underwrite the risks. Business reaches the syndicates mostly through brokers.
  • Captives and risk retention groups: A captive is an insurer formed to insure the risks of its parent, or of a group of related owners, rather than the public. A risk retention group is a U.S. form of group captive that writes liability insurance for owners in a similar business and can operate in every state with only its domicile's licence.
  • Government insurers: Governments insure what the private market won't or can't, such as flood, crop and nuclear risks, and run residual markets and, in some places, workers compensation funds. Some Canadian provinces sell public auto insurance through crown corporations. See Government and Industry Insurance Programs and Social Insurance.
  • Licensing status: An admitted insurer is licensed in the state and subject to its rate, form and solvency rules, and its policyholders are protected by the state's guaranty fund. A non-admitted insurer is not licensed there but may write risks the admitted market declines through a surplus lines broker (Excess and Surplus Lines); it has more freedom of rate and form, and its policyholders usually lack guaranty fund protection.
  • Distribution: Insurers are also grouped by how they sell: through independent agents and brokers, exclusive agents, their own sales employees (direct writers), or by direct response without a producer. See Insurance Distribution Systems.

Classifying Several Insurers Classify each insurer by ownership, place of incorporation relative to Ohio, and licensing status in Ohio.

  1. A company owned by shareholders, incorporated in Ohio and licensed there, selling auto insurance through independent agents.

  2. A company owned by its policyholders, incorporated in Indiana and licensed in Ohio, selling through exclusive agents.

  3. A company incorporated in Bermuda that writes excess property coverage in Ohio through a surplus lines broker.

  4. An exchange whose subscribers insure one another, managed by an attorney-in-fact, incorporated in Pennsylvania and licensed in Ohio.

  5. A company formed by forty nursing homes to insure their liability, domiciled in Vermont and registered in Ohio.

Answer

  1. A stock insurer, domestic in Ohio and admitted there, using the independent agency system.
  2. A mutual insurer, foreign in Ohio (incorporated in another state) and admitted there, using the exclusive agency system.
  3. Ownership isn't stated. It is alien (incorporated in another country) and non-admitted, writing as an eligible surplus lines insurer.
  4. A reciprocal exchange, foreign in Ohio and admitted there.
  5. A risk retention group, foreign in Ohio. It is licensed only in Vermont, its domicile.

Net Cost Under a Participating Mutual Policy A business owner is offered two commercial property policies for the same coverage. A stock insurer quotes a nonparticipating premium of $24,000. A mutual quotes a participating premium of $25,500 and has paid policyholder dividends of 8% of premium in each of the last five years. With illustrative figures, compare the expected net costs and say what the owner gives up by choosing the mutual.

Answer

\begin{align*}
\text{Dividend} &= 0.08 \times 25{,}500 \\
&= 2{,}040 \\
\text{Net cost} &= 25{,}500 - 2{,}040 \\
&= 23{,}460
\end{align*}

If the mutual keeps paying at its recent rate, its net cost is $540 less than the stock insurer's premium. But the dividend is declared by the mutual's board out of its results and is not guaranteed, so in a bad year the owner could pay $1,500 more than the stock quote. The owner trades a certain price for a share in the insurer's results, which is part of what owning a mutual means.

How it appears on the exam

  • DISC-RM: The overview of insurance operations covers the classification of insurers. Questions give a description, such as who owns the insurer, where it is incorporated and whether it is licensed, and ask for the correct class, or ask how stock, mutual and reciprocal insurers differ in ownership, control and access to capital.
  • DISC-RM: The same terms return in the marketing and distribution section, where insurers are grouped by distribution system, and in reinsurance and alternative risk transfer, where captives and risk retention groups appear again.

Exam traps

  • Foreign is not alien: A foreign insurer is incorporated in another state of the same country, and an alien insurer is incorporated in another country. An insurer from a neighbouring state is foreign, not alien.
  • Lloyd's is not an insurer: Lloyd's provides the market and its rules, while the members, through syndicates, bear the risk. An answer that calls Lloyd's itself the insurer, or treats it as a mutual, misreads the structure.
  • Admitted is about the state, not the insurer: An insurer can be admitted in one state and non-admitted in another. Licensing status always refers to a particular jurisdiction.
  • Reciprocal versus mutual: In a mutual, the company insures its policyholder-owners. In a reciprocal, the subscribers insure one another through an attorney-in-fact, who is not an owner of the exchange.
  • Distribution is a separate dimension: A stock insurer can use independent agents, exclusive agents or direct response, and so can a mutual. Don't infer ownership from how an insurer sells.