Introduction to General Insurance

Learn Today. Lead Tomorrow.

ACTEX Learning

ACTEX Study Manual for

Introduction to

General Insurance

Summer 2015, Second Printing

Max Chuanlong Tang, ASA, MAAA, Ph.D.

ACTEX Learning

New Hartford, Connecticut

ACTEX Study Manual for

Introduction to

General Insurance

Summer 2015, Second Printing

Max Chuanlong Tang, ASA, MAAA, Ph.D.

ISBN: 978-1-63588-500-2

Printed in the United States of America.

No portion of this ACTEX Study Manual may be

reproduced or transmitted in any part or by any means

without the permission of the publisher.

Actuarial & Financial Risk Resource Materials

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Learn Today. Lead Tomorrow.

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ACTEX Introduction to General Insurance Study Manual, Summer 2015, Second Printing

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INTRODUCTION TO GENERAL INSURANCE

XAM STUDY MANUAL

Table of Contents

Text 1 – Insurance Operations

Assignment 1: Overview of Insurance Operations ....................................................................................... 1

Assignment 2: Insurance Regulation .......................................................................................................... 11

Assignment 3: Insurance Marketing Distribution ....................................................................................... 21

Assignment 4: The Underwriting Function ................................................................................................ 31

Assignment 5: Underwriting Property and Liability Insurance .................................................................. 3 9

Assignment 6: Risk Control and Premium Auditing .................................................................................. 49

Assignment 7: The Claim Function ............................................................................................................ 57

Assignment 8: Adjusting Property and Liability Claims ............................................................................ 67

Assignment 10: Reinsurance ....................................................................................................................... 83

Text 2 – Survey of Personal Insurance and Financial Planning

Assignment 2: Automoble Insurance and Society ...................................................................................... 93

Assignment 3: Personal Auto Policy – Liability, Med Pay, and UM Coverage ....................................... 101

Assignment 4: PAP: Physical Damage, Duties After Accidents, Endorsements ...................................... 111

Assignment 5: Homeowners Property Coverage ...................................................................................... 119

Assignment 6: Homeowners Liability, Conditions, Coverage Forms and Endorsements ....................... 129

Assignment 7: Other Residential Insurance .............................................................................................. 137

Text 3 – Survey of Commercial Insurance

Assignment 1: Commercial Property Insurance, Part I ............................................................................. 147

Assignment 2: Commercial Property Insurance, Part II ........................................................................... 157

Assignment 6Commercial General Liability Insurance, Part I ................................................................ 165

Assignment 7: Commercial General Liability Insurance, Part II .............................................................. 173

Assignment 9: Workers Compensation and Employers Liability Insurance ............................................ 181

Assignment 11: Specialty Coverages ........................................................................................................ 191

NOTES:

Past exam questions and answers have been taken from SOA’s Introduction to General Insurance Exam

(GIINT – February 2014), which are identified with “(SOA GIINT February 2014)” in the manual. The

past exam questions and answers are copyrighted by the Society of Actuaries and are reproduced in this

study manual with the permission of the SOA solely for the purpose of assisting students studying for the

actuarial exams. I am very grateful to the SOA for its permission to use this material. The SOA, however,

is in no way responsible for the structure or accuracy of the manual.

There are two accepted editions for the textbook of Insurance Operations), and the assignment number for

“Reinsurance” is different in the two editions. The study manual is based on the first edition of 2010,

where Assignment 10 is for “Reinsurance”. For candidates who use the Special SOA edition of 2015,

please note that reinsurance is discussed in Assignment 9.

The past exam questions have been attached to the assignment on which the questions are most likely

based. Note that some exam questions may make use of materials from multiple assignments of the

textbooks.

Questions without identification of “(SOA GIINT February 2014)” are original questions based on the

required study materials. Although I have made a conscientious effort to eliminate mistakes in questions

and answers, errors may exist. I encourage students who find errors to bring them to my attention. Any

other feedback is also very welcome.

