The Life and Health Insurance Industry
Role of Government in Insurance
The United States has a federal system of government in which the federal government and a
number of lower level governments, known as state governments, share governmental
；According to the U.S. Constitution, all governmental powers not specifically given to the federal government are left to the state governments.
；One power delegated to the federal government is the authority to regulate interstate
commerce conducted across state lines—which includes the power to regulate commerce—
the insurance industry.
；However, in enacting the federal McCarran-Ferguson Act, or Public Law 15, the U.S.
Congress agreed to leave insurance regulation to the states as long as Congress considered state regulation to be adequate.
Regulation of Insurance
In most countries, the two primary goals of insurance regulation are to ensure that insurance companies
1.Remain solvent—able to meet their debts and pay policy benefits when policy benefits come due
2.Conduct business fairly and ethically
In the United States, each state has enacted laws designed to ensure that insurance companies operating within the state are solvent
；To achieve that goal, the state imposes minimum requirements on the amount of the insurer’s assets, liabilities, capital, and surplus.
；These amounts represent components in the company’s basic accounting equation, under which the company’s assets must equal its liabilities and owners’ equity.
Basic accounting equation
Assets = Liabilities + Owners’ equity
；Examples of assets include cash and investments.
；States regulate types of investments insurance companies can make to ensure that investments are conservative and prudent.
；States also impose requirements on how insurers must determine the value of their assets.
；A large portion of an insurance company’s liabilities consists of the company’s policy
reserves, which represent the amount the insurer estimates it will need to pay policy benefits as they come due.
；States impose requirements on the methods that insurers use to calculate the amount oftheir policy reserves.
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；Owners’ equity in a stock insurance company consists of the company’s capital and surplus.
；Capital: the amount of money invested in the company by its owners
；Surplus: the amount by which the company’s assets exceed its liabilities and capital
；Because a mutual insurer does not issue stock, it has no capital, and, therefore, owners’ equity in a mutual company consists only of its surplus.
States oversee the financial condition of insurance companies by reviewing the companies’ Annual Statements:
Annual Statement: an accounting report that an insurer prepares each calendar year and files with the insurance department in each state in which it operates
The NAIC has developed an Annual Statement form that is accepted by all states so that an insurer can file the same form in all the states in which it operates.
State regulators also conduct an on-site financial condition examination of each insurance company every three to five years.
；State regulators have discretionary authority to conduct more frequent examinations of companies that appear most likely to have financial difficulties.
；The NAIC has developed an organized system of on-site examinations to coordinate this function between states to avoid duplication of effort by the various states. Relatively few insurance companies become financially unsound. When such a situation does occur, state insurance commissioners have the authority to take certain actions
If a domestic insurer—an insurer incorporated by the state—becomes financially unsound,
the insurance commissioner can take steps to either rehabilitate or liquidate the company
；If the company’s finances can be turned around, the commissioner will try to rehabilitate it.
；If the company is too financially unsound, the commissioner may declare the company insolvent and act to liquidate—dissolve—the corporation.When a foreign insurer—an insurer
incorporated under the insurance laws of another state—becomes financially unsound, the
insurance commissioner has the authority to revoke or suspend the insurer’s license to operate in the state.
In the United States, a life and health guaranty association is an organization that operates
under the supervision of the state insurance commissioner to protect policyowners, insureds, beneficiaries, and specified others against losses that result from the financial impairment or insolvency of a life or health insurer that operates in the state.
；Typically, a guaranty association provides funds to guarantee payment for certain policies up to stated dollar limits.
；In some cases, a policyowner may have the option to obtain a replacement policy. ；To pay these obligations, the guaranty association requires all life and health insurers operating in the state to pay money into a guaranty fund.
Market Conduct Regulation
In the United States, each state has enacted market conduct laws that regulate how
insurance companies conduct their business within the state.
State insurance regulators perform periodic market conduct examinations of insurers similar to financial condition examinations.
States require that all individuals—known as insurance producers—and agencies that market
and sell insurance must be licensed by each state in which they conduct business.
