This is “Insurance Operations: Marketing, Underwriting, and Administration”, section 7.1 from the book Enterprise and Individual Risk Management (v. 1.0). For details on it (including licensing), click here.
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In this section we elaborate on the following:
We begin with marketing despite the fact that it is not the first step in starting a business. From a consumer’s point of view, it is the first glimpse into the operations of an insurer. Insurance may be bought through agents, brokers, or (in some cases) directly from the insurer (via personal contact or on the Internet). An agent legally represents the company, whereas a broker represents the buyer and, in half of the states, also represents the insurer because of state regulations.Etti G. Baranoff, Dalit Baranoff, and Tom Sager, “Nonuniform Regulatory Treatment of Broker Distribution Systems: An Impact Analysis for Life Insurers,” Journal of Insurance Regulations, Regulations 19, no. 1 (Fall 2000): 94. Both agents and brokers are compensated by the insurer. The compensation issue was brought to the limelight in 2004 when New York State Attorney General Eliot Spitzer opened an investigation of contingent commissions that brokers received from insurers; these contingent commissions were regarded as bid rigging. Contingent commissions are paid to brokers for bringing in better business and can be regarded as profit sharing. As a result of this investigation, regulators look for more transparency in the compensation disclosure of agents and brokers, and major brokerage houses stopped the practice of accepting contingency commission in the belief that clients view the practice negatively.“2006: The Year When Changes Take Hold,” Insurance Journal, January 2, 2006, accessed March 6, 2009, http://www.insurancejournal.com/magazines/west/2006/01/02/features/64730.htm; Steve Tuckey, “NAIC Broker Disclosure Amendment Changes Unlikely,” National Underwriter Online News Service, April 15, 2005, accessed March 6, 2009, http://www.nationalunderwriter.com/pandc/hotnews/viewPC.asp?article =4_15_05_15_17035.xml; “NAIC Adopts Model Legislation Calling For Broker Disclosures Defers One Section for Further Consideration” at http://www.naic.org/spotlight.htm; Mark E. Ruquet, “MMC Says Contingent Fees No Longer A Plus” National Underwriter Online News Service, February 15, 2006.
In many states, producerAnother name for both agents and brokers. is another name for both agents and brokers. This new name has been given to create some uniformity among the types of distribution systems. Because life/health insurance and property/casualty insurance developed separately in the United States, somewhat different marketing systems evolved. Therefore, we will discuss these systems separately.
Most life/health insurance is sold through agents, brokers, or (the newest term) producers, who are compensated by commissions. These commissions are added to the price of the policy. Some insurance is sold directly to the public without sales commissions. Fee-only financial planners often recommend such no-load insurance to their clients. Instead of paying an agent’s commission, the client pays the planner a fee for advice and counseling and then buys directly from the no-load insurer. Unlike the agent, the planner has no incentive to recommend a high-commission product. Whether your total cost is lower depends on whether the savings on commissions offsets the planner’s fee.
Some companies insist that their agents represent them exclusively, or at least that agents not submit applications to another insurer unless they themselves have refused to issue insurance at standard premium rates. Others permit their agents to sell for other companies, though these agents usually have a primary affiliation with one company and devote most of their efforts to selling its policies.
The two dominant types of life/health marketing systems are the general agency and the managerial (branch office) system.
A general agentAn independent businessperson rather than an employee of the insurance company who is authorized by contract with the insurer to sell insurance in a specified territory. is an independent businessperson rather than an employee of the insurance company and is authorized by contract with the insurer to sell insurance in a specified territory. Another major responsibility is the recruitment and training of subagents. Subagents usually are given the title of agent or special agent. Typically, subagents are agents of the insurer rather than of the general agent. The insurer pays commissions (a percentage of premiums) to the agents on both new and renewal business. The general agent receives an override commission (a percentage of agents’ commissions) on all business generated or serviced by the agency, pays most of it to the subagents, and keeps the balance for expenses and profit. Agent compensation agreements are normally determined by the insurer.
In most cases, the general agent has an exclusive franchise for his or her territory. The primary responsibilities of the general agent are to select, train, and supervise subagents. In addition, general agents provide office space and have administrative responsibilities for some customer service activities.
A large number of life/health insurers use personal producing general agents. A personal producing general agentAgent who sells for one or more insurers, often with a higher-than-normal agent’s commission and seldom hires other agents. sells for one or more insurers, often with a higher-than-normal agent’s commission and seldom hires other agents. The extra commission helps cover office expenses. The trend is toward an agent representing several different insurers. This is desirable for consumers because a single insurer cannot have the best products for all needs. To meet a client’s insurance needs more completely, the agent needs to have the flexibility to serve as a broker or a personal producing general agent for the insurer with the most desirable policy.
A branch office is an extension of the home office headed by a branch manager. The branch managerA company employee who is compensated by a combination of salary, bonus, and commissions related to the productivity of the office to which he or she is assigned. is a company employee who is compensated by a combination of salary, bonus, and commissions related to the productivity of the office to which he or she is assigned. The manager also employs and trains agents for the company but cannot employ an agent without the consent of the company. Compensation plans for agents are determined by the company. All expenses of maintaining the office are paid by the company, which has complete control over the details of its operation.
Group life, health, and retirement plans are sold to employers by agents in one of the systems described above or by brokers. An agent may be assisted in this specialized field by a group sales representative. Large volumes of group business are also placed through direct negotiations between employers and insurers. A brokerage firm or an employee benefits consulting firm may be hired on a fee-only basis by the employer who wishes to negotiate directly with insurers, thus avoiding commissions to the agent/broker. In these direct negotiations, the insurer typically is represented by a salaried group sales representative.
Supplemental insurance plans that provide life, health, and other benefits to employees through employer sponsorship and payroll deduction have become common. These plans are marketed by agents, brokers, and exclusive agents. The latter usually work on commissions; some receive salaries plus bonuses.
Like life/health insurance, most property/casualty insurance is sold through agents or brokers who are compensated on a commission basis, but some is sold by salaried representatives or by direct methods. The independent (American) agency system and the exclusive agency system account for the bulk of insurance sales.
The distinguishing characteristics of the independent (American) agency system are the independence of the agent, the agent’s bargaining position with the insurers he or she represents, and the fact that those who purchase insurance through the agent are considered by both insurers and agents to be the agent’s customers rather than the insurer’s. The independent agentAgent who usually represents several companies, pays all agency expenses, is compensated on a commission plus bonus basis, and makes all decisions concerning how the agency operates. usually represents several companies, pays all agency expenses, is compensated on a commission plus bonus basis, and makes all decisions concerning how the agency operates. Using insurer forms, the agent binds an insurer, sends underwriting information to the insurer, and later delivers a policy to the insured. The agent may or may not have the responsibility of collecting premiums. Legally, these agents represent the insurer, but as a practical matter they also represent the customer.
An independent agent owns the x-dateHas the right to contact the customer when a policy is due for renewal.; that is, he or she has the right to contact the customer when a policy is due for renewal. This means that the insured goes with the agent if the agent no longer sells for the insurance company. This ownership right can be sold to another agent, and when the independent agent decides to retire or leave the agency, the right to contact large numbers of customers creates a substantial market value for the agency. This marketing system is also known as the American agency system. It is best recognized for the Big I advertisements sponsored by the Independent Insurance Agents & Brokers of America. These advertisements usually emphasize the independent agent’s ability to choose the best policy and insurer for you. (Formerly known as the Independent Insurance Agents of America, the 106-year-old association recently added the “& Brokers” to more accurately describe its membership.Sally Roberts, “Big I Changes Name to Reflect Membership Changes,” Business Insurance, May 6, 2002.)
