Types of Insurers by Form of Ownership 1.

Capital stock companies 2.

Mutual companies 3.

Lloyd's associations 4.

Health Expense Associations 5.

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.

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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.

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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

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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.

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Lloyd’s Associations 1.

Named after London coffee house where modern marine insurance originated.

2.

3.

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

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

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Exhibit 25.1 Alternative Modes of Demutualization

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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.

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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.

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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.

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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.

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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 NCCI American Association of Insurance Services National Council on Compensation Insurance

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Government Insurers Defined 1.

Direct provision by the government 2.

Government reinsurance 3.

Does not include self-insurance of government exposures

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Reasons for Government Insurance 1.

2.

3.

4.

5.

Fundamental risks that require compulsion and lack equity Hazard considered too great by private insurance Adverse selection against private insurers Tools of social change by government Mistaken notion that government can repeal the law of averages

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Similarities in Various Fields of Insurance 1.

2.

3.

Although details of operation may vary, the programs discussed all use some form of pooling of exposure units.

The possibility of loss is transferred from the individual to the group where losses are shared on some prescribed basis.

Basic concepts of pooling and sharing of losses and individual’s substitution of small, certain cost for large uncertain loss are fundamental to all the programs.

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Functions of Insurers 1.

Ratemaking 2.

Production 3.

Underwriting 4.

Loss Settlement 5.

Investment

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Basic Concepts in Ratemaking Rate Premium Gross Rate Pure Premium Loading Price charged per unit of protection Determined by multiplying rate by units of protection purchased Composed of two parts, designed to pay losses and expenses Portion of the Gross Rate designed to pay losses Portion of Gross Rate designed to cover expenses of operation

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Pure Premium Total Losses Exposure Units = Pure Premium $3,000,000 100,000 = $30

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Converting Pure Premium to Gross Rate Expense Ratio: Expense part of the rate expressed as percentage of the final rate Permissible Loss Ratio: Gross Rate: 1 minus expense ratio Pure Premium 1 _ expense ratio $ 30 = 30 1 - .40 .60

= $50

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Underwriting 1.

Basic purpose: avoid adverse selection 2.

Relationship of underwriting to adequacy of rates 3.

Exposure that is unacceptable at one rate may be acceptable at another

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Sources of Underwriting Information 1. The application 2. Information from the agent or broker 3. Investigations 4. Information bureaus 5. Physical examinations or inspections

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Postselection Underwriting 1.

2.

3.

4.

Postselection underwriting (or renewal underwriting) occurs when the insurer decides whether to continue insurance.

Insurer may decline to renew insurance or may offer narrower coverage.

Because cancellation or nonrenewal can impose hardship on insured, some states limit the insurer’s right to exercise these options.

When the option of postselection underwriting is limited, insurers may be more selective in initial underwriting.

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Adjusters 1.

Staff adjusters 2.

Adjusting bureaus 3.

Independent adjusters 4.

Public adjusters

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Adjustment Process 1.

Notice 2.

Investigation 3.

Proof of loss 4.

Payment or denial

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Composition of Insurers’ Investments Type of Investment Corporate Stocks Corporate Bonds Government Bonds Mortgages Real Estate Policy Loans Miscellaneous Life Insurers 20.6% 41.0% 17.1% 8.9% 2.1% 4.3% 6.0% 100.0% Property & Liability 21.2% 18.3% 51.2% 0.4% 1.3% 7.6% 100.0%

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Reinsurance 1.

Nature of reinsurance 2.

General approaches

•

facultative

•

treaty 3.

Types of treaties

•

facultative

•

automatic

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Reinsurance in Property & Liability Insurance 1.

Proportional reinsurance

•

Quota-share

•

Surplus-share 2.

Excess-of-loss reinsurance

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Reinsurance in Life Insurance 1.

Term insurance approach (reinsure difference between face value of policy and amount of reserves) 2.

Coinsurance approach (quota share)

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Functions of Reinsurance 1.

Spreading of risk 2.

Financing function - surplus relief

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Miscellaneous Insurer Functions Legal Accounting Engineering

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