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CHAPTER 1 : Nature and History of Insurance

REGULATION OF THE INSURANCE INDUSTRY

In the study of insurance, it is necessary to understand a definition of insurance. It is a mechanism to contractually shift burdens of a number of pure risks by pooling those risks together.

The insurance industry is mainly regulated by the states, but the federal government does exert some regulatory influence. In addition, the industry regulates itself, mainly through the efforts of the NAIC (National Association of Insurance Commissioners). Their prime responsibility is to protect the interests of insurance consumers.

McCarran-Ferguson Act of 1945

Essentially this law stated that the federal government had the right to regulate the insurance industry, but it would not do so so along as the individual states did an adequate job of regulation.

The Fair Credit Act

Laws regarding consumer privacy rights and other areas affecting the insurance industry.

Also, federal security laws applied to insurance companies issuing variable contracts. These companies must conform to the regulation of the Securities and Exchange Commission (SEC) as well as state regulation. Producers selling variable products must hold a securities license as well as a life insurance license.

INSURANCE AS A DEVICE FOR HANDLING RISK

A risk is a chance or uncertainty of loss.

A pure risk is that there is a chance of loss. When you suffer a loss and no gain it is a pure risk.

A speculative risk involves a uncertainty of loss but also a chance of gain. When you gamble you may win or lose. This is a speculative risk and therefore not insurable.

METHODS OF HANDLING RISK

There are basically five ways of handling risk

1. AVOID - Avoiding any situation or event that involves a chance of loss.

2. REDUCE - Not circumventing the situation, but reducing the chance the loss will occur or the severity of the loss.

3. RETAIN - Assuming responsibility for the loss and becoming self-insured.

4. TRANSFER - Transferring the risk of loss to any party. In insurance, the insured transfers a potential risk of loss to the insurer.

5. SHARING - Closely related to transferring. In insurance, the insureds are part of a pool of insureds.

LOSS, PERIL, AND HAZARD

Loss is the reduction in quality, quantity, or value of something.

1. PERIL - is the potential or actual cause of loss.

2. HAZARD - is anything that increases the chance of loss.

3. PHYSICAL HAZARDS - are characteristics that increase the likelihood of loss.

4. MORAL HAZARDS - result from individuals values and character traits.

5. MORALE HAZARDS - arise due to a persons indifference or carelessness.

6. LEGAL HAZARDS - are due to court actions that increase the likelihood of people filing claims and being awarded large amounts.

INSURANCE

A contract whereby one seeks to indemnify another against loss, damage, or liability arising from a contingent or unknown event.

The individual (insured) makes a payment (premium) to the insurance company (insurer) to cover potential losses. In this way the risk (uncertainty or chance of loss) is spread among many people so the cost to the individual is small.

Essentially, the mechanism of insurance is risk transfer - transferring the risk of loss from the insured to the insurer or insurance company.

Indemnify means to restore the victim of a loss, in whole or in part to the financial position that he or she enjoyed prior to suffering the loss.

INSURABLE INTEREST

Simply stated, an insurable interest is a financial interest in having the life of the insured continue. In life insurance, the policy owner must have a insurable interest at the time of application for the insurance.

Chapter 2: Commissioners' Duties and Powers

The Insurance Department is an administrative department of the state government and is responsible for the regulation of all aspects of the insurance industry.

The Insurance Department is administered by the Insurance Commissioner who has the statutory responsibility to regulate the industry in the public's interest, balancing the needs of the consumer with those of the insurance industry to ensure and maintain a viable insurance market.

The Insurance Commissioner is appointed by the Governor and empowered to enforce and execute the insurance laws of the Commonwealth. These powers and duties include the right to:

1. Staff the department

2. Appoint deputies

3. Conduct investigations

4. Hold hearings and issues fines

5. Suspensions or revocations of certificates or licenses

The Insurance Commissioner is charged with these responsibilities and requires detailed annual financial statements on all admitted insurance companies.

Bureau of Producer Licensing

The Bureau of Producer Licensing is responsible for testing and licensing insurance producers, public adjusters, surplus line agents, motor vehicle physical damage appraisers and professional bondsmen in the Commonwealth.

The Bureau of Producer Licensing also monitors compliance with continuing education requirements for insurance producers as well as regulates the 24-hour pre licensing program.

Office of Rate and Policy Regulation

Reporting to the Insurance Commissioner, the Office of Rate and Policy Regulation, under the direction of a Deputy Insurance Commissioner, is responsible for reviewing and regulating insurance rates charged and policy forms sold in Pennsylvania for Accident and Health, Life, and Property and Casualty Insurance.

The Chief Actuary, under the direction of the Deputy Insurance Commissioner is responsible for reviewing all major rate filings, as well as reviewing reserve work for company solvency.

Bureau of Accident and Health Insurance

The Bureau of Accident and Health Insurance oversees health maintenance organizations (HMOs), preferred provider organizations (PPOs), and commercial and non-profit insures including Blue Cross/Blue Shield plans.

The Bureau of Accident and Health Insurance also coordinates the licensing of HMOs with the Department of Health. In addition, it is responsible for ensuring that all state laws and regulations are in compliance with federal legislation pertaining to health care reform.

Bureau of Life Insurance

The Bureau of Life Insurance reviews life insurance and credit insurance rates, values, policies and forms for compliance with the department's laws and regulations.

The Bureau of Life Insurance also provides valuation of Life and Accident Health insurance reserves to determine compliance with the valuation law. Valuation is a process of determining a company's liability under its policy regulations.

