Insurance in the United States

Insurance in the United States

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Insurance in the United States refers to the market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...

 for risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...

 in the United States of America. Insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

, generally, is a contract in which the insurer (stock insurance company, mutual insurance company
Mutual insurance
A mutual insurance company is an insurance company which has no shareholders but instead is owned entirely by its policyholders. The primary form of financial business set up as a mutual company in the United States has been mutual insurance. Under this idea, what would have been profits are...

, reciprocal
Reciprocal inter-insurance exchange
A reciprocal inter-insurance exchange, is an insurance company referred to in United States state legislation as either a reciprocal insurance exchange, a reciprocal interinsurance exchange, or perhaps most properly a reciprocal inter-insurance exchange and is managed by an attorney in fact...

, or Lloyd's syndicate, for example), agrees to compensate or indemnify another party (the insured, the policyholder or a beneficiary) for specified loss or damage to a specified thing (e.g., an item, property or life) from certain perils or risks in exchange for a fee (the insurance premium). For example, a property insurance company may agree to bear the risk that a particular piece of property (e.g., a car or a house) may suffer a specific type or types of damage or loss during a certain period of time in exchange for a fee from the policyholder who would otherwise be responsible for that damage or loss. That agreement takes the form of an insurance policy.

History



The first insurance company in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 underwrote fire insurance and was formed in Charleston
Charleston, South Carolina
Charleston is the second largest city in the U.S. state of South Carolina. It was made the county seat of Charleston County in 1901 when Charleston County was founded. The city's original name was Charles Towne in 1670, and it moved to its present location from a location on the west bank of the...

, South Carolina
South Carolina
South Carolina is a state in the Deep South of the United States that borders Georgia to the south, North Carolina to the north, and the Atlantic Ocean to the east. Originally part of the Province of Carolina, the Province of South Carolina was one of the 13 colonies that declared independence...

, in 1735. In 1752, Benjamin Franklin helped form a mutual insurance company called the Philadelphia Contributorship, which is the nation’s oldest insurance carrier still in operation. Franklin's company was the first to make contributions toward fire prevention. Not only did his company warn against certain fire hazards, it refused to insure certain buildings where the risk of fire was too great, such as all wooden houses.
The first stock insurance company formed in the United States was the Insurance Company of North America in 1792. Massachusetts
Massachusetts
The Commonwealth of Massachusetts is a state in the New England region of the northeastern United States of America. It is bordered by Rhode Island and Connecticut to the south, New York to the west, and Vermont and New Hampshire to the north; at its east lies the Atlantic Ocean. As of the 2010...

 enacted the first state law requiring insurance companies to maintain adequate reserves in 1837. Formal regulation of the insurance industry began in earnest when the first state commissioner of insurance was appointed in New Hampshire
New Hampshire
New Hampshire is a state in the New England region of the northeastern United States of America. The state was named after the southern English county of Hampshire. It is bordered by Massachusetts to the south, Vermont to the west, Maine and the Atlantic Ocean to the east, and the Canadian...

 in 1851. In 1869, the State of New York appointed its own commissioner of insurance and created a state insurance department to move towards more comprehensive regulation of insurance at the state level.
Insurance and the insurance industry has grown, diversified and developed significantly ever since. Insurance companies were, in large part, prohibited from writing more than one line of insurance until laws began to permit multi-line charters in the 1950s. From an industry dominated by small, local, single-line mutual companies and member societies, the business of insurance has grown increasingly towards multi-line, multi-state and even multi-national insurance conglomerates and holding companies.

The State-Based Insurance Regulatory System


Historically, the insurance industry in the United States was regulated almost exclusively by the individual state governments. The first state commissioner of insurance was appointed in New Hampshire
New Hampshire
New Hampshire is a state in the New England region of the northeastern United States of America. The state was named after the southern English county of Hampshire. It is bordered by Massachusetts to the south, Vermont to the west, Maine and the Atlantic Ocean to the east, and the Canadian...

