ANSWERS TO THE QUESTIONS IN THE COURSE GUIDE. Insurance Operations CPCU nd Edition TABLE OF CONTENTS. Assignment Title Page

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1 ANSWERS TO THE QUESTIONS IN THE COURSE GUIDE Insurance Operations CPCU nd Edition TABLE OF CONTENTS Assignment Title Page 1 Overview of Insurance Operations 7 2 Insurance Regulation 26 3 Insurance Marketing and Distribution 48 4 The Underwriting Function 70 5 Risk Control and Premium Auditing 97 6 The Claim Function Actuarial Operations Reinsurance Principles and Concepts Business Needs and Information 203 Technology Alignment 10 Insurer Strategic Management 223 Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH FAX customerservice@keirsuccess.com Keir Educational Resources 1

2 Assignment 1 Overview of Insurance Operations Educational Objective 1 Property and casualty insurers are classified by their: (1) Legal form of ownership, (2) Place of incorporation, (3) Licensing status, and (4) Distribution Systems and channels (1) Legal Form of Ownership There are three legal forms of ownership; proprietary insurers, cooperative insurers, and other types. Proprietary insurers are formed for the profit of their owners. Cooperative insurers exist for the benefit of the members (policyholders) and are nonprofit organizations. Other types of insurers include pooled arrangements and governmental insurers. Proprietary Insurers: Proprietary insurers consist of stock insurance companies, Lloyd s associations, and insurance exchanges. Stock insurance companies: A board of directors, elected by the stockholders, governs the company. Similar in many ways to other publicly held companies, these insurers are subject to a variety of state regulations concerning operations, reserve funds, assets and investments. Stock insurance companies control the majority of the property and casualty market. Lloyd s associations, which are groups of individual insurance companies, control a very small portion of the property and casualty market. There are two types of Lloyd s associations: Lloyd s of London and American Lloyds. Lloyd s of London is a marketplace for insurance underwriting by syndicate and is licensed in only two states, Illinois 2016 Keir Educational Resources 2 and Kentucky. These insurance syndicates often underwrite unusual loss exposures. American Lloyds are found primarily in Texas and underwrite fire and auto insurance. Each member of the association receives a proportionate share of the premium for incurring their share of loss exposure. Insurance exchange: an example of an insurance exchange is the Insurance Exchange of Illinois. Formed in 1979, this exchange exists for underwriting excess and surplus lines of insurance. Member syndicates operate as separate businesses focusing on special types of exposures. Cooperative insurers: The two main types of cooperative insurers are mutual insurance companies and reciprocal exchanges. Mutual insurance companies are nonprofit organizations that exist to provide low cost insurance to their members. Every policyholder is a member of the company and shares in the company s success via dividends. The members elect a governing board of directors to handle the daily operations. There is an increasing trend toward the demutualization, that is, the conversion from a mutual insurer to a stock insurer. Fraternal organizations operate similarly to mutual insurers, and combine a social function (such as a lodge or brotherhood) as part of their overall operation. Reciprocal exchanges are nonprofit organizations that are managed by an attorneyin-fact instead of a board of directors. Each member (policyholder) of the reciprocal exchange is an insurer that assumes personal liability for the insurance that is underwritten.

