2005
Insurance Reference Manual
Personal Insurance Federation of California Insurance Reference Book
TYPES OF INSURANCE
INTRODUCTION
In an effort to provide a better understanding of the industry, some background is necessary on the types of insurance companies doing business in California and the marketing systems they use.
TYPES OF INSURANCE COMPANIES
There are three basic types of insurers; the stock company, the mutual company and the reciprocal exchange.
A capital stock company (stock company) is a corporation owned by individuals who contribute capital in the hope of earning a profit through the sale of insurance protection. The stockholders elect the directors, direct the company's operations and share in any profits earned.
Mutual insurance companies are insurance companies without capital stock, owned by the policyholders for the purpose of sharing in the profits through dividends at the end of the policy year. Every policyholder is a member of the company and is entitled to vote at any regular or special meeting of the company, in much the same way as the stockholders of an ordinary corporation. Usually, each insured has one vote which he/she may exercise in person or by proxy.
A reciprocal exchange is similar to a mutual company in that the policyholders in a reciprocal are both insured and insurer. There are no stockholders. The reciprocal is not incorporated, but is actually an aggregation of individuals, firms and/or business corporations which exchange insurance on one another.
Each member assumes a fraction of the coverage on every other member. Profits earned by the reciprocal are distributed among the members in the form of premium refunds. On the other hand, if premiums collected are not adequate to meet the losses and expenses incurred, each member may be assessed a pro-rata share of the loss.
In addition, there are reinsurers, or insurance companies which reinsure part of the insurance other companies have written. As an example, let's say company "A" sells insurance to customer "B," but company "A" does not want to be completely responsible for the entire risk. Company "A" would then approach insurance company "C" and, by paying a premium to company "C," transfer part of the risk to company "C." This is how a reinsurance company functions, to assume part of the risk of other insurance companies' writings.
MARKETING SYSTEMS
Insurance may be purchased in several marketing systems; from exclusive agents who work for one company and sell only the lines of insurance offered by that company; independent agents and/or brokers, who are independent business persons and represent a number of different companies; or through direct mail; e-mail or 1-800 numbers.
There are generally two groups who purchase insurance in the market place, competitive (sometimes called voluntary or private market) and shared (usually referred to in the industry as a residual or assigned risk market).
The competitive market is the most common and can best be described as a market where a buyer can shop for insurance from several companies regardless of the type of coverage desired. However, if for some reason, there are circumstances that make it difficult for the buyer to purchase insurance in the competitive market, then the shared market is a mechanism established by the Legislature to provide a market for them for certain coverages.
Shared markets, which are underwritten by the insurance industry, provide a back-up to the competitive market. The shared market in California is made up of several industry "cooperatives" mandated by the legislature and include the California Automobile Assigned Risk Plan, the State Compensation Insurance Fund of California, and the California FAIR Plan Association.
The people who find themselves in a shared market, as a group, either represent a greater risk or have more frequent claims of greater severity than the purchaser of insurance in the competitive market. This does not, however, make these individuals or groups second-class citizens in the service they receive from the industry. It merely means that the chances are greater that they will have a claim against their policy based on their previous experiences, driving record, geographic location, etc., and must pay a higher rate to offset that additional risk.
The California Insurance Guaranty Association has been formed by the industry to protect the claimants and policyholders of a company that goes out of business because of insolvency. The costs for paying the "covered claims" of insolvent companies are borne by consumers purchasing insurance in California . The total annual cost to consumers varies depending on the number of insolvent companies.
TYPES OF INSURANCE
The definition of insurance is: "A contractual relationship between the insured and the insurer, the latter agreeing (in return for a premium) to pay losses due to specified causes. This sometimes includes specified services." More simply stated, insurance is the pooling of money by many people to protect themselves from the risk of losses which may be difficult for an individual to withstand financially.
There are various types of "pooling" arrangements, many of which are familiar to us as life insurance, health insurance, fire insurance or auto insurance. Often, a single policy provides several kinds of coverage as in an automobile or homeowner's policy. This section will give brief descriptions of the more common forms of insurance.
AUTOMOBILE
Automobile insurance can provide coverage for liability, medical expenses, uninsured motorist, vehicle physical damage, lost wages, funeral expenses, etc. Liability insurance provides a way of meeting the financial responsibility which might result from causing loss or harm to another person or property (for example: injuring another person or damaging another car in a collision). The primary vehicle physical damage perils are collision, fire and theft.
The owner of a motor vehicle in California is required by law to have liability insurance and coverage for bodily injury and physical damage. Each coverage in an automobile policy carries a specified amount of premium, even though the insurance buyer pays a lump sum which is a total of all the component premiums (see the definition of COVERAGES in the glossary). Sections 16028 and 16028.4 of the Vehicle Code cover this area. This is an example of a financial responsibility law (FR Law).
California statues require the owner of each motor vehicle to prove financial responsibility if involved in any accident.
Under state law, insurance companies must submit proposed rates to the insurance commissioner for approval before a new rate can be implemented. This procedure is called "prior approval" ratemaking (see the section on Ratemaking, Premiums and Profits).
CRIME AND SURETY
Crime insurance is written to protect the insured against loss by burglary, robbery and theft. Businesses can buy it separately and the private citizen can obtain such coverage in a homeowner's policy.
A bond is a contract under which one party binds himself financially to the performance by another of an agreed-upon obligation. A fidelity bond is an agreement to pay a third party if the principal under bond does not perform in an honest manner. A surety bond is an agreement to pay a third party if the principal under bonds fails to perform certain obligations, such as completing a construction project.
GENERAL LIABILITY
General liability insurance is designed to protect the insured against financial liability for losses caused another party by the insured's act or failure to act in a specific situation. The most common form of liability insurance covers the losses caused by a motorist who injures someone in a traffic accident. However, it can also cover losses caused by an accident which injures a visitor to the insured's home, apartment or business.
Professional liability insurance, of which medical malpractice liability insurance is the best known, also is written for attorneys, accountants, architects, engineers, insurance agents, weather forecasters and numerous others offering professional services. This type of liability insurance protects the insured against claims which arise from malpractice and errors of omission and commission.
Product liability insurance provides protection against claims arising from the consumption or use of articles manufactured, sold, handled or distributed by the insured.
Some types of liability insurance rates must be approved by the California Insurance Commissioner before they become effective. This is called "prior approval" ratemaking.
PROPERTY
Property insurance can provide coverage to protect against financial loss from fire, wind, flood, collision, theft and many other perils. Often a single policy will cover both property damage and liability, as in the case of homeowner's policies.
Property insurance is not required by law, but it often is required by a lender for property which is security for a loan. A bank or other financial institution may require collision insurance on a vehicle on which it lends money. A financial institution may require a person to have insurance on a home or business on which it lends money. Under state law, rates on homeowner's and other property insurance come under the "prior approval" ratemaking procedure.
EARTHQUAKE
Most property owners in California should be keenly interested in earthquake insurance. This form of insurance is currently required by California law to be offered to any individual who purchases homeowner's insurance. In 1996, the California Earthquake Authority (CEA) was formed by law to offer solely earthquake insurance. The CEA is a privately funded, publicly managed entity which provides earthquake coverage to residential property owners, condominium owners, mobile home owners and renters. It is funded by a voluntary assessment of participating insurance companies and by premiums paid by consumers who purchase earthquake policies from the CEA. In addition to the CEA, all non-participating CEA homeowners' insurance companies in California offer earthquake insurance. Also, there are several insurers who write earthquake insurance exclusively. Homeowners looking for earthquake insurance can contact a local insurance agent, broker or insurance company through the phone book or internet. Coverage against earthquakes can include payment for losses resulting from structural damage, damage to furnishings and damage to vehicles.
TITLE
Buyers of real property and/or lenders of mortgage money often hire lawyers to determine if the title to property is free and clear of encumbrance. If a purchaser or lender should later find the need to prove ownership, the legal battle may be long and costly, even if it is won. To protect against this, the purchaser or lender can buy title insurance.
Title insurance companies provide essential services to sellers and buyers of real estate, real estate developers and builders, mortgage lenders and real estate brokers. These services assist all of the parties in a real estate transaction by ensuring that the acquisition or transfer of their interests in the property can be effected with a maximum degree of efficiency, security and safety.
The nature of the services reflect the unique nature of real estate in our society. The purchase of residential real estate is usually the most expensive and long-term financial undertaking an individual or family ever makes. Most importantly, our system of law recognizes far more rights and interests in real estate (life estates, future interests, subsurface rights, rights-of-way, easements and liens, just to name a few) than it does in any other type of personal property, such as an automobile.
As a result of its unique attributes, those who have an interest in real estate - particularly the seller, the buyer and the mortgage lender -are properly concerned that their rights and interests in the property are clear at the time the property is purchased, that the transfer is effected expeditiously and correctly, and that their interests in the property are safe-guarded to the maximum extent possible. The services provided by title insurance companies are designed to further these goals.
LIFE
Life insurance may be the most familiar of all insurance products. In essence, a person pays a specified amount of money to an insurance company in return for the agreement of that company to pay a specified amount of money, upon his death, retirement or disability, to whomever the purchaser designates. The person designated to receive the proceeds of the policy is called the beneficiary. There are three principal types of life insurance: whole life, endowment and term.
Whole life insurance is a type of insurance contract under which the insured is covered for his entire life. It is designed to provide money after death regardless of when the insured dies, and accumulates cash values that are available as low interest loans during the life of the policy.
Endowment insurance is a type of contract under which the insurer promises to pay a stated amount of money to the beneficiary at once if the insured dies during the life of the policy or to the insured if the person lives past the endowment period. This type of policy is often described as a savings account protected by life insurance.
Term insurance is a life contract under which the insurer agrees to pay the face amount of the policy to a beneficiary if the insured dies within a period of time specified by the contract. Term insurance is suitable for insuring any need which is not of lifelong duration. It often covers the period of a mortgage, for example.
HEALTH
Health insurance is designed to pay the costs of hospital and medical expenses. In some cases, it is designed to pay the insured specified amounts due to loss of income caused by sickness or an accident. The first health insurance company was organized in this country in 1847. Early policies covered only the replacement of income lost from disability arising from a specific disease and did not provide protection for medical expenses. Throughout the years, the coverage was expanded and the number of policyholders grew. Now, nearly 90 percent of the civilian population of the nation is protected by some form of private health insurance.
Many insurers have broadened their coverage in recent years to include payments for nursing home care, mental illness, alcoholism, drug addiction, out-of-hospital drugs, vision care and dental care. Coverages vary from state to state. Health insurance policies today normally offer an array of benefits for total disability - expenses for hospital, surgical, medical and nursing care and waiver of premium for total disability.
The first accident insurance company in the United States was organized in 1850, apparently in response to the need created by frequent rail and steamboat accidents. Today accident insurance generally offers financial protection against: 1) loss of life; 2) dismemberment and loss of sight; 3) partial or total disability; 4) expenses of medical, surgical, hospital and nurses' care; and 5) loss of income resulting from an accident or sickness.
Individual policies are offered which cover one person and/or family. Group policies are written which cover all members of a group (for example: the employees of a business and their families). Policy forms for health and accident insurance are subject to approval by the insurance commissioner.
WORKERS' COMPENSATION
Workers' compensation insurance is required by law for nearly all employers. The total cost of the insurance is borne by the employer. If an employee dies from work-related injuries, the workers' compensation insurance provides payment to the beneficiary. If the employee is disabled, workers' compensation insurance replaces a portion of wages lost as a result of the disability. It also pays expenses for medical care and rehabilitation to return an injured employee to a useful life. Work-related accidents and injuries, as well as occupational diseases, are covered by this type of insurance.
One of the benefits of the workers' compensation system is the promotion of occupational safety through adjusting workers' compensation insurance rates to employers. If an employer's incidence of work injuries is reduced, the improvement is reflected in a reduction of that employer's compensation insurance costs. Thus, efforts by the employer to create a safer work environment can reduce his total costs of doing business. Conversely, an increase in an employee's incidence of work injuries produces an increase in the employer's rates.
Competition among companies determines rates for workers' compensation insurance in the state.
Back to Table of Contents
