CLIFF NOTES

PREPARING PEOPLE TO PASS

 Basic Principles of Life and Health Insurance and Annuities

➢ TYPES OF INSURANCE COMPANIES

Commercial Insurers (also known as private insurance companies) are in the business of selling insurance for a
profit. Commercial insurers offer many lines of insurance. Some sell primarily life insurance and annuities, while
other sell accident and health insurance, or property and casualty insurance. An insurance company selling more
than one line of insurance is known as a Multi-line insurer. Commercial insurance is divided into two main groups:
stock and mutual insurers.

Stock Companies are organized and incorporated under state laws for the purpose of making a profit for its
stockholders (shareholders). Traditionally, stock insurers are called nonparticipating insurers because
policyholders do not participate in receiving dividends or electing the board of directors, unless they are also a
stockholder of the company. When declared, stock dividends are paid to stockholders. In a stock company, the
directors and officers are responsible to the stockholders. Transformation of a stock insurer into a mutual insurer
is termed mutualization, and the reverse is termed demutualization. Dividends from a stock insurer subject to
taxation because they are considered profit.

Mutual Companies are owned by their policyholders. Mutual insurers are known as Participating Insurers
because policyholders PARTICIPATE in receiving dividends and electing the board of directors. When declared,
mutual company dividends are paid to the policyholders. Dividends from a mutual insurer are not subject to
taxation because the dividends are considered to be a return of premium. The only exception is if the policyowner
chooses to let the dividends sit and collect interest. In this case, only the accumulated interest would be taxable.

If a company operates as both a PARTICIPATING and NONPARTICIPATING insurer they are known as a MIXED
insurer. DIVIDENDS can NEVER be guaranteed regardless of the type of company offering them.

Strong Assessment Mutual Companies are classified by the way the charge premium.

1. A pure assessment mutual company, operates based on loss-sharing by group members. No premium is
payable in advance. Instead, each member is assessed an individual portion of losses that occur.
2. An advance premium assessment mutual, charges a premium at the beginning of the policy period. If the
original premiums exceed the operating expenses and losses, the surplus is returned to the policyholders as
dividends. However, if total premiums are not enough to meet losses, additional assessments are levied
against the members. Normally, the amount of assessment that may be levied is limited either by state law or
simply as a provision in the insurer’s by-laws.

Fraternal benefit societies are special types of mutual companies, nonprofit religious, ethnic or charitable
organizations that provide insurance solely to their members. Fraternal must be formed for reasons other than
obtaining insurance. An example of fraternal societies is Knights of Columbus.

Risk retention groups are mutual companies formed by a group of people in the same industry or profession.
Examples would be pharmacists, dentists, and engineers.
 Service Providers offer benefits to subscribers in return for the payment of a premium. These services are
packaged into various plans, and those who purchase the plans are known as subscribers. Examples of service
providers are Health Maintenance Organizations (HMO) and Preferred Provider Organizations (PPO).

Reciprocal insurers are unincorporated groups of individual members that provide insurance for other members
through indemnity contracts. Each member acts as both insurer and insured and are managed by Attorney in
Fact.

Reinsurers make arrangements with other insurance companies to transfer a portion of their risk to the reinsurer.
The company transferring the risk is called the Ceding Company and the company assuming the risk is the
Reinsurer.

• In a reinsurance agreement, the insurance company that transfers its loss exposure to another insurer is called
the primary insurer

Captive Insurer is an insurer established and owned by the parent company to insure the parent company’s loss
exposure.

Home Service Insurers (also known as industrial insurance), is sold by home service or debit life insurance
companies. Face amounts are small; usually $1,000 to $2,000 and premiums are paid weekly.