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；Be sponsored for licensing by a licensed insurer
；Complete approved educational course work and/or pass a written examination ；Provide assurance that he is of reputable character
Producer's licenses typically must be renewed every year, and many states require producers to participate in continuing education courses to renew their licenses.A state may revoke or suspend a producer's license if she engages in certain unethical practices, such as some form of misrepresentation in which the producer deliberately makes false or misleading statements to induce a customer to purchase insurance
Each state also regulates the policy forms that insurers may use within the state. policy form:
a standardized form that shows the terms, conditions, benefits, and ownership rights of a particular type of insurance product
；An insurer usually must file with the state insurance department a copy of each policy form it plans to use and must receive the department's approval before using the form. ；Many states impose readability requirements on insurance policies to reduce the amount of technical jargon and legal language included in those policies.
Canada has a federal system of government in which powers are shared between a federal government and a number of lower level governments known as provincial governments.
；Although similar to the U.S. regulatory system, the Canadian insurance regulatory system provides a more prominent role for the federal government than does the U.S. system.
；In Canada, insurers can be federally incorporated or provincially incorporated
Canadian Life and Health Insurance Compensation Corporation
The Canadian Life and Health Insurance Compensation Corporation (CompCorp) is a
federally incorporated, nonprofit company established by the insurance industry to protect Canadian consumers against loss of benefits in the event a life or health insurance company becomes insolvent.
；All insurers operating in Canada are required to become members of CompCorp.
；CompCorp guarantees payment under covered policies up to certain specified limits.
Introduction to Risk and Insurance
The Concept of Risk
Risk exists when there is uncertainty about the future. Individuals and businesses experience two kinds of risk
Speculative risk involves three possible outcomes: (1) gain, (2) loss, or (3) no change.
Pure risk involves no possibility of gain; either a loss occurs or no loss occurs
The possibility of financial loss without the possibility of gain—pure risk—is the only kind
of risk that can be insured.
The purpose of insurance is to compensate for financial loss, not to provide an opportunity for financial gain.
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Risk management involves identifying and assessing the risks we face.
Four risk management techniques that people and businesses can use to eliminate or reduce their exposure to financial risk are:
1. Avoiding the risk
2. Controlling the risk
3. Accepting the risk
4. Transferring the risk
Characteristics of Insurable Risks
Insurance products are designed in accordance with basic principles that define which
a potential loss—to be considered insurable, it must have risks are insurable. For a risk—
1.The loss must be definite.
2.The loss must be significant.
3.The The loss must occur by chance.
4.loss rate must be predictable.
5.The loss must not be catastrophic to the insurer
；These five basic characteristics define an insurable risk and form the foundation of the business of insurance.
；A potential loss that does not have these characteristics generally is not considered an insurable risk.
1. The loss must occur by chance. For a potential loss to be insurable, the element of chance must be present.
The loss should be caused either by an unexpected event or by an event that is not intentionally caused by the person covered by the insurance.
For example, people cannot generally control whether they will become seriously ill; as a result, insurers can offer medical expense insurance policies to protect against financial losses caused by the chance event that an insured person will become ill and incur medical expenses.
When this principle of loss is applied in its strictest sense to life insurance, an apparent problem arises: death is certain to occur. The timing of an individual’s death, however, is
usually out of the individual’s control and, therefore, usually occurs by chance.
2. The loss must be definite. For most types of insurance, an insurable loss must be definite in terms of time (when to pay policy benefits) and amount (how much those benefits should be).
Because death, illness, disability, and retirement are generally identifiable conditions, insurers typically can determine when a loss occurred. Determining the amount of benefits depends on whether the insurance policy is a contract of indemnity or a valued contract. contract of indemnity: an insurance policy under which the amount of the policy benefit payable for a covered loss is based on the actual amount of financial loss that results from the loss, as determined at the time of loss
Many medical expense insurance policies are contracts of indemnity.
valued contract: specifies the amount of the policy benefit that will be payable when a covered loss occurs, regardless of the actual amount of the loss that was incurred
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Most life insurance policies are valued contracts.
3. The loss must be significant. In general, insurable losses are losses that cause financial hardship to most people. Insignificant losses are not normally insured.For example, the administrative expense of paying benefits for a very small loss, such as the loss of an umbrella, would drive the cost for such insurance protection so high in relation to the amount of the potential loss that most people would find the protection unaffordable.
On the other hand, insurance coverage is available to protect against a potential loss, such as an accidental injury, which might cause a person to miss work and lose a significant amount of income.
4. The loss rate must be predictable. To provide a specific type of insurance coverage, an
the loss rate—that the people insurer must be able to predict the probable rate of loss—
insured by the coverage will experience.Although insurers cannot predict when a person will experience a loss, they can predict with a fairly high degree of accuracy the number of people in a given large group who will die, become disabled, or need hospitalization during a given period of time.
These predictions of future losses are based on the concept that, even though individual events occur randomly, we can use observations of past events to determine the likelihood—or
probability—that a given event will occur in the future.
When insurers make predictions about the covered losses a given group is likely to experience during a given period of time, they rely on the law of large numbers and statistical records
contained in mortality and morbidity tables.
The law of large numbers states that, typically, the more times we observe a particular event, the more likely it is that our observed results will approximate the ―true‖ probability that the event will occur.Insurers collect specific information about large numbers of people to identify the pattern of losses those people experienced. Using these statistical records, insurers develop
mortality tables: charts that indicate with great accuracy the number of people in a large group (100,000 people or more) who are likely to die at each age; these charts display the rate
of mortality, or incidence of death, by age, among a given group of people.
morbidity tables: charts that display the rates of morbidity, or incidence of sickness and
accidents, by age, occurring among a given group of people.
Insurers use predicted loss rates to establish premium rates that will be adequate to pay claims.
5. The loss must not be catastrophic to the insurer. A potential loss is not considered insurable if a single occurrence is likely to cause or contribute to catastrophic financial damage to the insurer.Such a loss is not insurable because the insurer could not responsibly promise to pay benefits for the loss.
To prevent the possibility of catastrophic loss and ensure that losses occur independently of each other, insurers spread the risks they choose to insure.For example, a property insurer would be unwise to issue policies covering all homes within a 50-mile radius of an active volcano because one eruption of the volcano could result in more claims at one time than the insurer could pay. Instead, the insurer would also issue policies covering homes in areas not threatened by the volcano.
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Insurability of Specific Risks
Insurance is sold on a case-by-case basis and insurers determine whether each proposed risk is an insurable risk.
；Not all individuals of the same sex and age have an equal likelihood of suffering a loss. ；Further, those individuals who believe they have a greater-than average likelihood of loss tend to seek insurance protection to a greater extent than do those who believe they have an average or less-than-average likelihood of loss. This tendency is called antiselection,
adverse selection, or selection against the insurer. Insurers carefully review each application
to assess the degree of risk the company will be assuming if it issues a requested policy.
The process of identifying and classifying the degree of risk represented by a proposed insured is called underwriting or selection of risks. It consists of
1.Identifying the risks that a proposed insured presents
2.Classifying the degree of risk that a proposed insured represents
Identifying risks: insurers have identified a number of factors that can increase or decrease the likelihood that an individual will suffer a loss. The most important of these factors are
physical hazard: a physical characteristic that may increase the likelihood of loss
Example: a person with a history of heart attacks possesses a physical hazard that increases the likelihood of dying sooner than a person of the same age and sex who does not have a similar medical history
moral hazard: a characteristic that exists when the reputation, financial position, or criminal record of an applicant or proposed insured indicates that the person may act dishonestly in the insurance transaction Example: a person who has a confirmed record of illegal or unethical behavior is likely to behave similarly in an insurance transaction
Classifying risks: after identifying the risks presented by a proposed insured, the underwriter can classify the proposed insured into an appropriate risk class
risk class: a grouping of insureds who represent a similar level of risk to the insurer
；Classifying risks into classes enables the insurer to determine the equitable premium rate to charge for the requested coverage.
；People in different risk classes are charged different premium rates.
To classify proposed insureds, underwriters apply general rules of risk selection, known as underwriting guidelines, established by the insurer.
Life insurers’ underwriting guidelines generally identify at least four risk classes for
proposed insureds: (1) standard risks, (2) preferred risks, (3) substandard risks, and (4) declined risks.standard risks: proposed insureds who have a likelihood of loss that is not significantly greater than average; traditionally, most individual life and health insurance policies have been issued at standard premium rates
The premium rates that standard risks are charged are called standard premium
rates.preferred risks: proposed insureds who present a significantly less-than-average likelihood of loss; preferred risks are charged lower-than-standard premium rates
Insurance company practices vary widely as to what qualifies a proposed insured as a preferred risk or a standard risk.declined risk: proposed insureds who are considered to
present a risk that is too great for the insurer to cover
substandard risks (or special class risks): proposed insureds who have a significantly
greater-than-average likelihood of loss but are still found to be insurable
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Insurers use several methods to compensate for the additional risk presented by insureds who are classified as substandard risks. For example；In individual life insurance,
insurers typically charge substandard risks a higher-than-standard premium rate, called a substandard premium rate or special class rate.