Several companies, called direct writersCompanies that market insurance through exclusive agents.,The term direct writer is frequently used to refer to all property insurers that do not use the Independent Agency System of distribution, but some observers think there are differences among such companies. market insurance through exclusive agents. Exclusive agentsAgents permitted to represent only their company or a company in an affiliated group of insurance companies. are permitted to represent only their company or a company in an affiliated group of insurance companies. A group is a number of separate companies operating under common ownership and management. This system is used by companies such as Allstate, Nationwide, and State Farm. These insurers compensate the agent through commissions that are lower than those paid to independent agents, partly because the insurer absorbs some expenses that are borne directly by independent agents. The insurer owns the x-date. The customer is considered to be the insurer’s rather than the agent’s, and the agent does not have as much independence as do those who operate under the independent agency system. Average operating expenses and premiums for personal lines of insurance tend to be lower than those in the independent agency system.
Some direct writers place business through salaried representativesEmployees of the company., who are employees of the company. Compensation for such employees may be a salary and/or a commission plus bonus related to the amount and quality of business they secure. Regardless of the compensation arrangement, they are employees rather than agents.
A considerable amount of insurance and reinsurance is placed through brokers. A brokerIndividual who solicits business from the insured and also acts as the insured’s legal agent when the business is placed with an insurer. solicits business from the insured, as does an agent, but the broker acts as the insured’s legal agent when the business is placed with an insurer. In about half the states, brokers are required to be agents of the insurer. In the other states, brokers do not have ongoing contracts with insurers—their sole obligation is to the client. When it appears desirable, a broker may draft a specially worded policy for a client and then place the policy with an insurer. Some property/casualty brokers merely place insurance with an insurer and then rely on this company to provide whatever engineering and loss-prevention services are needed. Others have a staff of engineers to perform such services for clients. Modern brokerage firms provide a variety of related services, such as risk management surveys, information systems services related to risk management, complete administrative and claim services to self-insurers, and captive insurer management.
Brokers are a more significant part of the marketing mechanism in commercial property, liability, employee benefits, and marine insurance than in personal lines of insurance. Brokers are most active in metropolitan areas and among large insureds, where a broker’s knowledge of specialized coverages and the market for them is important. Some brokerage firms operate on a local or regional basis, whereas others are national or international in their operations.
With today’s proliferation of lines and services, it is extremely difficult for brokers to understand all the products completely. Brokers are always looking for unique product designs, but gaining access to innovative products and actually putting them into use are two different things. Generally, each broker selects about three favorite insurers. The broker’s concern is the underwriting standards of their insurers. For example, a broker would like to be able to place a client who takes Prozac with an insurer that covers such clients.
With today’s proliferation of Internet marketingSelecting an insurance product and comparing price and coverage on the Internet., one can select an insurance product and compare price and coverage on the Internet. For example, someone interested in purchasing a life insurance policy can click on Insweb.com. If she or he is looking for health insurance, ehealthinsurance or other such Web sites present information and a questionnaire to fill out. The site will respond with quotes from insurers and details about the plans. The customer can then send contact information to selected insurers, who will begin the underwriting process to determine insurability and appropriate rates. The sale is not finalized through the Internet, but the connection with the agent and underwriters is made. Any Internet search engine will lead to many such Web sites.
Most insurance companies, like other businesses, set up their own Web sites to promote their products’ features. They set up the sites to provide consumers with the tools to compare products and find the unique characteristics of the insurer. See the box, Note 7.15 "Shopping for Insurance on the Internet" for a description of Internet sites.
Mass merchandisingThe selling of insurance by mail, telephone, television, or e-mail. is the selling of insurance by mail, telephone, television, or e-mail. Mass merchandising often involves a sponsoring organization such as an employer, trade association, university, or creditor; however, you are likely to be asked to respond directly to the insurer. Some mass merchandising mixes agents and direct response (mass mailing of information, for example, that includes a card the interested person can fill out and return); an agent handles the initial mailing and subsequently contacts the responding members of the sponsoring organization.
In some cases, you can save money buying insurance by mass merchandising methods. Direct response insurers, however, cannot provide the counseling you may receive from a good agent or financial planner.
