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CHAPTER 8
Insurance Functions
I. SUGGESTED CLASSROOM TIME: 90–120 MINUTES
II. CHAPTER OVERVIEW
This chapter has two purposes: It provides a good explanation of what transpires in the
offices of an insurance company, and it illustrates employment possibilities and career
opportunities that may have great appeal to students. This chapter assumes that the
student probably has heard about insurance agents but is unaware of the broad scope of
the agent’s duties. The difference between distribution in the life and nonlife insurance
industry is stressed early in the chapter and reinforced by separate treatment of each.
When this section of the chapter is completed, a good appreciation for the skills required
to be an insurance agent should be understood. Likewise, the role of insurance brokers in
both the property and liability and life areas is set forth.
Two other company functions, loss settlement and underwriting, may have
III. LECTURE OUTLINE
A. Introduction—examine internal functions of insurance companies to describe the
necessary steps in delivering the product. In addition, this topic provides an overview
B. Insurance Agents and Brokers
1. Marketing—product development, training, advertising and other activities that
help in the sale of the insurance product are done at the home office by salaried
specialists. Agents sell most of the insurance by contacting buyers personally. A lot
of different agency arrangements have evolved for marketing insurance. The
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Internet is evolving into a marketing and sales tool and is used by many in the
distribution chain.
a. Insurance agent—a person authorized to act on behalf of another person called
b. Law of agency
i. Scope of authority sets forth and limits agents’ actions. Some agents may
bind insurers (in property area); some may not. Life insurance field agents
do not have binding authority.
ii. Duties of an agent include: loyalty (no self-dealing at principal’s expense);
c. Insurance broker—a representative with limited authority to find insurance for
the buyer. Works for the insurance buyer and earns a commission, which is a
d. Licensing requirements are typically uniform for agents and brokers and
usually involve educational requirements.
e. Types of property and liability insurance agents and brokers
i. Exclusive agents work for one insurer as a commissioned employee.
f. Life insurance agents and brokers
i. They can be exclusive agents or independent agents. Exclusive agents are
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2. Loss adjustors
a. Investigate reported losses, determine amount of insurer’s liability, or
recommend denial of claims
b. Most property loss adjustment is done by independent adjusters or adjustment
bureaus because most losses occur at locations where home office employees
are not close by.
3. Underwriters—typically home office employees who select and classify insureds. An
important part of the selection process is rating (pricing) the exposure. This
involves experience and judgment, in both life and property insurance, with the
goal to categorize and price correctly.
a. Good underwriting produces losses closely approximating expected losses.
Overly strict underwriting means profitable business is turned down. Overly
loose underwriting means financial problems and an uncompetitive product, or
c. Life insurance underwriters must use judgment in assessing the health,
occupation, and moral history of the applicant. Health records come from the
applicant’s doctor and the Medical Information Bureau (MIB). The use of
genetic information is currently controversial.
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4. Actuaries—mathematicians (statisticians) specializing in insurance calculations.
a. Calculate rates, dividends, operating results, and loss reserves
b. Help develop new policies and participates in securing regulatory approval for
rates and policies
5. Other Insurance Company Occupations/ Business Functions
a. Accountant—problems with applying rules to insurance companies led to
Generally Accepted Accounting Principles (GAAP) for insurance companies.
6. Reinsurance
a. Smooth loss ratios or limit dollar loss on any one exposure
IV. ANSWERS TO REVIEW QUESTIONS
1. What duties do principals owe their agents? What duties do agents owe
their principals? The law defines several duties agents owe their principals. Among
these are the duty of loyalty (agents must not further their own interest at their
the agent’s services and honoring all other agreed on commitments to the agent.
2. Explain the basis for conflict between the insurance agent and the home
office underwriter. In practice why are such conflicts often not a problem?
An insurance agent is compensated based on the quantity of insurance sold, which
translates into more income for the agent. The underwriter is judged primarily on the
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3. Describe the differences between an insurance agent and an insurance
broker. Are these differences important to the insurance consumer? The
insurance agent generally represents the insurer and is authorized to act on its behalf.