；In individual health insurance, insurers charge a substandard premium rate or modify the policy in some way—such as by excluding a particular risk from coverage—to
compensate for the greater risk.
issued, the policyowner must have an insurable interest in the risk that is insured—the
policyowner must be likely to suffer a genuine loss or detriment should the event insured against occur.
For life insurance, the presence of an insurable interest usually can be found by applying the following rule:An insurable interest exists when the policyowner is likely to benefit if the insured continues to live and is likely to suffer some loss or detriment if the insured dies.
；Underwriters screen every life insurance application to make sure that the insurable interest requirement imposed by law in the applicable jurisdiction will be met when the policy is issued. ；Insurers also make sure that applications meet the company’s underwriting guidelines,
which frequently include insurable interest requirements that go beyond the requirements imposed by law.
；If the insurer determines that the proposed policyowner does not meet insurable interest requirements, then the insurer will not issue the policy.
；Even if the insurable interest requirement imposed by the applicable jurisdiction is met, an insurer can refuse to issue the policy if its own, more stringent insurable interest requirements are not met.Insurable interest requirement…
when a person purchases life insurance on her own life
；All persons are considered to have an insurable interest in their own lives. ；A person is always considered to have more to gain by living than by dying. ；Therefore, an insurable interest between the policyowner and the insured is presumed when a person seeks to purchase insurance on her own life.
；Insurable interest laws do not require that the named beneficiary have an insurable interest in the policyowner-insured’s life.
；However, most insurance company’s underwriting guidelines require that the beneficiary also must have an insurable interest in the life of the insured when a policy is issued.
Insurable interest requirement…
when a person purchases life insurance on another person’s life (third-party policy)
；Laws in many countries and in most states in the United States require only that the
policyowner have an insurable interest in the insured’s life when the policy is issued.
；However, most insurance company underwriting guidelines and the laws in some states
require both the policyowner and the beneficiary of a third-party policy to have an insurable interest in the insured’s life when the policy is issued.The insurable interest requirement must
be met before a life insurance policy will be issued. After the policy is in force, the presence or absence of insurable interest is no longer relevant. Therefore, a beneficiary need not provide evidence of insurable interest to receive the benefits of a life insurance policy.
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Certain family relationships are assumed by law to create an insurable interest between an insured and a policyowner or beneficiary. In these family relationships, even if the policyowner or beneficiary has no financial interest in the insured’s life, the bonds of love and affection alone are sufficient to create an insurable interest.
According to laws in most jurisdictions, the insured’s
spouse mother grandparent sister
child father grandchild brother
are deemed to have an insurable interest in the life of the insured.
An insurable interest is not presumed when the policyowner or beneficiary is more distantly related to the insured than these relatives or when the parties are not related by blood or marriage. In these cases, a financial interest in the continued life of the insured must be demonstrated to satisfy the insurable interest requirement.
The Insurance Policy
Fundamentals of Contract Law
The parties to an individual insurance contract are (1) the insurance company and (2) the
policyowner. The parties to a group insurance contract are the:；insurance company
；group policyholder: the person or organization that decides what types of group insurance coverage to purchase for group members, negotiates the terms of the insurance contract, and purchases the group insurance coverageIf a party to the contract does not carry out its promise, then that party has breached the contract. Laws provide remedies to innocent parties for losses resulting from breach of contract.
Types of Contracts
Contracts come in a variety of types.formal contract: one that is enforceable because the
parties to the contract met certain formalities concerning the form of the agreement; generally the contract must be in writing and must contain some form of seal to be enforceable; few types of contracts are formal An insurance contract is an informal
contract: one that is enforceable because the parties to the contract met requirements concerning the substance of the agreement rather than the form of the agreement; may be oral or written
bilateral contract: both parties to the contract make legally enforceable promises when they enter into the contract
An insurance contract is a unilateral contract because only one party to the
contract—the insurance company—makes legally enforceable promises when the parties
enter into the contract.