I would like to thank Julia Zuo and Tony Tang for their editorial work on this manual. I would also like to

thank Stephen Camilli, FSA and Vice President of ACTEX Publications, for his insightful comments.

Max C. Tang

May 1, 2015

Insurance Operations Assignment 1: Overview of Insurance Operations  1

Text 1 – Insurance Operations

ASSIGNMENT 1

OVERVIEW OF INSURANCE OPERATIONS

I. CLASSIFICATIONS OF INSURERS

A. Introduction

1. Insurance – system where participants (e.g. individuals, families, businesses), make payments

in exchange for commitment to reimburse specific types of losses in certain circumstances

2. Insured – participants in system who benefit from reimbursement of covered losses

3. Insurer – organization or entity that facilitates pooling funds and paying benefits

a. The principal function of insurers: acceptance of risks that others transfer through

insurance

b. Core operations: 1) underwriting, 2) claims, and 3) marketing

B. Four Ways of Classifications of Property-Casualty Insurers

1. Legal form of ownership

2. Place of incorporation

3. Licensing status

4. Insurance distribution systems and channels

C. Classification Summary

1. Legal form of ownership

a. Proprietary

i. Stock insurers

ii. Lloyd’s of London and American Lloyds

iii. Insurance exchange

b. Cooperative

i. Mutual insurers

ii. Reciprocal insurance exchanges

iii. Fraternal organizations

iv. Other cooperatives – captive insurers, risk retention groups, purchasing groups

c. Other

i. Pools

ii. Government insurers

2. Place of incorporation

a. Domestic

Foreign

c. Alien

3. Licensing status

a. Admitted

b. Nonadmitted

4. Insurance distribution systems and channels

a. Independent agency and brokerage marketing system

b. Direct write marketing system

c. Exclusive agency marketing system

D. Legal Form of Ownership

1. Proprietary insurers

a. Stock insurers – Owned by their stockholders, most prevalent type of propriety insurer in

2  Assignment 1: Overview of Insurance Operations Insurance Operations

b. Lloyds associations – Lloyd’s of London and American Lloyds

i. Lloyd’s of London is a marketplace, similar to stock exchange

ii. Provides the physical and procedural facilities for members to write insurance

iii. In the past, insurance each member wrote was backed by his/her personal fortune;

now, more members are corporations and have only limited liabilities

iv. Provides coverage for many unusual or difficulties loss exposure and underwrites

much of global marine and aviation insurance

v. American Lloyds associations are smaller and most are domiciled in Texas because

of the favorable regulatory climate

vi. Most were formed or have been acquired by insurers.

vii. Members (underwriters) are not liable beyond their investment in the association

c. Insurance exchange – similar to Lloyds associations. Members can be individuals,

partnerships, or corporations, and have limited liability

2. Cooperative Insurers – owned by policyholders and includes mutual insurers, reciprocal

insurance exchanges, fraternal organization, and other cooperatives.

a. Mutual insurer – an insurer that is owned by its policyholders and is formed as a

corporation for the purpose of providing insurance to policyholders.

i. Policyholders have voting rights

ii. Some profit is retained to increase surplus

iii. Excess profit is usually returned to policyholders

iv. Includes some large national/regional insurers

b. Reciprocal insurance exchange – an insurer owned by policyholders and is formed as an

unincorporated association for the purpose of providing insurance coverage to its

members (called subscribers), and managed by an attorney-in-fact.

i. Members agree to mutually insure each other

ii. Members share profits/losses in proportion of their purchased insurance

iii. May be formed to receive favorable tax treatment

c. Fraternal organizations resemble mutual companies, but they combine a lodge or social

function with their insurance function. They write primarily in life and health insurance.

