Insurance in the United States refers to the market for risk in the United
States of America, the world's largest
insurance market by premium volume. Of the $4.640 trillion of gross premiums written worldwide
in 2013, $1.274 trillion (27%) were written in the United States.
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). 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.
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Insurance provides
indemnification against loss or liability from specified events and
circumstances that may occur or be discovered during a specified period.
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—FASB Statement of Financial Accounting Standards No. 113, "Accounting
for Reinsurance of Short-Duration and Long-Duration Contracts" December
1992
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History
The first insurance company in the United
States underwrote fire insurance and was formed in Charleston, South
Carolina, in 1735. 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.
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 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.
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.
Regulation
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. 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 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 that the business of insurance was subject to federal regulation under the
Commerce Clause of the U.S. Constitution. The United States Congress, however,
responded almost immediately with the McCarran-Ferguson Act 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 (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.
However, there are still significant differences between states in their
systems of insurance regulation, and the cost of compliance with those systems
is ultimately borne by insureds in the form of higher premiums. McKinsey & Company estimated
in 2009 that the U.S. insurance industry incurs about $13 billion annually in
unnecessary regulatory costs under the state-based regulatory system.
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 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 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 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.
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.
Organization
Admitted v. surplus
An important artifact of the state-based insurance regulation system in the
United States is the dichotomy between admitted and surplus insurers. 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,
policy forms, 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 line insurers are supposed to underwrite only very
unusual or difficult-to-insure risks. Although experienced insurance brokers
are well aware of what risks an admitted insurer will not accept, they must
document a ritual of actually shopping around a risk to several admitted
insurers (who will reject it, of course) before applying for coverage with a
surplus line insurer.
To relieve insurers and brokers of that tedious and time-consuming chore,
many states (with the notable exception of Texas) now maintain "export
lists" of risks that the state insurance commissioner has already
identified as having no coverage available whatsoever from any admitted insurer
in the state. In turn, brokers presented by clients with those risks can
immediately "export" them to the out-of-state surplus market and
apply directly to surplus line insurers without having to first document
multiple attempts to present the risk to admitted insurers.
By their very nature, export lists illustrate what U.S. insurers consider
to be hard-to-insure risks. For example, the California export list includes ambulance services, amusement parks, fireworks displays, moving a building, hot air
balloons, product recalls, sawmills and security guards, as well as
particular types of insurance like employment practices liability and kidnap and ransom.
Although surplus line insurers are still regulated by the states in which
they are actually admitted, the disadvantages of obtaining insurance from a
surplus line insurer are that the policy will usually be written on a
nonstandard form (that is, not from the Insurance Services Office), and if
the insurer collapses, its insureds in states in which it is nonadmitted will
not enjoy certain types of protection available to insureds in states in which
the insurer is admitted. However, for persons trying to obtain coverage for
unusual risks, the choice is usually between a surplus line insurer or no
coverage at all.
Insurance groups
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 of 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 into "runoff" (in which it continues to exist only to
process remaining claims and no longer writes new coverage) 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
- Auto
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.
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 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 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."
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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.
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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
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