Government Insurance: Federal and state government are also insurers. They provide social insurance programs,
to protect against universal risks by redistributing income to help people who cannot afford the cost of incurring
such losses themselves. These programs have far reaching effects and millions of people depend on them. Types
of Government Insurance include:

• Social Security (Old Age Survivor Disability Insurance OASDI – Provides income benefits for the elderly
(retirement), survivors of those who died young (young child of a deceased parent), and those qualifying for
federal disability.
• Medicare - Health insurance to CARE for the elderly
• Medicaid - Health insurance to AID the financially needy.
• S.G.L.I. and V.G.L.I (Serviceman’s or Veteran’s Group Life Insurance: life insurance for active and retired
members of the military)
• Tri-Care (health insurance for members of the military and their family)

Self-Insurers retain risks and must have a large number of similar risks and enough capital to pay claims. However,
they may save money if the loss experience is lower than the expected costs. Self-insurers are not a method of
transferring risk, rather self-insurers establish their own self-funded plan to cover potential losses. A Self-funded
plan is a plan in which an employer pays insurance benefits from a fund derived from the employer’s current
revenues

Lloyd’s of London is not an insurance company. Members of the association form syndicates to underwrite and
issue insurance- like coverage. This is a group of investors who share in unusual risk.

➢ HOW INSURANCE IS SOLD

Distribution Systems are the ways insurance products are marketed and sold to the public. Insurance can be
purchased through licensed insurance producers, who are either agents or brokers, or through a number of other
ways. Agents are either captive/career agents or independent agents. Captive agents work for only one insurer.
Independent agents work for themselves or for several insurers non- exclusively.
 Career Agency System: With the career agency system commercial insurers establish offices in certain locations.
Career agents are recruited to work at these locations. A general agent hires and trains new producers and
supervises a number of other producers. All producers under the career agency system are captive agents and
employees of the insurer.

Personal Producing General Agency System: With the personal producing general agency (PPGA) system, agents
work for an independent agency selling policies from several insurance companies. Unlike the career agency
system, agents are not employees of the insurance company. Instead, they work for the PPGA. Furthermore,
personal producing general agents primarily sell insurance, instead of recruiting and training new agents as in the
career agency system.

Independent Agency System (American Agency System): Independent agents represent a number of insurance
companies under separate contractual agreements. They may also work for themselves or under other insurance
agents. Independent insurance agents have control and ownership over their clients’ accounts. This means they
may place clients’ business with a different insurer when policies are up for renewal. Independent insurance
agents earn commissions on the sales they make and overrides on sales made by agents they manage.

Managerial System: With the managerial system, branch offices are established in several locations.
Instead of a general agent running the agency, a salaried branch manager is employed by the insurer. The branch
manager supervises agents working out of that branch office. The insurer pays the branch manager’s salary and
pays him a bonus based on the amount and type of insurance sold and number of new agents hired.

Mass Marketing: Another way to sell insurance is through mass marketing methods. Direct selling (or direct mail)
is a mass marketing method where agents are not used. Instead, policies are marketed and sold through television
and radio advertisements, print sources found in newspapers and magazines, by mail, in vending machines, and
over the internet.

➢ INDUSTRY OVERSIGHT AND REGULATION

The insurance industry is primarily regulated on a state-by-state basis with minimal federal oversight. The primary
purpose of this regulation is to promote public welfare and provide consumer protection and ensure fair trade
practices, contracts and prices. Key historical events that have shaped the current regulation include:

• 1869 Paul v. Virginia: the U.S. Supreme Court ruled that insurance transactions crossing state lines are not
interstate commerce.

• 1905 The Armstrong Investigation Act gave the authority to the states to regulate insurance.

• 1944 United States v. South-Eastern Underwriters Association ruled that insurance transactions crossing
state lines are interstate commerce and are subject to federal regulation. Thus, many federal laws were
conflicting with existing state laws. However, this decision did not affect the power of states to regulate
insurance.

• 1945 The McCarran Ferguson Act states that while the federal government has authority to regulate the
insurance industry, it would not exercise its right if the insurance industry was regulated effectively and
adequately on the state level. Under the McCarran-Ferguson Act, the minimum penalty of a producer who
 has obtained personal information about a client without having a legitimate reason to do so is a fine of
$10,000.

• 1970 Fair Credit Reporting Act: provides individuals privacy protection and fair and accurate credit reporting.
Insurance companies are required to notify applicants if a credit check will be made on them. Under the Fair
Credit Reporting Act, the maximum penalty of a producer who has obtained Consumer Information Reports
under false pretenses is a fine of $5,000.