d. Other cooperative insurers include captive insurers, risk retention groups, and purchasing

groups

i. Captive insurer – a subsidiary company formed by a business organization or a group

of affiliated organizations to provide all or part of its insurance

a) “Formalized self-insurance”

b) May also be formed to cover losses that other insurers will not cover at any price

c) Some states encourage the formation and operation of captive insurers, while

others do not permit the formation of captive insurers

ii. Risk retention groups and purchasing groups usually organized so that a limited

group or type of insured is eligible to purchase insurance from them

a) Can be formed as stock companies, mutual, or reciprocal exchanges

b) Becoming more significant in the evolving insurance market place

3. Other insurers include pools and government insurers

a. Pools – A pool consists of several insurers, not otherwise related, that join together to

insure lose exposures that individual insurers are not willing to insure: losses that occur

too frequently or are too severe (e.g. airplane crashes or nuclear meltdowns)

i. Pools formed voluntarily or to meet statutory requirements

ii. Pools operate either

a) As syndicate – Insured has contractual relationship with pool members and can

sue any or all of them directly

b) Through reinsurance – Insured has a contractual relationship only with the

member that issued the policy. Policyholder has no legal rights against the other

members of the pool and may not even know that they exist

iii. Many pools are required by law

a) Virtually all states require some kind of pooling arrangement to provide auto

Insurance Operations Assignment 1: Overview of Insurance Operations  3

liability insurance for drivers who cannot obtain insurance in the standard market

b) Fair Access to Insurance Requirements (FAIR) plans – an insurance pool through

which private insurers collectively address an unmet need for property insurance

on urban properties (in more than half the states)

c) Windstorm coverage in southeastern states

b. Federal government offered insurance

i. National Flood Insurance Program (NFIP)

ii. Terrorism Risk Insurance Act

iii. All states offer some forms of government insurance (e.g. workers’ compensation

insurance)

E. Place of Incorporation

1. A domestic insurer is incorporated within a specific state or, if not incorporated, is formed

under the laws of that state – insurance is regulated at the state level

a. Reciprocal insurance exchanges are the only unincorporated insurers permitted in most

states

b. Insurance exchanges and Lloyd’s organizations are permitted under law in only a few

states

2. A foreign insurer is a domestic insurer licensed to do business in states other than its

domiciled state

3. Alien insurers are incorporated or formed in another country

F. Licensing Status

1. A licensed insurer (admitted insurer) – an insurer that has been granted a license to operate in

a particular state

2. An unlicensed insurer (nonadmitted insurer) – has not been granted a license to operate in a

given state

3. Surplus lines broker is a person or firm that places business with insurers not licensed

(nonadmitted) in the state in which the transaction occurs but that is permitted to write

insurance because coverage is not available through standard market insurers

4. Producers for primary insurance (except for surplus lines brokers) are licensed to place

business only with admitted insurers

5. License status is also important for reinsurance

G. Insurance Distribution Systems and Channels

1. Independent agency and brokerage marketing system – an insurance marketing system where

producers (agents or brokers), who are independent contractors, sell insurance, usually as

representatives of several unrelated insurers

2. Direct writer marketing system – an insurance marketing system that uses sales agents (or

sales representatives) who are direct employees of the insurer

3. Exclusive agency marketing system – an insurance marketing system under which agents

contract to sell insurance exclusively for one insurer (or an associated group of insurers).

