# The business of insurance

## Insurance organizations

An insurance company needs several key departments:

- Legal - attorneys and actuaries frame the policy document.
- Underwriting - company underwriters and field underwriters (aka insurance agents) write new business.
- [Marketing](marketing.md) - branding to attempt to differentiate a fundamentally identical product.
- Finance - performs [accounting](money-accounting.md) and billing activities.
- Claims - manages insurance payouts.

There are a few ways to structure an insurance business.

- Stock companies - incurs profits/losses and owned by shareholders who have voting rights
- Mutual companies - incurs profits/losses and owned by policyholders who have voting rights
  - Assessment mutuals require policyholders to pay additional fees when premiums are insufficient for claims.
  - Nonassessment mutuals can't require additional amounts from policyholders when premiums are insufficient (most modern companies are nonassessment mutuals).
- Fraternal/benefit societies - memberships are based on religious, national, or ethnic affiliations, and members of the society must become a member of that organization.
  - They're charitable organizations, so they're exempt from [taxation](money-accounting.md).
- Reciprocals - an unincorporated group of subscribers who agree to pool their risks together to pay for losses and purchase reinsurance.
  - An "attorney-in-fact" solicits new subscribers, collects premiums, and performs administrative tasks.
- Risk retention groups - members of a similar trade pool their risks to mitigate them together, and is effectively a [cartel](mgmt-badsystems.md) when *very* powerful.
- Lloyd's associations - a group of members, which is *not* insurance, where professional underwriters accept risk on syndicates' behalf.

Beyond private organizations, governments also create insurance policies.

- Social Security, Medicare, Medicaid
- State worker's compensation programs
- Special military insurance like Servicemembers Group Life Insurance (SGLI) and Tricare
- Specific coverages like the National Flood Insurance Program (NFIP)

However, government and private insurance are *not* the same:

1. Participating in government insurance programs is mandatory and automatic for all citizens (i.e., through [taxation](money-accounting.md)).
2. The benefits to participants are through passing specific laws, *not* through a policy, and changing benefits means a cumbersome legislation process.
3. Social insurance programs are always adequate to meet public needs, but aren't equitable: while private insurance payments are approximately proportional to statistical likelihood, the least-contributors (indigent, elderly, dependents) benefit the most in government insurance.
4. Any government insurance provider effectively owns a [monopoly](mgmt-badsystems.md) on the system from the lack of [competitive alternatives](money-economics.md).

## Insurance product distribution

There are several ways to distribute insurance services:

1. Captive/Exclusive Agency System - insurance producers who are part of an insurance company
   - Trained and supervised by a company employee or General Agent (GA) who may also be a producer
   - Represents the insurer and not the insured
   - Paid first year commissions, plus a training allowance, and comparatively smaller renewal commissions
2. Independent Agency System - no direct affiliation with a particular insurer
   - Can be a General Agent or Managing General Agent (MGA)
   - Represents the insured more than the insurer
   - Can represent as many insurers as they desire and paid commissions on new business they write
3. Managing General Agent System - recruits, hires, trains and [supervises](mgmt-1_why.md) other producers
   - Producers tend to only insure with companies the MGA has had business relationships with
4. Brokers - independent producers who sell insurance, but *can't* bind insurance contracts
   - They're a third party to any insurance arrangement
5. Direct Response - non-agent services that involve media advertising and the customer responding by contacting with an advertised phone number or response document
6. Direct Writing Companies - producers are salaried employees of a direct writing company, so the company itself owns the policy and not the producer
7. Internet Insurance Sales Systems - insurance that can be purchased online directly through the insurance company or agent
8. Franchise Marketing Systems - covering employee groups that are too small to meet the requirements of a group policy, so no group underwriting or premium rate reduction involved
9. Non-Insurance Marketing Systems - insurance products through financial institutions which issue credit cards, with the product deducted from that bank's accounts

For this reason, there can be *multiple* unrelated entities that form an insurance contract:

1. The insurance carrier itself, which pays out a claim.
2. An insurance agent, which can be independent of the carrier.
3. A broker, who is independent of the insurance agent.

One strange language distinction in insurance is that a domestic company is an insurer domiciled with the same legal address as the insured, a foreign company is still in the country but outside the state, and an alien company is outside the country.

## Sustainability

To stay in business, an insurance company has to maintain a delicate balance:

1. The insuring company must compete with other insurance, so they must keep their premiums as low as reasonably possible.
2. The insuring company's loss ratio (losses from claims / premium income) must always stay low (never break above 100%, or they're losing money).
3. Ideally, an insurance company's loss ratio is <60% because a typical insurance company's expense ratio ([business](business.md) costs / operating income) is 35-40%.

Since insurance needs liquidity to pay for claims, multiple organizations track their performance:

- They check underwriting performance, management economy, reserve adequacy, adequacy of net resources, and the soundness of the investments.
- A.M. Best is the oldest and largest financial rating service, but Standard & Poor's, Moody's, Duff & Phelps, and Weiss Research all rate performance.
- The Insurance Division of each state also performs examinations and has the authority to place restrictions on writing new business, give directives on [managing](mgmt-1_why.md) the company, and in extreme cases order liquidations of the company.
- The National Association of Insurance Commissioners (NAIC) has no regulatory authority, but actively creates uniform recommendations which each state generally adopts (including minimum insurance regulatory standards and ratios), as well as conducting Zone Examinations, maintaining an Insurance Regulatory Information System (IRIS) to review insurance company operations.

There are only 3 ways for insurance companies to make money:

1. Profit directly from underwriters.
   - The underwriters' profit most steadily comes from insuring good risks with few to no losses.
   - Underwriters can also sell more coverage (e.g., higher liability limits) or adding more features (e.g., extra insurance gimmicks).
2. [Investments](money-investing.md) with income not related to claim payments.
   - They can't simply invest into anything, and their investment portfolios are typically tracked.
3. Reducing overall claims expense, typically from finding legal ways to *not* pay a claim.
   - This often comes through adapting policy language to conform to *very* specific situations.
   - Insurance companies have the most control over reducing claims expense, but it's also the most [unethical](morality.md).

If an insurance company ever becomes insolvent (i.e., can't pay claims), the government has its guaranty.

- That government's Insurance Division will manage claims for certain admitted property, casualty, life, accident, and health insurance policies.
- In effect, they end up requiring other carrier organizations to pay for a certain amount of policy claims and return unearned premiums.

If a person seeking insurance can't get it through any conventional channels, most Insurance Divisions provide their insurance plan.

- Government-rated insurance typically has *insanely* expensive premiums, and its coverage is typically weak.
- Sometimes, a government will mandate a private insurance carrier to insure a particular risk.

Insurance companies will use *any* information available to adjust their rating.

- Auto insurance companies will use individuals' driving data to adjust rating, sometimes without the insured's consent.
- Satellite images are enough information for insurers to drop homeowners policies due to roof status or unclaimed trampolines.