Bureau of Property and Casualty

The Bureau of Property and Casualty Insurance is responsible for personal and commercial property and casualty lines of business such as automobile, homeowners, workers compensation and liability insurance.

The Bureau of Property and Casualty Insurance also works closely with the Department of Labor and Industry on workers compensation issues and with the Medical Professional Liability Catastrophe Loss Fund.

Regulation of Insurance Companies

Insurance companies are regulated by the Insurance Department under the direction of the Insurance Commissioner.

The following are the primary functions and objectives of state regulation:

Company Solvency is required by the Commissioner prior to and while conducting business in the state. This includes the requirements to apply and be approved as a licensed company and to provide detailed information on company operations and financial stability.

Rate Regulation is performed by the Commissioner through detailed rate reviews. The Commissioner will prohibit rates that are excessive, inadequate, or unfairly discriminatory. Policy Forms are the actual insurance policies and endorsements used by insurers. Most Policy Forms must be filed with the Insurance Department prior to their introduction. This requirement is to ensure the policy language and coverage's are in the public's best interest.

Agency Appointments are written agreements between the producer and the insurance company under which the producer agrees to solicit, negotiate, and service insurance policies for compensation. These appointing companies must notify the Insurance Department of produce appointments and certify that the appointed producers are qualified and have not violated any provisions of the Pennsylvania Insurance Law.

Purpose of Examination of Books and Records

The purpose of this regulation is to improve the Insurance Department's surveillance f the financial condition of insurers by requiring periodic examinations.

Area's that are commonly examined by the Insurance Department auditors include:

Claims Department - The auditor may review an insurer's claims reserves (its potential liabilities) to determine if they are adequate and sufficient to pay incurred claims (its estimate of future claim payments). If claims reserves are inadequate, an insurer will have to increase its reserves and reduce it's policyholder's surplus (the amount of assets exceed liabilities).

Underwriting Departments - An auditor may review the policy forms and rates being used to determine if they are in compliance with their filings.

Marketing Departments - An auditor may review the advertising materials to ensure that they comply with Insurance Department requirements.

Disciplinary Procedure

The Insurance Department may initiate procedures and assess penalties as follows:

Administrative Hearing - An administrative hearing may be conducted to determine if a violation of applicable law has occurred.

Administrative Penalty - Upon the determination that a violation has occurred, the department may issue an order requiring that person to cease and desist from engaging in such violation. They may also suspend or revoke the person's certificate of license.

Cease and Desist Orders - The Insurance Department may issue a cease and desist order requiring the person or insurer to stop the activity in question.

Injunction - If the alleged violator fails to comply with the order, an injunction may be filed with the Commonwealth Court of Pennsylvania in the county in which the violation occurred.

Civil Penalties - In addition to any other penalties imposed, the court, in an action filed by the Insurance Department, may impose the following civil penalties:

1. A penalty of not more than $5,000 for each violation, not to exceed an aggregate penalty of $50,000 in any six month period for any act or practice that the person knew, or should have known, was a violation.

2. A penalty of not more than $1,000 for each violation, not to exceed an aggregate penalty of $10,000 in any six month period for any act or practice that the person did not know, nor reasonably should have known, was a violation.

3. A penalty of not more than $10,000 for each violation of a cease and desist order, while such order is in effect.

Chapter 6: Major Lines and Basis of Life and Major Lines of Insurance

TERM INSURACE

Term Insurance provides life insurance protection for a designated number of years, anywhere from one year to thirty years. It is pure insurance protection only as it accumulates no cash values and expires with no value at the end of the term.

The shorter the initial term coverage, the lower the premium. A five-year term policy would be less costly than a ten-year term policy.

Term insurance can be written as renewable, convertible, or nonrenewable. Nonrenewable term is for a certain amount of time at the end of which the policy simply terminates. If the policy is written as renewable term, the policy may be renewed for another term without proof of insurability.

1. A five-year renewable term policy can be renewed for another five years without proof of insurability.

2. An Annual Renewable Term (ART) may be renewed each year without proof of insurability.

Although no proof of insurability is needed, the insured person is older at each renewal and thus the premium will increase as mortality increases with age.

Convertible Term insurance allows the policy owner to convert the term coverage to permanent insurance without proof of insurability. Normally when this right is exercised, a new permanent policy will be issued based on the attained age (present age) of the insured. Some companies allow this conversion to be based on the original age when the term contract first was issued. From that point forward, the premiums would be based on the younger age.

PERMANENT INSURANCE

Whole life insurance is designed to last for the entire span of life of the insured individual. This is considered to be age 100. It is a product that provides for a level death benefit and level premiums. The face amount of insurance stays the same for the length of the policy until death or age 100 and the premiums never fluctuate and are payable until age 100.

In order to allow an individual to have level premiums in the early years, it is necessary for the insured to pay more premium than is needed to provide the current years insurance protection. However, in the later years of the policy, the insured is paying less than is needed to cover the cost of insurance protection.

Another characteristic of whole life insurance is that it builds cash values. Part of the premium payment goes into the cash value account of the policy and earns a guaranteed interest rate stated in the contract. These cash values grow on a tax-deferred basis. A whole life contract normally will not have any cash value until the third year.

An insured with a whole life contract may borrow against the cash values in the policy. If he or she does take a loan against the cash values, interest will be charged. A policy owner is not required to repay a policy loan. If not repaid, it is simply deducted from the face amount of the insurance policy along with any outstanding interest before the beneficiary receives the death proceeds.

A policy owner also may surrender a policy and receive the accumulated cash values. As permanent insurance allows for policy loans and cash surrender, it is said to have living benefits. The owner of the policy has use of the cash values while alive.