4. Distribution channel –The channel used by the producer of a product or service to transfer

that product or service to the ultimate customer

II. INSURANCE GOALS

A. Earn Profit

1. Profit goal is most commonly associated with proprietary, or for-profit, insurers

2. Not primary goal for cooperative insurers, but they should also earn a profit

B. Meet Customer Needs

1. Provide products and services customers seek at competitive prices

2. Prompt services

4  Assignment 1: Overview of Insurance Operations Insurance Operations

3. Quick and professional assistance

4. May conflict with profit goal

C. Comply with Legal Requirements – One of an insurer’s greatest responsibilities is compliance

with state regulations

D. Diversify Risk

1. Emerging goal for property-casualty insurers.

2. Meeting this goal complements the insurer’s goal of earning a profit and fulfilling its duty to

society

E. Fulfill Duty to Society – all corporations are obligated to promote the well being of society

III. CONSTRAINTS ON ACHIEVING INSURER GOALS

A. Internal Constraints

1. Efficiency – Inefficiency might prevent insurers from meeting their profit and service goal,

which can lead to the inability to meet societal goal

2. Expertise – Lack of expertise could prevent an insurer from making a profit or meeting

customers’ needs, or it could eventually cause the insurer to fail to attain any of its goals.

3. Size – a small insurer, that may be able to respond more quickly to an emerging trend, has

more challenges than a large insurer in terms of available resources

4. Financial resources – When financial resources become strained, insurers are unable to

effectively train staff, make new capital investments, or reach new markets

5. Other internal constraints – lack of name or brand recognition or a damaged reputation

B. External Constraints

1. Regulation

2. Rating agencies

3. Public opinion

4. Competition

5. Economic condition

6. Insurance marketing and distribution

7. Other external constraints

IV. MEASURING INSURANCE PERFORMANCE

A. Meeting Profitability Goals

1. Premiums and investment income

a. Premium growth – not always a positive indicator of an insurer’s success; should

consider whether growth resulted from a competitive advantage, relaxed underwriting,

inadequate insurance rates, or a combination of these factors

b. Rate of premium growth over time – helps determine insurer profitability

2. Underwriting performance

a. Net underwriting gain or loss = earned premium – (incurred losses + underwriting

expenses)

b. Three ratios are used to measure an insurer’s underwriting performance:

i. Loss ratio = incurred losses / earned premium

ii. Expense ratio = incurred underwriting expenses / written premium

iii. Combined ratio (trade basis) = Loss ratio + Expense ratio

Insurance Operations Assignment 1: Overview of Insurance Operations  5

3. Overall operating performance –Net underwriting gain or loss plus net investment gain or

loss for specific period

a. Investment income ratio = net investment income / earned premiums

b. Overall operating ratio = combined ratio (trade basis) – investment income ratio

c. Return on equity = net income / owners’ equity

d. It is important to analyze the gain or loss from operations for several years.

4. Estimation of loss reserves

a. Loss reserves are generally the largest liability in the insurer’s balance sheet and can have

a significant effect on the insurer’s overall profitability

b. One of the biggest problems in measuring insurer profitability arises from errors in

estimating loss reserves

B. Meeting Customer Needs

1. Complaints and praise

2. Customer satisfaction data

a. Retention ratio – the percentage of expiring insurance policies that an insurer renews; can

be measured by policy count, premium volume, or both.

b. Lapse ratio

i. Calculated by dividing the number of policies that lapse during the period by the total

number of policies written at the beginning of the period

ii. A lapse in insurance is defined as a point in time when a policy has been canceled or

terminated for failure to pay the premium, or when the policy contract is void for

other reasons

3. Insurer-producer relationships – Insurers that market products through independent agents

and brokers usually view this network of producers as their customers, in addition to the

ultimate insurance customer

4. State insurance department statistics

5. Consumer reports

C. Meeting Legal Requirements

1. Success or failure indicated by the number of criminal, civil, and regulatory actions taken

against the insurer

2. Market conduct regulation – State insurance departments monitor the treatment of insureds,

applicants for insurance, and claimants, overseeing four insurer operational areas: sales and

