From Wikipedia, the free encyclopedia
Insurance is the equitable transfer of the risk of a loss, from one entity to another in exchange for payment. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss.
An insurer, or insurance carrier, is a company selling the insurance; the insured, or policyholder, is the person or entity buying the insurance policy. The amount of money to be charged for a certain amount of insurance coverage is called the premium. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.
The transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer's promise to compensate (indemnify) the insured in the case of a financial (personal) loss. The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated.
Principles
Insurability
Insurance involves pooling funds from many insured entities (known as exposures) to pay for the losses that some may incur. The insured entities are therefore protected from risk for a fee, with the fee being dependent upon the frequency and severity of the event occurring. In order to be insurable, the risk insured against must meet certain characteristics in order to be an insurable risk. Insurance as a financial intermediary is a commercial enterprise and a major part of the financial services industry, but individual entities can also self-insure through saving money for possible future losses.[1]
Risk which can be insured by private companies typically share seven common characteristics:[2]
1. Large number of similar exposure units: Since insurance operates through pooling resources, the majority of insurance policies are provided for individual members of large classes, allowing insurers to benefit from the law of large numbers in which predicted losses are similar to the actual losses. Exceptions include Lloyd's of London, which is famous for insuring the life or health of actors, sports figures and other famous individuals. However, all exposures will have particular differences, which may lead to different premium rates.
2. Definite loss: The loss takes place at a known time, in a known place, and from a known cause. The classic example is death of an insured person on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
3. Accidental loss: The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be pure, in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, such as ordinary business risks or even purchasing a lottery ticket, are generally not considered insurable.
4. Large loss: The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. For small losses, these latter costs may be several times the size of the expected cost of losses. There is hardly any point in paying such costs unless the protection offered has real value to a buyer.
5. Affordable premium: If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, then it is not likely that the insurance will be purchased, even if on offer. Furthermore, as the accounting profession formally recognizes in financial accounting standards, the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, then the transaction may have the form of insurance, but not the substance. (See the US Financial Accounting Standards Board standard number 113)
6. Calculable loss: There are two elements that must be at least estimable, if not formally calculable: the probability of loss, and the attendant cost. Probability of loss is generally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.
7. Limited risk of catastrophically large losses: Insurable losses are ideally independent and non-catastrophic, meaning that the losses do not happen all at once and individual losses are not severe enough to bankrupt the insurer; insurers may prefer to limit their exposure to a loss from a single event to some small portion of their capital base. Capital constrains insurers' ability to sell earthquake insurance as well as wind insurance in hurricane zones. In the US, flood risk is insured by the federal government. In commercial fire insurance, it is possible to find single properties whose total exposed value is well in excess of any individual insurer's capital constraint. Such properties are generally shared among several insurers, or are insured by a single insurer who syndicates the risk into the reinsurance market.
Legal
When a company insures an individual entity, there are basic legal requirements. Several commonly cited legal principles of insurance include:[3]
1. Indemnity – the insurance company indemnifies, or compensates, the insured in the case of certain losses only up to the insured's interest.
2. Insurable interest – the insured typically must directly suffer from the loss. Insurable interest must exist whether property insurance or insurance on a person is involved. The concept requires that the insured have a "stake" in the loss or damage to the life or property insured. What that "stake" is will be determined by the kind of insurance involved and the nature of the property ownership or relationship between the persons. The requirement of an insurable interest is what distinguishes insurance from gambling.
3. Utmost good faith – (Uberrima fides) the insured and the insurer are bound by a good faith bond of honesty and fairness. Material facts must be disclosed.
4. Contribution – insurers which have similar obligations to the insured contribute in the indemnification, according to some method.
5. Subrogation – the insurance company acquires legal rights to pursue recoveries on behalf of the insured; for example, the insurer may sue those liable for insured's loss.
6. Causa proxima, or proximate cause – the cause of loss (the peril) must be covered under the insuring agreement of the policy, and the dominant cause must not be excluded
7. Mitigation - In case of any loss or casualty, the asset owner must attempt to keep loss to a minimum, as if the asset was not insured.
Indemnification
To "indemnify" means to make whole again, or to be reinstated to the position that one was in, to the extent possible, prior to the happening of a specified event or peril. Accordingly, life insuranceis generally not considered to be indemnity insurance, but rather "contingent" insurance (i.e., a claim arises on the occurrence of a specified event). There are generally three types of insurance contracts that seek to indemnify an insured:
1. a "reimbursement" policy, and
3. an "indemnification" policy.
From an insured's standpoint, the result is usually the same: the insurer pays the loss and claims expenses.
If the Insured has a "reimbursement" policy the insured can be required to pay for a loss and then be "reimbursed" by the insurance carrier for the loss and out of pocket costs including, with the permission of the insurer, claim expenses.[4][5]
Under a "pay on behalf" policy, the insurance carrier would defend and pay a claim on behalf of the insured who would not be out of pocket for anything. Most modern liability insurance is written on the basis of "pay on behalf" language which enables the insurance carrier to manage and control the claim.
Under an "indemnification" policy the insurance carrier can generally either "reimburse" or "pay on behalf of" whichever is more beneficial to it and the insured in the claim handling process.
An entity seeking to transfer risk (an individual, corporation, or association of any type, etc.) becomes the 'insured' party once risk is assumed by an 'insurer', the insuring party, by means of acontract, called an insurance policy. Generally, an insurance contract includes, at a minimum, the following elements: identification of participating parties (the insurer, the insured, the beneficiaries), the premium, the period of coverage, the particular loss event covered, the amount of coverage (i.e., the amount to be paid to the insured or beneficiary in the event of a loss), andexclusions (events not covered). An insured is thus said to be "indemnified" against the loss covered in the policy.
When insured parties experience a loss for a specified peril, the coverage entitles the policyholder to make a claim against the insurer for the covered amount of loss as specified by the policy. The fee paid by the insured to the insurer for assuming the risk is called the premium. Insurance premiums from many insureds are used to fund accounts reserved for later payment of claims — in theory for a relatively few claimants — and for overhead costs. So long as an insurer maintains adequate funds set aside for anticipated losses (called reserves), the remaining margin is an insurer's profit.
Societal effects
Insurance can have various effects on society through the way that it changes who bears the cost of losses and damage. On one hand it can increase fraud, on the other it can help societies and individuals prepare for catastrophes and mitigate the effects of catastrophes on both households and societies.
Insurance can influence the probability of losses through moral hazard, insurance fraud, and preventive steps by the insurance company. Insurance scholars have typically used morale hazard to refer to the increased loss due to unintentional carelessness and moral hazard to refer to increased risk due to intentional carelessness or indifference.[6] Insurers attempt to address carelessness through inspections, policy provisions requiring certain types of maintenance, and possible discounts for loss mitigation efforts. While in theory insurers could encourage investment in loss reduction, some commentators have argued that in practice insurers had historically not aggressively pursued loss control measures - particularly to prevent disaster losses such as hurricanes - because of concerns over rate reductions and legal battles. However, since about 1996 insurers began to take a more active role in loss mitigation, such as through building codes.[7]
Insurers' business model
Underwriting and investing
The business model is to collect more in premium and investment income than is paid out in losses, and to also offer a competitive price which consumers will accept. Profit can be reduced to a simple equation:
Insurers make money in two ways:
1. Through underwriting, the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks;
The most complicated aspect of the insurance business is the actuarial science of ratemaking (price-setting) of policies, which uses statistics and probability to approximate the rate of future claims based on a given risk. After producing rates, the insurer will use discretion to reject or accept risks through the underwriting process.
At the most basic level, initial ratemaking involves looking at the frequency and severity of insured perils and the expected average payout resulting from these perils. Thereafter an insurance company will collect historical loss data, bring the loss data to present value, and compare these prior losses to the premium collected in order to assess rate adequacy.[8] Loss ratios and expense loads are also used. Rating for different risk characteristics involves at the most basic level comparing the losses with "loss relativities" - a policy with twice as many losses would therefore be charged twice as much. More complex multivariate analyses are sometimes used when multiple characteristics are involved and a univariate analysis could produce confounded results. Other statistical methods may be used in assessing the probability of future losses.
Upon termination of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's underwriting profit on that policy. Underwriting performance is measured by something called the "combined ratio"[9] which is the ratio of expenses/losses to premiums. A combined ratio of less than 100 percent indicates an underwriting profit, while anything over 100 indicates an underwriting loss. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings.
Insurance companies earn investment profits on "float". Float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest or other income on them until claims are paid out. TheAssociation of British Insurers (gathering 400 insurance companies and 94% of UK insurance services) has almost 20% of the investments in the London Stock Exchange.[10]
In the United States, the underwriting loss of property and casualty insurance companies was $142.3 billion in the five years ending 2003. But overall profit for the same period was $68.4 billion, as the result of float. Some insurance industry insiders, most notably Hank Greenberg, do not believe that it is forever possible to sustain a profit from float without an underwriting profit as well, but this opinion is not universally held.
Naturally, the float method is difficult to carry out in an economically depressed period. Bear markets do cause insurers to shift away from investments and to toughen up their underwriting standards, so a poor economy generally means high insurance premiums. This tendency to swing between profitable and unprofitable periods over time is commonly known as the underwriting, or insurance, cycle.[11]
Claims
Claims and loss handling is the materialized utility of insurance; it is the actual "product" paid for. Claims may be filed by insureds directly with the insurer or through brokers or agents. The insurer may require that the claim be filed on its own proprietary forms, or may accept claims on a standard industry form, such as those produced by ACORD.
Insurance company claims departments employ a large number of claims adjusters supported by a staff of records management and data entry clerks. Incoming claims are classified based on severity and are assigned to adjusters whose settlement authority varies with their knowledge and experience. The adjuster undertakes an investigation of each claim, usually in close cooperation with the insured, determines if coverage is available under the terms of the insurance contract, and if so, the reasonable monetary value of the claim, and authorizes payment.
The policyholder may hire their own public adjuster to negotiate the settlement with the insurance company on their behalf. For policies that are complicated, where claims may be complex, the insured may take out a separate insurance policy add on, called loss recovery insurance, which covers the cost of a public adjuster in the case of a claim.
Adjusting liability insurance claims is particularly difficult because there is a third party involved, the plaintiff, who is under no contractual obligation to cooperate with the insurer and may in fact regard the insurer as a deep pocket. The adjuster must obtain legal counsel for the insured (either inside "house" counsel or outside "panel" counsel), monitor litigation that may take years to complete, and appear in person or over the telephone with settlement authority at a mandatory settlement conference when requested by the judge.
If a claims adjuster suspects under-insurance, the condition of average may come into play to limit the insurance company's exposure.
In managing the claims handling function, insurers seek to balance the elements of customer satisfaction, administrative handling expenses, and claims overpayment leakages. As part of this balancing act, fraudulent insurance practices are a major business risk that must be managed and overcome. Disputes between insurers and insureds over the validity of claims or claims handling practices occasionally escalate into litigation (see insurance bad faith).
Marketing
Insurers will often use insurance agents to initially market or underwrite their customers. Agents can be captive, meaning they write only for one company, or independent, meaning that they can issue policies from several companies. The existence and success of companies using insurance agents is likely due to improved and personalized service.[12]
Insurance companies
Insurance companies may be
classified into two groups:
·
Life insurance companies, which sell life
insurance, annuities and pensions products.
·
Non-life, general, or property/casualty
insurance companies, which sell other types of insurance.
General insurance companies
can be further divided into these sub categories.
·
Standard lines
·
Excess lines
In most countries, life and
non-life insurers are subject to different regulatory regimes and different tax and accounting rules. The main reason for
the distinction between the two types of company is that life, annuity, and
pension business is very long-term in nature — coverage for life assurance or a
pension can cover risks over many decades. By contrast, non-life insurance cover
usually covers a shorter period, such as one year.
In the United States,
standard line insurance companies are insurers that have received a license or
authorization from a state for the purpose of writing specific kinds of
insurance in that state, such as automobile insurance or homeowners' insurance.[27] They are typically referred
to as "admitted" insurers. Generally, such an insurance company must
submit its rates and policy forms to the state's insurance regulator to receive
his or her prior approval, although whether an insurance company must receive
prior approval depends upon the kind of insurance being written. Standard line
insurance companies usually charge lower premiums than excess line insurers and
may sell directly to individual insureds. They are regulated by state laws,
which include restrictions on rates and forms, and which aim to protect
consumers and the public from unfair or abusive practices.[27] These insurers also are
required to contribute to state guarantee funds, which are used to pay for
losses if an insurer becomes insolvent.[27]
Excess line insurance
companies (also known as Excess and Surplus) typically insure risks not covered
by the standard lines insurance market, due to a variety of reasons (e.g., new
entity or an entity that does not have an adequate loss history, an entity with
unique risk characteristics, or an entity that has a loss history that does not
fit the underwriting requirements of the standard lines insurance market).[27] They are typically referred
to as non-admitted or unlicensed insurers.[27] Non-admitted insurers are
generally not licensed or authorized in the states in which they write
business, although they must be licensed or authorized in the state in which
they are domiciled.[27] These companies have more
flexibility and can react faster than standard line insurance companies because
they are not required to file rates and forms.[27] However, they still have
substantial regulatory requirements placed upon them.
