Insurer types, admitted and domicile status, financial ratings, and distribution systems

Who stands behind the policy

Every policy is a promise, and the value of that promise depends on who makes it. Exams test four ways of classifying an insurer: how it is owned, where it is domiciled, whether it is admitted in the state, and how financially strong it is. Then they test the separate question of how it sells — its distribution system.

Insurer types by ownership

• Stock insurer. Owned by stockholders who supplied its capital. Profits can be paid to stockholders as dividends. Policies are typically nonparticipating: policyholders are customers, not owners, and do not share in profits.
• Mutual insurer. Owned by its policyholders. There are no stockholders, so surplus can be returned to policyholders as policy dividends. These policies are participating. A policy dividend is a return of excess premium, so it is not guaranteed and is generally not taxable income.
• Reciprocal insurer (reciprocal exchange). An unincorporated group of subscribers who insure one another, each taking on a share of the others' risks. It is run by an attorney-in-fact who has authority to bind the subscribers.
• Lloyd's associations. Individuals or syndicates, called underwriters or "names," who join together under a common name. Each accepts a share of a risk through an attorney-in-fact and is liable only for the share it agreed to take. Lloyd's of London is the best-known example. Lloyd's does not insure the risk itself: the members do.
• Fraternal benefit society. A nonprofit social, religious or service organization with a lodge system and a representative form of government. It sells life and health coverage only to its members.
• Risk retention group. A liability insurer owned by members in the same industry or profession, who pool their own liability risk.
• Government insurers. Programs that cover risks private insurers will not take on affordable terms, such as flood insurance, crop insurance and Social Security.

Memory hook: stock — stockholders own it. Mutual — policyholders own it. Reciprocal — subscribers insure each other through an attorney-in-fact.

Demutualization converts a mutual into a stock company. Mutualization converts a stock company into a mutual.

Domicile: where the insurer was formed

Domicile is about where the insurer is incorporated or organized, not where it does business. It is always judged from the viewpoint of the state you are standing in:

• Domestic insurer — organized under the laws of this state.
• Foreign insurer — organized under the laws of another U.S. state.
• Alien insurer — organized under the laws of another country.

An insurer chartered in Ohio is domestic in Ohio and foreign in every other state. A Swiss insurer is alien in every state.

Admitted or nonadmitted

Domicile and authority are separate questions.

• An admitted (authorized) insurer holds a certificate of authority, a license from the state's insurance regulator, to transact the lines named on it. A domestic, foreign or alien insurer can each be admitted.
• A nonadmitted (unauthorized) insurer holds no certificate of authority in that state. In general it may not solicit business there. It can reach residents lawfully through surplus lines (excess lines) brokers, for risks that admitted insurers will not write. Those placements usually do not have the protection of the state guaranty fund.

Doing an insurance business without the required license exposes the insurer to penalties.

Financial ratings

Independent rating services grade an insurer's financial strength and its ability to pay claims. They look at reserves, surplus (assets over liabilities), investments, operating results and management. The main raters are A.M. Best, Standard & Poor's, Moody's and Fitch, and each uses its own letter scale. In A.M. Best's scale, A++ and A+ are "superior." Ratings are opinions, not guarantees. A producer should place business with financially sound insurers and should never misrepresent an insurer's rating or financial condition.

Distribution (marketing) systems

How the insurer reaches the buyer:

• Independent agency system (American agency system). Independent agents represent several insurers. The agent, not the insurer, owns the expirations: the renewal records and the client list.
• Exclusive or captive agency system. Agents represent one insurer or its group, and the insurer owns the expirations. This includes the career agency system common in life insurance. In that system the company recruits, trains and supervises agents, often through general agents or branch managers.
• Direct writing / direct response. The insurer sells through its own salaried employees, or directly by mail, phone or the internet with no agent.
• Managing general agent (MGA). A wholesale intermediary that the insurer authorizes to appoint and supervise agents in a territory, and sometimes to underwrite.
• Brokers represent the buyer, not the insurer.