advertising, underwriting, ratemaking, and claim settlement

D. Meeting Social Responsibilities

No standards exist

2. Workplace safety programs

3. Support of community projects

4. Employee benefits

V. FUNCTIONAL VIEW OF INSURANCE

A. Core Functions

1. Marketing and distribution – Determining what products or services customers want and

need, advertising the products, and delivering them to customers

2. Underwriting – The process of selecting insureds, pricing coverage, determining insurance

policy terms and conditions, and then monitoring the underwriting decisions made

3. Claims – The purpose of claim function is to fulfill the insurer’s promise to make a payment

to, or on behalf of, the insured if a covered event occurs

6  Assignment 1: Overview of Insurance Operations Insurance Operations

B. Supporting Functions

1. Risk control

2. Premium auditing

3. Actuarial

4. Reinsurance

5. Information technology

C. Other Common Function Areas

1. Investments

2. Accounting and finance

3. Customer service

4. Legal and compliance

5. Human resources

6. Special investigation units

Insurance Operations Assignment 1: Overview of Insurance Operations  7

SAMPLE EXAM QUESTIONS

1. Which of the following is NOT an operating goal of an insurer? (SOA GIINT February 2014)

A. Comply with legal requirements.

B. Concentrate risk.

C. Meet customer needs.

D. Earn a profit.

E. Fulfill its duty to society.

2. What are the three core functions that exist within a typical insurer? (SOA GIINT February 2014)

A. Accounting, actuarial, and underwriting.

B. Actuarial, claims, and underwriting.

C. Accounting, marketing and distribution, and sales.

D. Claims, marketing and distribution, and underwriting.

E. Actuarial, marketing and distribution, and sales.

3. Which of the following errors is the most significant problem in measuring insurer profitability?

(SOA GIINT February 2014)

A. Errors in setting adequate rates.

B. Errors in estimating future investment returns.

C. Errors in estimating loss reserves.

D. Errors in estimating sales growth.

E. Errors in classification of loss exposure units.

4. Which of the following is false?

A. A foreign insurer is an insurer that is incorporated under the laws of a country outside of the

United States.

B. An insurer incorporated in state A is a domestic insurer in state A.

C. Mutual companies include some large national/regional insurers.

D. Nowadays a large portion of Lloyd’s of London members are corporations and have only limited

liabilities.

E. Fraternal organizations resemble mutual companies, and they write primarily in life and health

insurance.

5. Which of the following is a proprietary insurer?

I. Fraternal organizations

II. Reciprocal exchanges

III. American Lloyds associations

A. I

B. II

C. III

D. I and II

E. I, II, and III

8  Assignment 1: Overview of Insurance Operations Insurance Operations

6. Which of the following statements are true?

I. Under a syndicate pool policy, the insured has a contractual relationship with each member of

the pool.

II. A reciprocal exchange is owned by its policyholders.

III. A foreign insurer operating in a given state is an insurer incorporated in another country.

A. I only

B. II only

C. III only

D. I and II only

E. I, II, and III

7. Which of the following is NOT an internal constraint on achieving insurer goals?

A. Efficiency

B. Expertise

C. Size

D. Financial resources

E. Insurance marketing and distribution

8. Which of following is NOT a cooperative insurer?

A. Captive insurer

B. Lloyd’s of London

C. Mutual insurance company

D. Reciprocal exchange

E. Risk retention group

9. Unincorporated associations that enable individuals to write insurance as individuals and

whose members insure one another are called:

A. Lloyd’s associations

B. Proprietary insurers

C. Captive insurers

D. Reciprocal exchanges

E. Mutual insurers

10. Which of the following statements are true?

I. Under a reinsurance pool policy, the policyholder has no legal rights against the other

members of the pool and might not even know that they exist.

II. Virtually all states require some kind of pooling arrangement to provide auto liability

insurance for drivers who cannot obtain such insurance in the standard market.

III. Cooperative insurers include captive insurers, risk retention groups, and purchasing

groups.

A. I only

B. II only

C. III only

D. I and II only

E. I, II, and III

Insurance Operations Assignment 1: Overview of Insurance Operations  9

SAMPLE EXAM QUESTION ANSWERS

1. B

2. D

3. C

4. A

5. C

6. D

7. E

8. B

9. D

10. E

10  Assignment 1: Overview of Insurance Operations Insurance Operations