A financial plannerIndividual who facilitates some insurance sales by serving as a consultant on financial matters, primarily to high-income clients. facilitates some insurance sales by serving as a consultant on financial matters, primarily to high-income clients. An analysis of risk exposures and recommendations on appropriate risk management techniques, including insurance, are major parts of the financial planning process. A fee-only financial planner, knowledgeable in insurance, may direct you to good-quality, no-load insurance products when they are priced lower than comparable products sold through agents. You are already paying a fee for advice from the financial planner. Why also pay a commission to an insurance agent or broker?
In many instances, it is appropriate for the financial planner to send you to an insurance agent. Products available through agents may have a better value than the still limited supply of no-load products. Also, your financial planner is likely to be a generalist with respect to insurance, and you may need advice from a knowledgeable agent. In any event, financial planners are now part of the insurance distribution system.
True to its name, Progressive was the first large insurer to begin selling insurance coverage via the Internet in the late 1990s. Other well-known names like Allstate and Hartford quickly followed suit. So-called aggregator sites like Insure.com, Quotesmith.com, Ehealthinsurance.com, and InsWeb.com joined in, offering one-stop shopping for a variety of products. To tap the potential of e-commerce, insurers have had to overcome one big challenge: how to sell complex products without confusing and driving away the customer. Therefore, the sale is not finalized on the Internet. The glimpse into the product is only the first step for comparative shopping.
An insurance application can be frustrating even when an agent is sitting across the desk explaining everything, but most people don’t walk out in the middle of filling out a form. On the Internet, however, about half of those filling out a quote request quit because it is too complicated or time-consuming. Most of those who do finish are “just looking,” comparing prices and services. Twenty-seven million shoppers priced insurance online in 2001, according to a recent study by the Independent Insurance Agents of America and twenty-six insurers, but less than 5 percent closed the deal electronically.
As shopping on the Internet becomes a boom business, each state department of insurance provides guidelines to consumers. For example, the Texas Department of Insurance issued tips for shopping smart on the Internet, as follows:
Insurance on the Internet—Shopping Tips and Dangers
Sources: Lynna Goch, “What Works Online: Some Insurers Have Found the Key to Unlocking Online Sales,” Best’s Review, May 2002; Ron Panko, “IdentityWeb: Linking Agents and Customers,” Best’s Review, May 2002; Google search for “shopping for insurance on the Internet”; and http://www.tdi.state.tx.us/consumer/cpinsnet.html.
Ideally, an agent has several years of experience before giving advice on complicated insurance matters. You will be interested in the agent’s experience and educational qualifications, which should cover an extensive study of insurance, finance, and related subjects. A major route for life/health agents to gain this background is by meeting all requirements for the Chartered Life Underwriter (CLU) designation. The Chartered Financial Consultant (ChFC) designation from the American College (for information, see http://www.amercoll.edu/) is an alternative professional designation of interest to life/health agents. Property/casualty agents gain a good background by earning the Chartered Property and Casualty Underwriter (CPCU) designation granted by the American Institute for Property and Liability Underwriters (see http://www.aicpcu.org/). Another, broader designation with applications to insurance is Certified Financial Planner (CFP), awarded by the Certified Financial Planner Board of Standards (see http://www.cfp-board.org/).
UnderwritingThe process of evaluating risks, selecting which risks to accept, and identifying potential adverse selection. is the process of classifying the potential insureds into the appropriate risk classification in order to charge the appropriate rate. An underwriterIndividual who decides whether or not to insure exposures on which applications for insurance are submitted. decides whether or not to insure exposures on which applications for insurance are submitted. There are separate procedures for group underwriting and individual underwriting. For group underwriting, the group characteristics, demographics, and past losses are judged. Because individual insurability is not examined, even very sick people such as AIDS patients can obtain life insurance through a group policy. For individual underwriting, the insured has to provide evidence of insurability in areas of life and health insurance or specific details about the property and automobiles for property/casualty lines of business. An individual applicant for life insurance must be approved by the life insurance company underwriter, a process that is sometimes very lengthy. It is not uncommon for the application to include a questionnaire about lifestyle, smoking habits, medical status, and the medical status of close family members. For large amounts of life insurance, the applicant is usually required to undergo a medical examination.