As long as policy premiums are paid, the insurer is legally bound by its contractual promises. The purchaser of an insurance policy does not promise to pay premiums and cannot be compelled by law to pay the premiums.
commutative contract: a contract in which the parties specify in advance the relatively equal values that they will exchange; most contracts fall into this like-for-like exchange category
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An insurance contract is an aleatory contract: one party provides something of value to
another party in exchange for a conditional promise, a promise to perform a stated act
only if a specified, uncertain event occurs—for example, the insured’s death (life
insurance) or illness/accident (health insurance)
If the specified event occurs, one party may receive something of greater value than that party gave.
bargaining contract: one in which the parties to a contract, as equals, set the terms and conditions of the contract
An insurance contract is a contract of adhesion: one party prepares the contract and the
other party must accept or reject as a whole, generally without any bargaining between the parties
Even if negotiations occur between an individual or a group policyholder and an insurer, the applicant must accept the contract as written. Courts interpret ambiguity in an insurance contract against the insurer that constructed the contract. Contract: General Requirements
The following terms describe the legal status of a contract.valid contract: satisfies all
legal requirements and is enforceable at law void contract: does not satisfy one or more
of the legal requirements and is never enforceable at law voidable contract: a party has
the right to avoid contractual obligations under the contract without incurring legal liability A legally enforceable informal contract must have:
； mutual assent ？;;contractual capacity
； adequate consideration ？;;lawful purpose
mutual assent: parties reach a meeting of the minds about the terms of their agreement; parties reach an agreement through a process of an offer and acceptance, in which one party makes an offer to contract and the other party accepts that offer
All parties must intend to be bound by contract terms and make some outward expression of that intent.
contractual capacity: each party must have the legal capacity to make a contract
；An insurer must have the legal capacity to issue the policy and the applicant must have the legal capacity to purchase the policy.
；Although every individual is presumed to have contractual capacity, some people do not have full contractual capacity.
；In most jurisdictions, people who have limited contractual capacity either (1) are minors or (2) lack mental capacity.
；Contracts entered into by individuals who do not have contractual capacity are generally void or voidable. minor: a person who has not attained the age of majority—the age at
which a person is given by law the rights and responsibilities of an adult
；Contracts entered into by a minor are voidable by the minor.;In most countries, the age
of majority is 18.
；In many jurisdictions, the age of majority for the purpose of making life insurance contracts has been modified by law to protect the insurer from the possibility that minors will later use their lack of legal capacity to void the contract.
Two situations arise in which a person’s mental capacity affects contractual capacity:
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；Contracts entered into by a person who has been declared insane or mentally incompetent are usually void.
；Contracts entered into by a mentally impaired person are generally voidable by that
person. If a mentally impaired person later regains mental competence, he or she may either reject the contract or require that it be carried out. The other party to the contract does not have the right to reject the contract and must carry out its terms if required to do so.
Organizations are generally presumed to have the contractual capacity of a mentally competent adult.
An insurer acquires its legal capacity to enter into an insurance contract by being licensed or authorized to do business.
Should an unauthorized insurer issue a policy to a person who is unaware of the insurer’s
lack of legal capacity, the policy may be enforceable against the insurer. In some jurisdictions, the contract is void. In other jurisdictions, the contract is voidable by the policyowner.
consideration: something that will be of value and legally adequate to the other party to the contract
The consideration given by an applicant for a life or health insurance contract consists of the application and the initial premium—the first premium paid for an insurance policy.
This consideration is given in return for the insurer’s promise to pay the policy benefit if the conditions stated in the policy occur. If the initial premium is not paid, then no contract has been formed. Renewal premiums—premiums payable after the initial premium—are a
condition for continuance of the policy, not consideration for the policy.
A contract must be made for a lawful purpose—a purpose that is not illegal or against the
public good—or it is void.
；Unless statutes have been enacted to the contrary, gambling agreements are not enforceable at law.
；One person cannot make a legally enforceable agreement that requires another person to do something that is in conflict with an existing law.
；Individual life or health insurance policy: lawful purpose is fulfilled by the presence of insurable interest at the formation of the contract.Only initial insurable interest is required for an individual life or health insurance policy. Continuing insurable interest is not required for the contract to remain valid.
；Group insurance contract: lawful purpose is met when the group policyholder enters into the contract to provide benefits to covered group members. Insurable interest usually is not required.
The Policy as Property
Because insurance policies are a type of property, they are subject to the principles of property law.property: a bundle of rights a person has with respect to something;
generally real or personal
；real property: land and whatever is growing on or affixed to the land
；personal property: all property other than real property; includes tangible property
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