3 Other insurers: not otherwise classified are pools and government insurers. An insurance pool is a group of insurers that join to insure unusual loss exposures. These pure risks often involve the potential for loss too large for an individual insurer to bear, either in terms of frequency or severity (catastrophic losses). It can also take the form of a reinsurance pool, where one insurer issues the policy and the other participants reinsure shares of the risk. Some statutorily-required pools involve high-risk drivers, workers compensation, and high risk property (FAIR plans). Governmental insurers can be either state or federal programs. Examples include the FDIC, National Flood Insurance Program (NFIP) and state workers compensation programs. Already described under pooling above are the statutorilyrequired mechanisms for high-risk drivers (residual market), workers compensation, and FAIR plans. incorporation. (2) Place of Incorporation Companies are also categorized by their place of A domestic insurer is one incorporated in the state in which it operates. (For example, a Pennsylvania company operating in Pennsylvania.) A foreign insurer is domiciled in a state other than the one in which it operates. (An example is a company incorporated in Delaware and operating in Pennsylvania). An alien company is formed outside the U.S. but operates in the U.S. (An example is a UK company operating in Pennsylvania.) (3) Licensing Status Companies are also classified by their licensing status. Admitted insurers are granted a license to operate in a state. Non-admitted (unlicensed) insurers have no license to operate in a given state. Producers of primary insurance are permitted to place 2016 Keir Educational Resources 3 business only with admitted insurers. Surplus lines brokers operate differently see Key Words and Phrases for surplus lines broker. today are: (4) Distribution Systems and channels The primary distribution systems used by insurers Independent agency/brokerage marketing system Direct writer marketing system Exclusive agency marketing system Insurers can use one or more of these systems. Please see Key Words and Phrases for each system. Key Words and Phrases 1. Proprietary insurers are organized to earn a profit for their owners. 2. Mutual insurer an insurer which is owned by the policyholders it covers, and which is formed as a corporation to provide insurance to its members. 3. Reciprocal insurance exchange (interinsurance exchange) is a group of members (also called subscribers) who enter into a contract where they agree to insure each other. An attorney-in-fact handles the management duties. Subscribers share profits and losses in proportion to the amount of coverage purchased by each. 4. Fair Access to Insurance Requirement (FAIR) plans are pools which are formed by private insurers to meet the insurance needs of those who own property in urban areas of high risk. 5. Residual market is a term given to insurers and other organizations which, through a shared risk arrangement, provide coverage for exposures usually not placeable in the mainstream private insurance market. 6. Surplus lines broker is a producer who places coverage with an insurer which is not licensed in the state where the business takes

4 place. This situation is allowed when such insurance is not available in the standard market. 7. Independent agency and brokerage marketing system. Independent agents and brokers are not employees of the insurer, but independent contractors. Agents and brokers may represent multiple insurance companies. 8. The direct writer marketing system uses agents or sales representatives that work directly for the insurer. 9. The exclusive agency marketing system is a system in which agents may represent only one insurer or group of insurers. 10. Distribution channel is the method used to sell, deliver and service a product to the end user. Review Questions 1-1. Property-casualty insurers are classified by: (1) legal form of ownership, (2) place of incorporation, (3) licensing status, and (4) distribution system or channel. members. The members (also called subscribers) enter into a contract where they agree to insure each other. An attorney-in-fact handles the management duties. Subscribers share profits and losses in proportion to the amount of coverage purchased by each A domestic insurer is an insurer which was incorporated in the state in which it does business, or is at least formed in accordance with that state s laws. The insurer is said to be domiciled in that state States issue to insurers a license enabling them to provide coverage within that state. To obtain a license, an insurer must establish that it meets various minimum requirements for financial strength, competence, and integrity The primary distribution systems insurers use are still the independent agency system, the direct writer system, and the exclusive agency system (see Key Words and Phrases above). The five alternative distribution channels insurance companies use are the internet, call centers, direct response, group marketing, and financial institutions Stock insurers are proprietary companies that are owned by their stockholders, managed by a board of directors and exist to make a profit for the stockholders. Mutual insurers are cooperative companies which are organized for the benefit of their members (policyholders). Their objective is to provide insurance for their policyholders at a low cost. Mutual insurance companies are owned by their policyholders (a) The Lloyds organizations exist as business frameworks where members (investors) can come to provide insurance for certain types of risks and hope for a profit. Such investors or groups of them (syndicates) provide coverage for unusual, large, or difficult situations such as ocean marine or aviation risks. (b) Reciprocal Exchanges also known as inter-insurance exchanges, are unincorporated associations, owned by their 2016 Keir Educational Resources 4