Most states require that
excess line insurers submit financial information, articles of incorporation, a
list of officers, and other general information.[27] They also may not write
insurance that is typically available in the admitted market, do not
participate in state guarantee funds (and therefore policyholders do not have
any recourse through these funds if an insurer becomes insolvent and cannot pay
claims), may pay higher taxes, only may write coverage for a risk if it has
been rejected by three different admitted insurers, and only when the insurance
producer placing the business has a surplus lines license.[27] Generally, when an excess
line insurer writes a policy, it must, pursuant to state laws, provide
disclosure to the policyholder that the policyholder's policy is being written
by an excess line insurer.[27]
On July 21, 2010, President Barack Obama signed into law the Nonadmitted and Reinsurance Reform Act of 2010 ("NRRA"), which
took effect on July 21, 2011 and was part of the Dodd-Frank Wall Street Reform
and Consumer Protection Act. The NRRA changed the regulatory
paradigm for excess line insurance. Generally, under the NRRA, only the
insured's home state may regulate and tax the excess line transaction.[28]
Insurance companies are generally
classified as either mutual or proprietary companies.[29] Mutual companies are owned
by the policyholders, while shareholders (who may or may not own policies) own
proprietary insurance companies.
Demutualization of mutual insurers to form
stock companies, as well as the formation of a hybrid known as a mutual holding
company, became common in some countries, such as the United States, in the
late 20th century. However, not all states permit mutual holding companies.
Other possible forms for an
insurance company include reciprocals, in which policyholders
reciprocate in sharing risks, and Lloyd's organizations.
Insurance companies are
rated by various agencies such as A. M. Best. The
ratings include the company's financial strength, which measures its ability to
pay claims. It also rates financial instruments issued by the insurance
company, such as bonds, notes, and securitization products.
Reinsurance companies are insurance
companies that sell policies to other insurance companies, allowing them to reduce
their risks and protect themselves from very large losses. The reinsurance
market is dominated by a few very large companies, with huge reserves. A
reinsurer may also be a direct writer of insurance risks as well.
Captive insurance companies may be defined as
limited-purpose insurance companies established with the specific objective of
financing risks emanating from their parent group or groups. This definition
can sometimes be extended to include some of the risks of the parent company's
customers. In short, it is an in-house self-insurance vehicle. Captives may
take the form of a "pure" entity (which is a 100% subsidiary of the
self-insured parent company); of a "mutual" captive (which insures
the collective risks of members of an industry); and of an
"association" captive (which self-insures individual risks of the
members of a professional, commercial or industrial association). Captives
represent commercial, economic and tax advantages to their sponsors because of
the reductions in costs they help create and for the ease of insurance risk
management and the flexibility for cash flows they generate. Additionally, they
may provide coverage of risks which is neither available nor offered in the
traditional insurance market at reasonable prices.
The types of risk that a
captive can underwrite for their parents include property damage, public and
product liability, professional indemnity, employee benefits, employers' liability,
motor and medical aid expenses. The captive's exposure to such risks may be
limited by the use of reinsurance.
Captives are becoming an
increasingly important component of the risk management and risk financing
strategy of their parent. This can be understood against the following
background:
·
heavy and increasing premium costs in almost
every line of coverage;
·
difficulties in insuring certain types of
fortuitous risk;
·
differential coverage standards in various
parts of the world;
·
rating structures which reflect market trends
rather than individual loss experience;
·
insufficient credit for deductibles and/or
loss control efforts.
There are also companies
known as 'insurance consultants'. Like a mortgage broker, these companies are
paid a fee by the customer to shop around for the best insurance policy amongst
many companies. Similar to an insurance consultant, an 'insurance broker' also
shops around for the best insurance policy amongst many companies. However,
with insurance brokers, the fee is usually paid in the form of commission from
the insurer that is selected rather than directly from the client.
Neither insurance
consultants nor insurance brokers are insurance companies and no risks are
transferred to them in insurance transactions. Third party administrators are
companies that perform underwriting and sometimes claims handling services for
insurance companies. These companies often have special expertise that the
insurance companies do not have.
The financial stability and
strength of an insurance company should be a major consideration when buying an
insurance contract. An insurance premium paid currently provides coverage for
losses that might arise many years in the future. For that reason, the
viability of the insurance carrier is very important. In recent years, a number
of insurance companies have become insolvent, leaving their policyholders with
no coverage (or coverage only from a government-backed insurance pool or other
arrangement with less attractive payouts for losses). A number of independent
rating agencies provide information and rate the financial viability of
insurance companies.
Across
the world
Life insurance premiums
written in 2005
Non-life insurance premiums
written in 2005
Global insurance premiums
grew by 2.7% in inflation-adjusted terms in 2010 to $4.3 trillion, climbing
above pre-crisis levels. The return to growth and record premiums generated
during the year followed two years of decline in real terms. Life insurance
premiums increased by 3.2% in 2010 and non-life premiums by 2.1%. While
industrialised countries saw an increase in premiums of around 1.4%, insurance
markets in emerging economies saw rapid expansion with 11% growth in premium
income. The global insurance industry was sufficiently capitalised to withstand
the financial crisis of 2008 and 2009 and most insurance companies restored
their capital to pre-crisis levels by the end of 2010. With the continuation of
the gradual recovery of the global economy, it is likely the insurance industry
will continue to see growth in premium income both in industrialised countries
and emerging markets in 2011.
Advanced economies account for
the bulk of global insurance. With premium income of $1,620bn, Europe was the
most important region in 2010, followed by North America $1,409bn and Asia
$1,161bn. Europe has however seen a decline in premium income during the year
in contrast to the growth seen in North America and Asia. The top four
countries generated more than a half of premiums. The US and Japan alone
accounted for 40% of world insurance, much higher than their 7% share of the
global population. Emerging economies accounted for over 85% of the world’s
population but only around 15% of premiums. Their markets are however growing
at a quicker pace. [30] The country expected to
have the biggest impact on the insurance share distribution across the world is
China. According to Sam Radwan of Enhance International,
low premium penetration (insurance premium as a % of GDP), an ageing
population and the largest car market in terms of new sales, premium growth has
averaged 15–20% in the past five years, and China is expected to be the largest
insurance market in the next decade or two.[31]
Regulatory
differences
In the United States,
insurance is regulated by the states under the McCarran-Ferguson Act, with "periodic proposals
for federal intervention", and a nonprofit coalition of state insurance
agencies called the National Association of Insurance Commissioners works to harmonize the
country's different laws and regulations.[32] The National Conference of
Insurance Legislators (NCOIL) also works to harmonize the different state laws.[33]
In the European Union, the
Third Non-Life Directive and the Third Life Directive, both passed in 1992 and
effective 1994, created a single insurance market in Europe and allowed
insurance companies to offer insurance anywhere in the EU (subject to
permission from authority in the head office) and allowed insurance consumers
to purchase insurance from any insurer in the EU.[34]As far as insurance in the United Kingdom, the Financial Services Authority took over insurance
regulation from the General Insurance Standards Council in 2005;[35] laws passed include the
Insurance Companies Act 1973 and another in 1982,[36] and reforms to warranty and other aspects under
discussion as of 2012.[37]
The insurance industry in China was nationalized in 1949
and thereafter offered by only a single state-owned company, the People's Insurance Company of China, which was
eventually suspended as demand declined in a communist environment. In 1978,
market reforms led to an increase in the market and by 1995 a comprehensive
Insurance Law of the People's Republic of China[38] was passed, followed in
1998 by the formation of China Insurance Regulatory Commission (CIRC), which has broad
regulatory authority over the insurance market of China.[39]
In India, IRDA is insurance
regulatory authority. As per the section 4 of IRDA Act' 1999, Insurance
Regulatory and Development Authority (IRDA), which was constituted by an act of
parliament. National Insurance Academy, Pune is apex insurance capacity builder
institute promoted with support from Ministry of Finance and by LIC, Life &
General Insurance companies.