4. Why do life insurance agents and property insurance agents have different
grants of authority? Property insurance agents often have the authority to bind
their companies to an insurance contract, whereas life insurance agents never have this
5. Describe the differences between an independent agent and a direct
writer. An independent agent represents several insurance companies and owns his
book of business. A direct writer (exclusive agent) represents only one insurance
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6. Evaluate the success of direct marketing and e-commerce in insurance
marketing. One need only watch a little television or open an Internet browser to
find an advertisement for an insurance product. While the financial facts are yet to be
7. What purpose does a “reservation of rights” letter serve? In some instances,
particularly losses involving liability claims, insurers initially may not be sure if the
insured’s claim is covered. In such situations, insurers may assume the liability
8. Should a good job of loss adjusting always involve the claims adjuster
negotiating the lowest possible dollar amount of claims settlement? A good
job of loss adjusting results in fair settlements: settlements fair to both insured and
9. What incentives does the insurer have to settle claims fairly? Insurers want
to settle claims fairly because to do so means that a good reputation will be established,
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10. Why do insurance companies hire independent loss adjustment bureaus?
In many cases insurers write insurance covering people or property that may be a long
11. Why must the underwriter be concerned about adverse selection? Adverse
selection occurs when “poor risks” (those loss exposures more likely to experience loss
than an “average exposure”) succeed in purchasing insurance at rates not fairly
12. Describe the functions carried out by actuaries in most insurance
companies. The key functions performed by actuaries are the setting of rates for the
13. What are the reasons that reinsurance is so widely purchased by insurers?
The essential reasons that primary insurers buy reinsurance are to protect their
14. What is the difference between a facultative and a treaty reinsurance
arrangement? Facultative reinsurance is sought by the ceding insurer on a case–by–
case basis. The reinsurance underwriter might reject some of the cases submitted.
15. What does “25, excess of 15” mean in a reinsurance arrangement? This
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16. What type of exposures would encourage a life insurance company to
purchase catastrophe reinsurance? Events such as the 9/11 event in New York,
where large numbers of persons are exposed to a catastrophe in a small geographic
V. ANSWERS TO OBJECTIVE QUESTIONS
1. The definition of agent is a person who is
2. A broker is
3. Independent loss adjusters
4. A fire insurance underwriter considers all except which of the following in setting
prices?
5. The responsibilities of the _____ functions include calculating the value of insurer
reserves and examining trends in insured loss data to forecast future premiums.
6. Pro rata reinsurance occurs if the
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7. ______ is a transaction engaged in by two insurers who agree to share premiums and
losses.
8. Treaty reinsurance means
9. Assume an excess-of-loss reinsurance arrangement with the primary insurer retaining
the first $10 million of loss and the reinsurer providing $50 million of coverage.
Assume that a $50 million covered loss occurs. Based on this data, which of the
following statements is true?
10. The insurance company purchasing insurance from the reinsurer is called the
VI. IDEAS FOR INSTRUCTORS AND TEACHING METHODS
1. Select classified advertisements out of one of a weekly or monthly insurance
periodicals to introduce the availability and the variety of jobs in the insurance
2. Place the students in the shoes of a new insurance company. Now that they have some
3. Set up a panel composed of local life or nonlife insurance agents, a claims adjuster, and
an underwriter. Have them address what their overall job is within the frame of
insurance operations and have them talk about the role they play in combating
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4. Split the class into two groups and assign the role of the insurance company to one side
and society to the other. Discuss the implications of using genetic information under
the following circumstances:
5. Recently, many insurers have started to use financial credit reports as a credible rating
tool. Discuss with the students and solicit reasons why an insurance company may
want to use such a rating tool. Also discuss with the students why consumers would not
want the insurer to do so. Is the use of the credit report “fair” based on each side’s
arguments? (This may lead to a discussion of “What is fair?”)