• 1999 Gramm-Leach-Bliley Act (Financial Services Modernization Act): This law repealed the Glass-Steagall
Act; this allows Banks, Retail Brokerages and Insurance companies to enter each other’s line of business.

• 2001 USA PATRIOT ACT (Uniting and Strengthening America by Providing Appropriate Tools Required
to Intercept and Obstruct Terrorism Act): as it relates to the insurance industry, is designed to detect and
deter terrorists and their funding by imposing anti-money laundering requirements on brokerage firms and
financial institutions.

• 2003 National Do Not Call Registry: Insurance calls are not exempt from the no not call registry.

• 2010 Patient Protection and Affordable Care Act (PPACA): often shortened to the Affordable Care Act (ACA),
represents one of the most significant regulatory overhauls and expansions of coverage in U.S. history.

The National Association of Insurance Commissioners (NAIC) is an organization composed of insurance

commissioners from all 50 states, the District of Columbia and the 4 US territories. They are responsible for
recommending appropriate laws and regulations. They are responsible for the creation of the Advertising Code
and the Unfair Trade Practices Act, and the Medicare Supplement Insurance Minimum Standards Model Act. The
NAIC has four broad objectives:

1. To encourage uniformity in state insurance laws and regulations

2. To assist in the administration of those laws and regulations by promoting efficiency
3. To protect the interest of policyowners and consumers
4. To preserve state regulation of the insurance business

Advertising Code: the code specifies certain words and phrases that are considered misleading and are not to be
used in advertising of any kind.

Unfair Trade Practices Act: gives chief financial officer the power to investigate insurance companies and
producers to impose penalties. In addition to that, the act gives officers the authority to seek a court injunction
to restrain insurers from using any methods believed to be unfair.

NAIFA (National Association of Insurance and Financial Advisors) and NAHU (National Association of Health
Underwriters): Members of these organizations are life and health agents dedicated to supporting the industry
and advancing the quality of service provided by insurance professionals. These organizations created a Code of
Ethics detailing the expectations of agents in their duties toward clients.
To sell insurance, each state requires high level of professionalism and ethics. Some of these standards and ethics
are:

• Selling to needs: agents must first determine the consumers’ needs then determine which policy fits their
needs best.
• Suitability of recommended products: an ethical agent must be able to assess the correlation between a
recommended product and the consumer’s needs.
• Full and accurate disclosure: an ethical agent must inform consumers of the benefits and limitations of
recommended products. Recommendations must be accurate, complete and clear.
• Documentation: an ethical agent must document each client’s meeting and transaction.
• Client Services: an ethical agent must know that a sale does not mark the end of the relationship, but rather
the beginning of the relationship. Therefore, routine follow-up calls are recommended.
• Buyer’s Guide: each state requires agents to deliver a buyer’s guide to consumers that explain various types
of life insurance products and other information on the recommended policy, such as premiums, dividends,
and benefit amounts.
• Policy Summary: help consumers evaluate the suitability of the recommended product.

Reserves: are the accounting measurement of an insurer’s future obligations to its policyholders. They are
classified as liabilities on the insurance company’s accounting statements since they must be settled at a future
date. Reserves are set aside by an insurance company and designated for the payment of future claims.

Liquidity: An insurer’s ability to make unpredictable payouts to policyowners

Guaranty Associations are established by all states to support insurers and protect consumers in case an insurer
becomes insolvent. State life and health guaranty associations provide a safety net for all member life, health and
annuities insurers in a particular state. Guaranty associations protect insureds in the event of insurer insolvency,
or inability to pay claims up to a certain limit.

Independent Rating Services are credit rating agencies that rate or “grade” the financial strength and stability of
insurers based on claims, reserves, and company profits. The nationally recognized statistical rating organizations
that rate insurers are A. M. Best, Moody’s, Standard and Poor’s, and Fitch Ratings. Each rating service has its
own rating system, but most use an A to F letter grading scheme.