Controversies
Insurance
insulates too much
An insurance company may
inadvertently find that its insureds may not be as risk-averse as they might
otherwise be (since, by definition, the insured has transferred the risk to the
insurer), a concept known as moral hazard. To
reduce their own financial exposure, insurance companies have contractual
clauses that mitigate their obligation to provide coverage if the insured
engages in behavior that grossly magnifies their risk of loss or liability.[citation needed]
For example, life insurance
companies may require higher premiums or deny coverage altogether to people who
work in hazardous occupations or engage in dangerous sports. Liability
insurance providers do not provide coverage for liability arising from intentional torts committed by or at the
direction of the insured. Even if a provider were so irrational as to want to
provide such coverage, it is against the public policy of most countries to
allow such insurance to exist, and thus it is usually illegal.[citation needed]
Complexity of insurance
policy contracts
9/11 was a major insurance loss,
but there were disputes over the World
Trade Center's insurance policy
Insurance policies can be
complex and some policyholders may not understand all the fees and coverages
included in a policy. As a result, people may buy policies on unfavorable
terms. In response to these issues, many countries have enacted detailed
statutory and regulatory regimes governing every aspect of the insurance
business, including minimum standards for policies and the ways in which they
may be advertised and sold.
For example, most insurance
policies in the English language today have been carefully drafted in plain English; the
industry learned the hard way that many courts will not enforce policies
against insureds when the judges themselves cannot understand what the policies
are saying. Typically, courts construe ambiguities in insurance policies
against the insurance company and in favor of coverage under the policy.
Many institutional
insurance purchasers buy insurance through an insurance broker. While on the
surface it appears the broker represents the buyer (not the insurance company),
and typically counsels the buyer on appropriate coverage and policy
limitations, in the vast majority of cases a broker's compensation comes in the
form of a commission as a percentage of the insurance premium, creating a
conflict of interest in that the broker's financial interest is tilted towards
encouraging an insured to purchase more insurance than might be necessary at a
higher price. A broker generally holds contracts with many insurers, thereby
allowing the broker to "shop" the market for the best rates and
coverage possible.
Insurance may also be
purchased through an agent. A tied agent, working exclusively with one insurer,
represents the insurance company from whom the policyholder buys (while a free
agent sales policies of various insurance companies). Just as there is a
potential conflict of interest with a broker, an agent has a different type of
conflict. Because agents work directly for the insurance company, if there is a
claim the agent may advise the client to the benefit of the insurance company.
Agents generally cannot offer as broad a range of selection compared to an
insurance broker.
An independent insurance
consultant advises insureds on a fee-for-service retainer, similar to an
attorney, and thus offers completely independent advice, free of the financial
conflict of interest of brokers and/or agents. However, such a consultant must
still work through brokers and/or agents in order to secure coverage for their
clients.
Limited
consumer benefits
In United States,
economists and consumer advocates generally consider insurance to be worthwhile
for low-probability, catastrophic losses, but not for high-probability, small
losses. Because of this, consumers are advised to select high deductibles and to not insure losses
which would not cause a disruption in their life. However, consumers have shown
a tendency to prefer low deductibles and to prefer to insure relatively
high-probability, small losses over low-probability, perhaps due to not
understanding or ignoring the low-probability risk.[40] This is associated with
reduced purchasing of insurance against low-probability losses, and may result
in increased inefficiencies from moral hazard.[40]
Redlining
Redlining is the practice of denying
insurance coverage in specific geographic areas, supposedly because of a high
likelihood of loss, while the alleged motivation is unlawful discrimination. Racial profiling or redlining has a long history in the
property insurance industry in the United States. From a review of industry
underwriting and marketing materials, court documents, and research by
government agencies, industry and community groups, and academics, it is clear
that race has long affected and continues to affect the policies and practices
of the insurance industry.[41]
In July, 2007, The Federal
Trade Commission (FTC) released a report presenting the results of a study
concerning credit-based insurance scores in automobile insurance.
The study found that these scores are effective predictors of risk. It also
showed that African-Americans and Hispanics are substantially overrepresented
in the lowest credit scores, and substantially underrepresented in the highest,
while Caucasians and Asians are more evenly spread across the scores. The
credit scores were also found to predict risk within each of the ethnic groups,
leading the FTC to conclude that the scoring models are not solely proxies for
redlining. The FTC indicated little data was available to evaluate benefit of
insurance scores to consumers.[42] The report was disputed by
representatives of the Consumer Federation of America, the National Fair
Housing Alliance, the National Consumer Law Center, and the Center for Economic
Justice, for relying on data provided by the insurance industry. [43]
All states have provisions
in their rate regulation laws or in their fair trade practice acts that
prohibit unfair discrimination, often called redlining, in setting rates and
making insurance available.[44]
In determining premiums and
premium rate structures, insurers consider quantifiable factors, including
location, credit scores, gender, occupation, marital status, and education level. However, the use of
such factors is often considered to be unfair or unlawfully discriminatory, and
the reaction against this practice has in some instances led to political
disputes about the ways in which insurers determine premiums and regulatory
intervention to limit the factors used.