Once the underwriter determines that insurance can be issued, the next decision is to apply the proper premium rate. Premium rates are determined for classes of insureds by the actuarial department. An underwriter’s role is to decide which class is appropriate for each insured. The business of insurance inherently involves discrimination; otherwise, adverse selection would make insurance unavailable.
Some people believe that any characteristic over which we have no control, such as gender, race, and age, should be excluded from insurance underwriting and rating practices (although in life and annuity contracts, consideration of age seems to be acceptable). Their argument is that if insurance is intended in part to encourage safety, then its operation ought to be based on behavior, not on qualities with which we are born. Others argue that some of these factors are the best predictors of losses and expenses, and without them, insurance can function only extremely inefficiently. Additionally, some argument could be made that almost no factor is truly voluntary or controllable. Is a poor resident of Chicago, for instance, able to move out of the inner city? A National Underwriter article provided an interesting suggestion for mitigating negative characteristics: enclosing a personalized letter with an application to explain special circumstances.Paul P. Aniskovich, “Letters With Apps Can Make The Difference,” National Underwriter, Life & Health/Financial Services Edition, November 12, 2001. For example, according to the article, “If your client is overweight, and his family is overweight, but living a long and healthy life, note both details on the record. This will give the underwriters more to go on.” The article continues, “Sending letters with applications is long overdue. They will often shorten the underwriting cycle and get special risks—many of whom have been given a clean bill of health by their doctor or are well on their way to recovery—the coverage they need and deserve.”
Over the years, insurers have used a variety of factors in their underwriting decisions. A number of these have become taboo from a public policy standpoint. Their use may be considered unfair discrimination. In automobile insurance, for instance, factors such as marital status and living arrangements have played a significant underwriting role, with divorced applicants considered less stable than never-married applicants. In property insurance, concern over redlining receives public attention periodically. RedliningWhen an insurer designates a geographical area in which it chooses not to provide insurance, or to provide it only at substantially higher prices. occurs when an insurer designates a geographical area in which it chooses not to provide insurance, or to provide it only at substantially higher prices. These decisions are made without considering individual insurance applicants. Most often, the redlining is in poor urban areas, placing low-income inner-city dwellers at great disadvantage. A new controversy in the underwriting field is the use of genetic testing. In Great Britain, insurers use genetic testing to screen for Huntington’s disease,Catherine Arnold, “Britain Backs Insurers Use of Genetic Testing,” National Underwriter, Life & Health/Financial Services Edition, November 27, 2000. but U.S. companies are not yet using such tests. As genetic testing continues to improve, look for U.S. insurance companies to request access to that information as part of an applicant’s medical history.
Two major areas of underwriting controversies are discussed in the box below, Note 7.19 "Keeping Score—Is It Fair to Use Credit Rating in Underwriting?" and in Note 8.35 "Insurance and Your Privacy—Who Knows?" in Chapter 8 "Insurance Markets and Regulation". The need for information is a balancing act between underwriting requirements and preserving the privacy of insureds. The tug-of-war between more and less information is a regulatory matter. The use of credit ratings in setting premiums illustrates a company’s need to place insureds in the appropriate risk classification—a process that preserves the fundamental rules of insurance operations (discussed in Chapter 6 "The Insurance Solution and Institutions"). We will explore underwriting further in other chapters as we look at types of policies.
Body-mass index, cholesterol level, SAT score, IQ: Americans are accustomed to being judged by the numbers. One important number that you may not be as familiar with is your credit score. Determined by the financial firm Fair, Isaac, and Co., a credit score (also known as a FICO score) is calculated from an individual’s credit history, taking into account payment history, number of creditors, amounts currently owed, and similar factors.