5 MULTIPLE CHOICE QUESTIONS WORKBOOK TABLE OF CONTENTS Assignment Title Que Ans Insurance Operations CPCU nd Edition Overview of Insurance 7 94 Operations 2 Insurance Regulation Insurance Marketing and Distribution 4 The Underwriting Function Risk Control and Premium Auditing 6 The Claim Function Actuarial Operations Reinsurance Principles and Concepts 9 Business Needs and Information Technology Alignment Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH FAX customerservice@keirsuccess.com 10 Insurer Strategic Management Keir Educational Resources 5

6 Assignment 1 Overview of Insurance Operations 1. Property/Casualty insurers in the United States can generally be classified in all of the following ways, EXCEPT: (TEXT 1.3) (A) Place of incorporation (B) Marketing systems used (C) Licensing status (D) Number of years in operation 2. All of the following are proprietary insurers, EXCEPT: (TEXT ) (A) Insurance exchanges (B) Lloyds of London (C) Mutual insurance companies (D) Stock insurance companies 3. A gathering of investors (individuals or corporations) who wish to make a profit from providing insurance which they back with their own assets is an example of: (TEXT 1.5) (A) An insurance pool (B) A governmental insurance plan (C) An insurance exchange (D) A Lloyds marketplace 4. Which statement is true of mutual insurers? (TEXT ) (A) No dividends are paid to policyholders. (B) The policyholders are the owners of the company. (C) Operating profit is not a concern because the main purpose of the organization is to provide insurance for its members/policyholders. (D) A mutual is a type of stock insurer. 5. All of the following are cooperative insurers, EXCEPT: (TEXT ) (A) Captives (B) Self-Insurers (C) Reciprocal Exchanges (D) Risk Retention Groups 6. For which reasons would a company or group of companies form a captive insurer? (TEXT ) (A) Lower cost of obtaining coverage (B) Obtaining coverage for exposures the traditional market will not cover (C) The company wants the benefit of more control over the entire insurance process (D) All of the above 7. A pooling arrangement where all of the property insurers in a state pool to provide property insurance for high-risk urban area properties is called: (TEXT 1.7) (A) A JUA (Joint Underwriting Authority) (B) A windstorm pool (C) A FAIR plan (Fair Access to Insurance Requirements) (D) None of the above 2016 Keir Educational Resources 6

7 Assignment 1 Overview of Insurance Operations 1. D is the answer. Property/Casualty insurers in the United States are classified in four ways: (a) place of incorporation; (b) marketing systems used; (c) licensing status; and (d) legal form of ownership. sometimes that remains to be seen in how effectively the captive operates. 7. C is the answer. Windstorm pools are for coastal areas where the windstorm peril causes difficulty to obtain coverage in the standard market. JUAs are usually for auto liability. 2. C is the answer. A mutual insurance company is not a proprietary insurer. Proprietary insurers (or owned insurers) have been formed to earn profit for their owners. Stock insurance companies, Lloyds, and insurance exchanges are all types of proprietary insurers. Cooperative ownership includes mutual insurance companies, reciprocal exchanges, and fraternal organizations. 3. D is the answer. Lloyds is a unique mechanism, and is not itself an insurer. It provides the physical and procedural facilities for its members (investors) to write insurance. 4. B is the answer. Dividends and profit sharing are paid to policyholders, operating profit is desired both to increase surplus and contribute to the financial health of the operation, and a mutual is a type of cooperative insurer, and does not issue stock. 5. B is the answer. Self-insurers provide insurance only for themselves when they choose to retain a part or all of their own loss exposures. There are no other members. Cooperative insurers are owned by their policyholders and are usually formed to provide insurance at a minimum cost. Captives, risk retention groups, and reciprocal exchanges (or interinsurance exchanges) are all cooperative insurers. 6. D is the answer. The formation of a captive brings each of these benefits to its owners. Lower cost of coverage is a goal and 2016 Keir Educational Resources 7