 in 1851 and the state-based insurance regulatory system grew as quickly as the insurance industry itself. Prior to this period, insurance was primarily regulated by corporate charter, state statutory law and de facto regulation by the courts in judicial decisions.
Under the state-based insurance regulation system, each state operates independently to regulate their own insurance markets, typically through a state department of insurance. Stretching back as far as the Paul v. Virginia
Paul v. Virginia
Paul v. Virginia, 75 U.S. 168 , was a historic case in corporate law in which the United States Supreme Court held that a corporation is not a citizen within the meaning of the Privileges and Immunities Clause...

case in 1869, challenges to the state-based insurance regulatory system have risen from various groups, both within and without the insurance industry. The state regulatory system has been described as cumbersome, redundant, confusing and costly.
The United States Supreme Court found in the 1944 case of United States v. South-Eastern Underwriters Association
United States v. South-Eastern Underwriters Association
United States v. South-Eastern Underwriters Association, 322 U.S. 533 is a United States Supreme Court decision that held that the Sherman Act, the federal antitrust statute, applied to insurance. To reach this decision, the Court held that insurance could be regulated by the United States...

that the business of insurance was subject to federal regulation under the Commerce Clause of the U.S. Constitution. The United States Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....

, however, responded almost immediately with the McCarran-Ferguson Act
McCarran-Ferguson Act
The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1015, is a United States federal law that exempts the business of insurance from most federal regulation, including federal anti-trust laws to a limited extent. The McCarran–Ferguson Act was passed by Congress in 1945 after the Supreme Court ruled in...

 in 1945. The McCarran-Ferguson Act specifically provides that the regulation of the business of insurance by the state governments is in the public interest. Further, the Act states that no federal law should be construed to invalidate, impair or supersede any law enacted by any state government for the purpose of regulating the business of insurance, unless the federal law specifically relates to the business of insurance.
A wave of insurance company insolvencies in the 1980s sparked a renewed interest in federal insurance regulation, including new legislation for a dual state and federal system of insurance solvency regulation. In response, the National Association of Insurance Commissioners
National Association of Insurance Commissioners
The National Association of Insurance Commissioners is an Internal Revenue Code Section 501 non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. The NAIC was formed in 1871. Its current...

 (NAIC) adopted several model reforms for state insurance regulation, including risk-based capital requirements, financial regulation accreditation standards and an initiative to codify accounting principles. As more and more states enacted versions of these model reforms into law, the pressure for federal reform of insurance regulation waned.
The NAIC acts as a forum for the creation of model laws and regulations. Each state decides whether to pass each NAIC model law or regulation, and each state may make changes in the enactment process, but the models are widely, albeit somewhat irregularly, adopted. The NAIC also acts at the national level to advance laws and policies supported by state insurance regulators. NAIC model acts and regulations provide some degree of uniformity between states, but these models do not have the force of law and have no effect unless they are adopted by a state. They are, however, used as guides by most states, and some states adopt them with little or no change.

Federal Regulation of Insurance


Nevertheless, federal regulation has continued to encroach upon the state regulatory system. The idea of an optional federal charter
Optional federal charter
Optional Federal Charter ' is a proposal to streamline and simplify US insurance regulation by allowing insurance companies to choose between a current state-based regulatory system and a single federal regulatory agency...

 was first raised after a spate of solvency and capacity issues plagued property and casualty insurers in the 1970s. This OFC concept was to establish an elective federal regulatory scheme that insurers could opt into from the traditional state system, somewhat analogous to the dual-charter regulation of banks. Although the optional federal chartering proposal was defeated in the 1970s, it became the precursor for a modern debate over optional federal chartering in the last decade.
In 1979 and the early 1980s the Federal Trade Commission
Federal Trade Commission
The Federal Trade Commission is an independent agency of the United States government, established in 1914 by the Federal Trade Commission Act...

 attempted to regulate the insurance industry, but the Senate Commerce Committee voted unanimously to prohibit the FTC's efforts. President Jimmy Carter attempted to create an "Office of Insurance Analysis" in the Treasury Department, but the idea was abandoned under industry pressure.
Over the past decade, renewed calls for optional federal regulation of insurance companies have sounded, including the Gramm-Leach-Bliley Act
Gramm-Leach-Bliley Act
The Gramm–Leach–Bliley Act , also known as the Financial Services Modernization Act of 1999, is an act of the 106th United States Congress...

 in 1999, the proposed National Insurance Act in 2006 and the Patient Protection and Affordable Care Act
Patient Protection and Affordable Care Act
The Patient Protection and Affordable Care Act is a United States federal statute signed into law by President Barack Obama on March 23, 2010. The law is the principal health care reform legislation of the 111th United States Congress...

 in 2010.
In 2010, Congress passed the Dodd–Frank Wall Street Reform and Consumer Protection Act which is touted by some as the most sweeping financial regulation overhaul since the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

. The Dodd-Frank Act has significant implications for the insurance industry. Significantly, Title V of created the Federal Insurance Office (FIO) in the Department of the Treasury
United States Department of the Treasury
The Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...

. The FIO is authorized to monitor all aspects of the insurance industry and identify any gaps in the state-based regulatory system. The Dodd-Frank Act also establishes the Financial Stability Oversight Council
Financial Stability Oversight Council
The Financial Stability Oversight Council is a United States Federal government organization, established by Title I of the Dodd–Frank Wall Street Reform and Consumer Protection Act, which was signed into law by President Barack Obama on July 21, 2010. Dodd-Frank provides the Council with broad...

 (FSOC), which is charged with monitoring the financial services markets, including the insurance industry, to identify potential risks to the financial stability of the United States.

Organization


Insurers in the U.S. may be "admitted," meaning that they have been formally admitted to a state's insurance market by the state insurance commissioner, and are subject to various state laws governing organization, capitalization, and claims handling. Or they may be "surplus," meaning that they are nonadmitted in a particular state but are willing to write coverage there. Surplus insurers are supposed to underwrite only very unusual risks. Although insurance brokers are well aware of what risks an admitted insurer will not accept, they must go through a ritual of shopping around a risk to admitted insurers (who will reject it, of course) before applying for coverage with a surplus insurer.

Only the smallest insurers exist as a single corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...

. Most major insurance companies actually exist as insurance groups. That is, they consist of holding companies which own several admitted and surplus insurers (and sometimes a few excess insurers and reinsurers as well). There are dramatic variations from one insurance group to the next in terms of how its various business functions are divided up among its subsidiaries or outsourced to third party corporations altogether.

An example of how insurance groups work is that when people call GEICO
GEICO
The Government Employees Insurance Company is an auto insurance company. It is a wholly owned subsidiary of Berkshire Hathaway that as of 2007 provided coverage for more than 10 million motor vehicles owned by more than 9 million policy holders. GEICO writes private passenger automobile insurance...

 and ask for a rate quote, they are actually speaking to GEICO Insurance Agency, which may then write a policy from any one of GEICO's four insurance companies. The customer then pays their premium to one of those four insurance companies (the one that actually wrote their policy), and any claims against their policy are charged to the issuing company. But as far as most layperson customers know, they are simply dealing with GEICO.

Institutions


Various associations, government agencies, and companies serve the insurance industry in the United States. The National Association of Insurance Commissioners
National Association of Insurance Commissioners
The National Association of Insurance Commissioners is an Internal Revenue Code Section 501 non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. The NAIC was formed in 1871. Its current...

 provides models for standard state insurance law, and provides services for its members, which are the state insurance divisions. Many insurance providers use the Insurance Services Office
Insurance Services Office
Insurance Services Office, Inc. , a subsidiary of Verisk Analytics, is a provider of data, underwriting, risk management and legal/regulatory services to property-casualty insurers and other clients...

, which produces standard policy forms and rating loss costs and then submits these documents on the behalf of member insurers to the state insurance divisions.

Definition


In recent years this kind of operational definition proved inadequate as a result of contracts that had the form but not the substance of insurance. The essence of insurance is the transfer of risk from the insured to one or more insurers. How much risk a contract actually transfers proved to be at the heart of the controversy. This issue arose most clearly in reinsurance, where the use of Financial Reinsurance
Financial reinsurance
Financial Reinsurance , is a form of reinsurance which is focused more on capital management than on risk transfer. In the non-life segment of the insurance industry this class of transactions is often referred to as finite reinsurance....

 to reengineer insurer balance sheets under US GAAP became fashionable during the 1980s. The accounting profession raised serious concerns about the use of reinsurance in which little if any actual risk was transferred, and went on to address the issue in FAS 113, cited above. While on its face, FAS 113 is limited to accounting for reinsurance transactions, the guidance it contains is generally conceded to be equally applicable to US GAAP accounting for insurance transactions executed by commercial enterprises.

Risk transfer requirement


FAS 113 contains two tests, called the '9a and 9b tests,' that collectively require that a contract create a reasonable chance of a significant loss to the underwriter for it to be considered insurance.

9. Indemnification of the ceding enterprise against loss or liability relating to insurance risk in reinsurance of short-duration contracts requires both of the following, unless the condition in paragraph 11 is met:

a. The reinsurer assumes significant insurance risk under the reinsured portions of the underlying insurance contracts.

b. It is reasonably possible that the reinsurer may realize a significant loss from the transaction.


Paragraph 10 of FAS 113 makes clear that the 9a and 9b tests are based on comparing the present value
Present value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...

 of all costs to the PV of all income streams. FAS gives no guidance on the choice of a discount rate
Discount rate
The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....

 on which to base such a calculation, other than to say that all outcomes tested should use the same rate.

Statement of Statutory Accounting Principles
Statutory accounting principles
The Statutory Accounting Principles are a set of accounting rules for insurance companies set forth by the National Association of Insurance Commissioners. They are used to prepare the statutory financial statements of insurance companies...

 ("SSAP") 62, issued by the National Association of Insurance Commissioners
National Association of Insurance Commissioners
The National Association of Insurance Commissioners is an Internal Revenue Code Section 501 non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. The NAIC was formed in 1871. Its current...

, applies to so-called 'statutory accounting' - the accounting for insurance enterprises to conform with regulation. Paragraph 12 of SSAP 62 is nearly identical to the FAS 113 test, while paragraph 14, which is otherwise very similar to paragraph 10 of FAS 113, additionally contains a justification for the use of a single fixed rate for discounting purposes. The choice of an "reasonable and appropriate" discount rate is left as a matter of judgment.

No brightline test


Neither FAS 113 nor SAP 62 defines the terms reasonable or significant. Ideally, one would like to be able to substitute values for both terms. It would be much simpler if one could apply a test of an X percent chance of a loss of Y percent or greater. Such tests have been proposed, including one famously attributed to an SEC official who is said to have opined in an after lunch talk that at least a 10 percent chance of at least a 10 percent loss was sufficient to establish both reasonableness and significance. Indeed, many insurers and reinsurers still apply this "10/10" test as a benchmark for risk transfer testing.

An attempt to use any numerical rule such as the 10/10 test will quickly run into problems. Suppose a contract has a 1 percent chance of a 10,000 percent loss? It should be reasonably self-evident that such a contract is insurance, but it fails one half of the 10/10 test.

Excess of loss contracts, like those commonly used for umbrella and general liability insurance, or to insure against property losses, will typically have a low ratio of premium paid to maximum loss recoverable. This ratio (expressed as a percentage), commonly called the "rate on line" for historical reasons related to underwriting practices at Lloyd's of London, will typically be low for contracts that contain reasonably self-evident risk transfer. As the ratio increases to approximate the present value of the limit of coverage, self-evidence decreases and disappears.

Contracts with low rates on line may survive modest features that limit the amount of risk transferred. As rates on line increase, such risk limiting features become increasingly important.

"Safe harbor" exemptions


The analysis of reasonableness and significance is an estimate of the probability of different gain or loss outcomes under different loss scenarios. It takes time and resources to perform the analysis, which constitutes a burden without value where risk transfer is reasonably self-evident.

Guidance exists for insurers and reinsurers, whose CEO's and CFO's attest annually as to the reinsurance agreements their firms undertake. The American Academy of Actuaries, for instance, identifies three categories of contract as outside the requirement of attestation:
  • Inactive contracts. If there are no premiums due nor losses payable, and the insurer is not taking any credit for the reinsurance, determining risk transfer is irrelevant.
  • Pre-1994 contracts. The attestation requirement only applies to contracts that were entered into, renewed or amended on or after 1 January 1994. Prior contracts need not be analyzed.
  • Where risk transfer is "reasonably self-evident."

Risk limiting features


An insurance policy should not contain provisions that allow one side or the other to unilaterally void the contract in exchange for benefit. Provisions that void the contract for failure to perform or for fraud or material misrepresentation are ordinary and acceptable.

The policy should have a term of not more than about three years. This is not a hard and fast rule. Contracts of over five years duration are classified as ‘long-term,’ which can impact the accounting treatment, and can obviously introduce the possibility that over the entire term of the contract, no actual risk will transfer. The coverage provided by the contract need not cease at the end of the term (e.g., the contract can cover occurrences as opposed to claims made or claims paid).

The contract should be considered to include any other agreements, written or oral, that confer rights, create obligations, or create benefits on the part of either or both parties. Ideally, the contract should contain an ‘Entire Agreement’ clause that assures there are no undisclosed written or oral side agreements that confer rights, create obligations, or create benefits on the part of either or both parties. If such rights, obligations or benefits exist, they must be factored into the tests of reasonableness and significance.

The contract should not contain arbitrary limitations on timing of payments. Provisions that assure both parties of time to properly present and consider claims are acceptable provided they are commercially reasonable and customary.

Provisions that expressly create actual or notional accounts that accrue actual or notional interest suggest that the contract contains, in fact, a deposit.

Provisions for additional or return premium do not, in and of themselves, render a contract something other than insurance. However, it should be unlikely that either a return or additional premium provision be triggered, and neither party should have discretion regarding the timing of such triggering.

All of the events that would give rise to claims under the contract cannot have materialized prior to the inception of the contract. If this "all events" test is not met, then the contract is considered to be a retroactive contract, for which the accounting treatment becomes complex.

See also


Other US insurance topics:
  • Health insurance in the United States
    Health insurance in the United States
    The term health insurance is commonly used in the United States to describe any program that helps pay for medical expenses, whether through privately purchased insurance, social insurance or a non-insurance social welfare program funded by the government...

  • Insurance Regulatory Information System
    Insurance Regulatory Information System
    The Insurance Regulatory Information System is a database of Insurance companies in the United States run by the National Association of Insurance Commissioners...

  • McCarran-Ferguson Act
    McCarran-Ferguson Act
    The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1015, is a United States federal law that exempts the business of insurance from most federal regulation, including federal anti-trust laws to a limited extent. The McCarran–Ferguson Act was passed by Congress in 1945 after the Supreme Court ruled in...

  • National Association of Insurance Commissioners
    National Association of Insurance Commissioners
    The National Association of Insurance Commissioners is an Internal Revenue Code Section 501 non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. The NAIC was formed in 1871. Its current...



General insurance topics:
  • Casualty insurance
    Casualty insurance
    Casualty insurance, often equated to liability insurance, is used to describe an area of insurance not directly concerned with life insurance, health insurance, or property insurance. It is mainly used to describe the liability coverage of an individual or organization's for negligent acts or...

  • Health insurance
    Health insurance
    Health insurance is insurance against the risk of incurring medical expenses among individuals. By estimating the overall risk of health care expenses among a targeted group, an insurer can develop a routine finance structure, such as a monthly premium or payroll tax, to ensure that money is...

  • History of insurance
    History of insurance
    History of insurance refers to the development of a modern business in insurance against risks, especially regarding ships, cargo, and buildings , death , automobile accidents , and the cost of medical treatment...

  • Insurance
    Insurance
    In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

  • Life insurance
    Life insurance
    Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...



Insurance systems in other countries:
  • Insurance in Australia
    Insurance in Australia
    Australia has a sophisticated and well-developed insurance market, which can be divided into roughly three components: life insurance, general insurance and health insurance...

  • Insurance in India
    Insurance in India
    Insurance is a subject listed in the concurrent list in the Seventh Schedule to the Constitution of India where both centre and states can legislate. The insurance sector has gone through a number of phases and changes...



U.S. Insurance Companies:
  • AIG
    AIG
    AIG is American International Group, a major American insurance corporation.AIG may also refer to:* And-inverter graph, a concept in computer theory* Answers in Genesis, a creationist organization in the U.S.* Arta Industrial Group in Iran...