An insurance underwriter's
job is to evaluate a given risk as to the likelihood that a loss will occur.
Any factor that causes a greater likelihood of loss should theoretically be
charged a higher rate. This basic principle of insurance must be followed if
insurance companies are to remain solvent.[citation needed] Thus,
"discrimination" against (i.e., negative differential treatment of)
potential insureds in the risk evaluation and premium-setting process is a
necessary by-product of the fundamentals of insurance underwriting. For
instance, insurers charge older people significantly higher premiums than they charge
younger people for term life insurance. Older people are thus treated
differently than younger people (i.e., a distinction is made, discrimination
occurs). The rationale for the differential treatment goes to the heart of the
risk a life insurer takes: Old people are likely to die sooner than young
people, so the risk of loss (the insured's death) is greater in any given
period of time and therefore the risk premium must be higher to cover the
greater risk. However, treating insureds differently when there is no
actuarially sound reason for doing so is unlawful discrimination.
What is often missing from
the debate is that prohibiting the use of legitimate, actuarially sound factors
means that an insufficient amount is being charged for a given risk, and there
is thus a deficit in the system.[citation needed] The failure to address the
deficit may mean insolvency and hardship for all of a company's insureds.[citation needed] The options for addressing
the deficit seem to be the following: Charge the deficit to the other
policyholders or charge it to the government (i.e., externalize outside of the
company to society at large).[citation needed]
Insurance
patents
New assurance products can
now be protected from copying with a business method patent in the United States.
A recent example of a new
insurance product that is patented is Usage Based auto insurance.
Early versions were independently invented and patented by a major US auto
insurance company,Progressive Auto Insurance (U.S. Patent 5,797,134) and a Spanish
independent inventor, Salvador Minguijon Perez (EP 0700009).
Many independent inventors
are in favor of patenting new insurance products since it gives them protection
from big companies when they bring their new insurance products to market.
Independent inventors account for 70% of the new US patent applications in this
area.
Many insurance executives
are opposed to patenting insurance products because it creates a new risk for
them. The Hartford insurance company, for
example, recently had to pay $80 million to an independent inventor, Bancorp
Services, in order to settle a patent infringement and theft of trade secret
lawsuit for a type of corporate owned life insurance product invented and
patented by Bancorp.
There are currently about
150 new patent applications on insurance inventions filed per year in the
United States. The rate at which patents have been issued has steadily risen
from 15 in 2002 to 44 in 2006.[45]
Inventors can now have
their insurance US patent applications reviewed by the public in the Peer to Patent program.[46] The first insurance patent
application to be posted was US2009005522 “Risk assessment
company”. It was posted on March 6, 2009. This patent application
describes a method for increasing the ease of changing insurance companies.[47]
Certain insurance products
and practices have been described as rent-seeking by critics.[citation needed] That is, some insurance
products or practices are useful primarily because of legal benefits, such as
reducing taxes, as opposed to providing protection against risks of adverse
events. Under United States tax law, for example, most owners of variable annuities and variable life insurance can invest their premium
payments in the stock market and defer or eliminate paying any taxes on their
investments until withdrawals are made. Sometimes this tax deferral is the only
reason people use these products.[citation needed] Another example is the
legal infrastructure which allows life insurance to be held in an irrevocable
trust which is used to pay an estate tax while the proceeds
themselves are immune from the estate tax.
Religious
concerns
Muslim scholars have
varying opinions about life insurance. Life insurance policies that earn
interest (or guaranteed bonus/NAV) are generally considered to be a form of riba[48] (usury) and some consider even policies that do
not earn interest to be a form of gharar (speculation). Some
argue that gharar is not present due to the
actuarial science behind the underwriting.[49]
Jewish rabbinical scholars
also have expressed reservations regarding insurance as an avoidance of God's
will but most find it acceptable in moderation.[50]
Some Christians believe
insurance represents a lack of faith[51][dead
link] and there is a long history
of resistance to commercial insurance in Anabaptist communities (Mennonites, Amish,Hutterites, Brethren
in Christ) but many participate in community-based self-insurance
programs that spread risk within their communities.
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