Like your grade point average (GPA), your credit score is one simple number that sums up years of hard work (or years of goofing off). But while your GPA is unlikely to be important five years from now, your credit score will affect your major financial decisions for the rest of your life. This number determines whether you’re eligible for incentive (low-rate) financing on new cars, how many credit card offers get stuffed in your mailbox each month, and what your mortgage rate will be. The U.S. Federal Trade Commission (FTC) issued a directive to consumers about the handling of credit scores. If you are denied credit, the FTC offers the following:
Your credit score may also affect how much you’ll pay for insurance. About half of the companies that write personal auto or homeowner’s insurance now use credit data in underwriting or in setting premiums, and the bad credit penalty can be 20 percent or more. But it’s not because they’re worried that poor credit risks won’t pay their insurance premiums. Rather, it’s the strong relationship between credit scores and the likelihood of filing a claim, as study after study has borne out. Someone who spends money recklessly is also likely to drive recklessly, insurers point out; someone who is lazy about making credit card payments is apt to be lazy about trimming a tree before it causes roof damage. Often, a credit record is the best available predictor of future losses. Insurers vary on how much they rely on credit scoring—most consider it as one factor of many in setting premiums, while a few flat out refuse to insure anyone whose credit score is below a certain number—but almost all see it as a valuable underwriting tool. It’s only fair, insurers say, for low-risk customers to pay lower premiums rather than subsidizing those more likely to file claims.
Consumer advocates disagree. Using credit scores in this manner is discriminatory and inflexible, they say, and some state insurance commissioners agree. Consumer advocate and former Texas insurance commissioner Robert Hunter finds credit scoring ludicrous. “If I have a poor credit score because I was laid off as a result of terrorism, what does that have to do with my ability to drive?” he asked at a meeting of the National Association of Insurance Commissioners in December 2001. Therefore, in 2004, twenty-four states have adopted credit scoring legislation and/or regulation that is based on a National Conference of Insurance Legislators (NCOIL) model law.
The debate over the use of credit scoring has spread across the country. More states are considering regulations or legislation to curb its use by insurers.
Questions for Discussion
Sources: Barbara Bowers, “Giving Credit Its Due: Insurers, Agents, Legislators, Regulators and Consumers Battle to Define the Role of Insurance Scoring” and “Insurers Address Flurry of Insurance-Scoring Legislative Initiatives,” Best’s Review, May 2002; U.S. Federal Trade Commission at http://www.ftc.gov/bcp/conline/pubs/credit/scoring.htm. See http://www.ncoil.org/ and all media outlets for coverage of this issue, which occurs very frequently.
After insurance is sold and approved by the underwriter, records must be established, premiums collected, customer inquiries answered, and many other administrative jobs performed. Administration is defined broadly here to include accounting, information systems, office administration, customer service, and personnel management.
ServiceThe ultimate indicator upon which the quality of the product provided by insurance depends. is the ultimate indicator on which the quality of the product provided by insurance depends. An agent’s or broker’s advice and an insurer’s claim practices are the primary services that the typical individual or business needs. In addition, prompt, courteous responses to inquiries concerning changes in the policy, the availability of other types of insurance, changes of address, and other routine matters are necessary.
Another service of major significance that some insurers offer, primarily to commercial clients, is engineering and loss control. Engineering and loss controlMethods of prevention and reduction of loss whenever the efforts required are economically feasible. is concerned with methods of prevention and reduction of loss whenever the efforts required are economically feasible. Much of the engineering and loss-control activity may be carried on by the insurer or under its direction. The facilities the insurer has to devote to such efforts and the degree to which such efforts are successful is an important element to consider in selecting an insurer. Part of the risk manager’s success depends on this element. Engineering and loss-control services are particularly applicable to workers’ compensation and boiler and machinery exposures. With respect to the health insurance part of an employee benefits program, loss control is called cost containment and may be achieved primarily through managed care and wellness techniques.
In this section you studied the following: