Insurance
in the United States refers to the market for risk in the United States of
America. Insurance, generally, is a contract in which the insurer (stock
insurance company, mutual insurance company, reciprocal, 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).[1]
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.[2]
“Insurance provides
indemnification against loss or liability from specified events and
circumstances that may occur or be discovered during a specified period.”
—FASB
Statement of Financial Accounting Standards No. 113, "Accounting for
Reinsurance of Short-Duration and Long-Duration Contracts" December
The
first insurance company in the United States underwrote fire insurance and was
formed in Charleston, South Carolina, in 1735.[3] In 1752, Benjamin Franklin
helped form a mutual insurance company called the Philadelphia Contributionship,
which is the nation’s oldest insurance carrier still in operation.[4][5]
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.[citation needed]
The
first stock insurance company formed in the United States was the Insurance
Company of North America in 1792.[6] Massachusetts 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 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.[7]
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.[3]
Regulation
Main
article: Insurance Regulatory Law
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 in 1851 and the state-based insurance regulatory
system grew as quickly as the insurance industry itself.[8] Prior to this
period, insurance was primarily regulated by corporate charter, state statutory
law and de facto regulation by the courts in judicial decisions.[9][10]
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 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.[11]
The
United States Supreme Court found in the 1944 case of United States v. South-Eastern
Underwriters Association that the business of insurance was subject to federal
regulation under the Commerce Clause of the U.S. Constitution.[12] The United
States Congress, however, responded almost immediately with the
McCarran-Ferguson Act in 1945.[13] 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.[14]
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.[15] In response, the National
Association of Insurance Commissioners (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.[16]
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.[17]
Federal
regulation of insurance
Nevertheless,
federal regulation has continued to encroach upon the state regulatory
system.[15] The idea of an optional federal charter 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.[18]
In
1979 and the early 1980s the Federal Trade Commission 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.[19]
Over
the past two decades, renewed calls for optional federal regulation of
insurance companies have sounded, including the Gramm-Leach-Bliley Act in 1999,
the proposed National Insurance Act in 2006 and the Patient Protection and
Affordable Care Act in 2010.[15]
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. 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. 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 (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.[20][21][15]
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. 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. All major insurance groups in the U.S. that transact insurance in California
maintain a publicly accessible list on their Web sites of the actual insurer
entities within the group, as required by California Insurance Code Section
702.
An
example of how insurance groups work is that when people call GEICO 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 seven insurance companies. When the
customer writes their check for the premium to "GEICO," the premium
is actually deposited with one of those seven insurance companies (the one that
actually wrote their policy). Similarly, any claims against the policy are
charged to the issuing company. But as far as most layperson customers know,
they are simply dealing with GEICO.
Obviously,
it is more difficult to operate an insurance group than a single insurance
company, since employees must be painstakingly trained to observe corporate
formalities so that courts will not treat the entities in the group as alter
egos of each other. For example, all insurance policies and all claim-related
documents must consistently reference the relevant company within the group,
and the flows of premiums and claim payments must be carefully recorded against
the books of the correct company. The advantage to the insurance group system
is that a group has increased survivability over the long run than a single
insurance company. If any one company in the group is hit with too many claims
and fails, the company can be quietly placed in runoff but the rest of the group
continues to operate. By way of contrast, when small insurers fail, they tend
to do so in a rather wild and spectacular fashion. Sometimes the result may be
a state-supervised takeover by which a state agency may have to assume part of
their residual liabilities.
Types
Life, Health
Health (dental, vision, medications)
Life (long-term care, accidental death
and dismemberment, hospital indemnity)
Annuities (securities)
Life and Annuities
Property and
Casualty (P n C)
Property (flood, earthquake, home, auto, fire, boiler, title, pet)
Casualty (errors and omissions,
workers' compensation, disability, liability)
Reinsurance
Institutions
Various
associations, government agencies, and companies serve the insurance industry
in the United States. The National Association of Insurance Commissioners
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, 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 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.
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 of all costs to the PV of all income streams. FAS gives no
guidance on the choice of a discount rate 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 ("SSAP") 62, issued by the
National Association of Insurance Commissioners, 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 bright-line
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
transfer is reasonably self-evident in most traditional per-risk or
per-occurrence excess of loss reinsurance contracts. For these contracts, a
predetermined amount of premium is paid and the reinsurer assumes nearly all or
all of the potential variability in the underlying losses, and it is evident
from reading the basic terms of the contract that the reinsurer can incur a
significant loss. In many cases, there is no aggregate limit on the reinsurer's
loss. The existence of certain experience-based contract terms, such as
experience accounts, profit commissions, and additional premiums, generally
reduce the amount of risk transfer and make it less likely that risk transfer
is reasonably self-evident.
—American
Academy of Actuaries[22]
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 These Topics – Use The Search Box Above Or Below
Other US
insurance topics:
Health insurance in the United States
Insurance Regulatory Information System
McCarran-Ferguson Act
National Association of Insurance
Commissioners
General
insurance topics:
Travel insurance
Casualty insurance
Health insurance
History of insurance
Insurance
Life insurance
Insurance
systems in other countries:
Insurance in Australia
Insurance in India
U.S. Insurance
Companies: