CHAPTER 5

TYPES OF INSURERS AND

MARKETING SYSTEMS

“Insurers are increasingly using multiple distribution

channels to sell their products.”
Insurance Information Institute

Learning Objectives

After studying this chapter, you should be able to

◆ Describe the major types of private insurers, including the following:

Stock insurers Lloyd’s of London

Mutual insurers Blue Cross and Blue Shield plans
Reciprocal exchanges Health maintenance organizations

◆ Explain why some life insurers have demutualized or formed holding companies.

◆ Describe the major distribution systems for selling life insurance.

◆ Describe the major distribution systems in property and casualty insurance, including the following:

Independent agency system Direct writer

Exclusive agency system Mixed systems
Direct response system
86
 K ristin, age 32, is a widow with two sons, ages 3 and 1. Her husband died recently
from pancreatic cancer. The amount of life insurance on his life was insufficient
for paying the funeral costs and other medical bills not covered by insurance. After
assessing her situation, Kristin believes she should purchase additional life insurance.
A friend suggests the purchase of life insurance from a mutual insurer because policy-
holders may receive dividends. Kristin has no idea what a mutual insurer is and how
a mutual insurer differs from other insurers. She is not alone in her confusion. Many
consumers also do not understand the differences among insurers.
Thousands of life and health insurers and property and casualty insurers are doing
business in the United States today. As part of the financial services industry, private
insurers have a profound impact on the American economy. Private insurers sell
financial and insurance products that enable individuals, families, and business firms
to attain a high degree of protection and economic security. The insurance industry
also provides millions of jobs for workers and is an important source of capital to
business firms. Indemnification for losses is one of the most important economic
functions of insurers; insureds are restored completely or partially to their previous
financial position, thereby maintaining their economic security.
In this chapter, we discuss the role of private insurance companies in the financial
services industry. Topics discussed include an overview of the financial services
industry, the major types of private insurers, the major marketing methods for selling
insurance, and the role of agents and brokers in the sales process.

OVERVIEW OF PRIVATE services industry. One common method is to determine

INSURANCE IN THE FINANCIAL the percentage of industry assets held by each financial
sector. Exhibit 5.1 shows the amount of assets held
SERVICES INDUSTRY
by various financial institutions in 2010. Assets in
The financial services industry consists of thousands the financial service industry totalled $60.8 trillion.
of financial institutions that provide financial products The banking sector held 27 percent of the total assets;
and services to the public. Financial institutions include the securities sector accounted for 21 percent of the
commercial banks, savings and loan institutions, credit assets; and the insurance industry held 11 percent
unions, life and health insurers, property and casualty of the total assets. However, this figure is somewhat
insurers, mutual funds, securities brokers and dealers, misleading and understates the relative financial
private and state pension funds, various government- importance of the insurance industry because private
related financial institutions, finance companies, and insurers also control a large amount of private pension
other financial firms. assets (shown separately in Exhibit 5.1).
There are various ways of measuring the relative The financial services industry is changing
importance of private insurance in the financial rapidly. Two trends clearly stand out—consolidation

87
88 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

Exhibit 5.1 United States.1 These insurers sell a variety of life

Assets of Financial Services Sectors, 2010 ($ billions) and health insurance products, annuities, mutual
funds, pension plans, and related financial products.
Insurance Exhibit 5.2 shows the top 17 U.S. life and health
$6,580.2
insurance groups ranked by revenues in 2010.
Other
In 2010, 2689 property and casualty insur-
Banking
$6,501.6 11% ers were also doing business in the United States.2
$16,492.2
11% These insurers sell property and casualty insurance
27%
and related lines, including inland marine coverages
and surety and fidelity bonds. Exhibit 5.3 shows the
Government- 14%
top 19 U.S. property and casualty insurers ranked by
related
$7,759.9 21% revenues in 2010.
17%
There are various ways of classifying insurance
companies. In terms of legal ownership and structure,
Pensions Securities
the major types of private insurers can be classified
$10,458.7 $13,007.6
as follows:
Note: Data are from the Board of Governors of the Federal Reserve System. ■ Stock insurers
Source: Insurance Information Institute, Financial Services Fact Book, 2012, p.v.
■ Mutual insurers
■ Lloyd’s of London
■ Reciprocal exchanges
■ Blue Cross and Blue Shield plans
and convergence of financial products and services. ■ Health maintenance organizations (HMOs)
Consolidation means that the number of firms in ■ Other types of private insurers
the financial services industry has declined over
time because of mergers and acquisitions. Because
of competitive reasons, the number of commercial Stock Insurers
banks, securities dealers and brokerage firms, life and A stock insurer is a corporation owned by stockholders.
health insurers, and property and casualty insurers has The objective is to earn profits for the stockholders.
declined significantly over time. The stockholders elect a board of directors, who in
Convergence means that financial institutions turn appoint executive officers to manage the corpora-
can now sell a wide variety of financial products that tion. The board of directors has ultimate responsibility
earlier were outside their core business area. Because for the corporation’s financial success. If the business
of the Financial Modernization Act of 1999, finan- is profitable, dividends can be declared and paid to the
cial institutions, including insurers, can now compete stockholders; the value of the stock may also increase.
in other financial markets that are outside their core Likewise, the value of the stock may decline if the busi-
business area. For example, many life insurers sell ness is unprofitable.
substantial amounts of life insurance and annuities
through banks. Some insurers have established banks
and savings institutions chartered by the Office of Mutual Insurers
Thrift Supervision (OTS). Other insurers have estab- A mutual insurer is a corporation owned by the
lished financial holding companies that allow them policyholders. There are no stockholders. The policy-
to engage in banking activities. holders elect a board of directors, who appoint
executives to manage the corporation. Because
relatively few policyholders bother to vote, the
TYPES OF PRIVATE INSURERS board of directors has effective management control
A large number of private insurers are currently of the company.
doing business in the United States. In 2010, 1061 A mutual insurer may pay dividends to the
life and health insurers were doing business in the policyholders or give a rate reduction in advance.
 TYPES OF PRIVATE INSURERS 89

Exhibit 5.2
Top U.S. Life/Health Insurance Groups by Revenues, 2010i ($ millions)

Rank Group Revenues Assets

1 MetLife $52,717 $730,906
2 Prudential Financial 38,414 539,854
3 New York Life Insurance 34,947 199,646
4 TIAA-CREF 32,225 417,332
5 Massachusetts Mutual Life Insurance 25,647 188,449
6 Northwestern Mutual 23,384 180,038
7 Aflac 20,732 101,039
8 Lincoln National 10,411 193,824
9 Unum Group 10,193 57,308
10 Genworth Financial 10,089 112,395
11 Guardian Life Insurance Co. of America 10,051 46,122
12 Principal Financial 9,159 145,631
13 Reinsurance Group of America 8,262 29,082
14 Thrivent Financial for Lutherans 7,471 62,760
15 Mutual of Omaha Insurance 5,724 24,986
16 Pacific Life 5,603 115,992
17 Western & Southern Financial Group 4,921 36,465
iRevenues for insurance companies include premium and annuity income, investment income and capital gains or losses but exclude deposits. Based on companies and
categories in the Fortune 500. Each company is assigned only one category, even if it is involved in several industries.
Source: Fortune; Insurance Information Institute, Financial Services Fact Book, 2012, p. 105.

Exhibit 5.3
Top U.S. Property/Casualty Companies by Revenues, 2010 ($ millions)

Rank Group Revenues Assets

1 Berkshire Hathaway $136,185 $372,229
2 American International Group 104,417 683,443
3 State Farm Insurance Cos. 63,177 192,794
4 Liberty Mutual lnsurance Group 33,193 112,350
5 Allstate 31,400 130,874
6 Travelers Cos. 25,112 105,181
7 Hartford Financial Services 22,383 318,346
8 Nationwide 20,265 148,702
9 United Services Automobile Association(USAA) 17,946 94,262
10 Progressive 14,963 21,150
11 Lowes(CNA) 14,621 76,277
12 Chubb 13,319 50,249
13 Assurant 8,528 26,397
14 Amarican Family Insurance Group 6,492 16,788
15 Fidelity National Finacial 5,740 7,888
16 Auto-Owners Insurance 5,396 15,316
17 Erie Insurance Group 4,890 14,344
18 [Link] 4,724 17,529
19 American Financial Group 4,497 32,454

Source: Fortune; Insurance Information Institute, Financial Services Fact Book, 2012, p. 89.
90 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

In life insurance, a dividend is largely a refund of a under the state’s insurance code, the insurer must
redundant premium that can be paid if the insurer’s have some type of social or religious organization in
mortality, investment, and operating experience existence. In addition, it must be a nonprofit entity
are favorable. However, because the mortality and that does not issue common stock; it must operate
investment experience cannot be guaranteed, divi- solely for the benefit of its members or beneficiaries;
dends legally cannot be guaranteed. and it must have a representative form of government
There are several types of mutual insurers, with a ritualistic form of work. Examples include the
including the following: Knights of Columbus, Woodmen of the World Life,
and Thrivent Financial.
■ Advance premium mutual
Fraternal insurers sell only life and health insur-
■ Assessment mutual
ance to their members. The assessment principle
■ Fraternal insurer
was used originally to pay death claims. Today,
most fraternal insurers operate on the basis of the
Advance Premium Mutual Most mutual insurers level premium method and legal reserve system that
are advance premium mutuals. An advance commercial life insurers use. Fraternal insurers also
premium mutual is owned by the policyholders; sell term life insurance and annuities. Because frater-
there are no stockholders, and the insurer does not nal insurers are nonprofit or charitable organizations,
issue assessable policies. Once the insurer’s surplus they receive favorable tax treatment.
(the difference between assets and liabilities)
exceeds a certain amount, the states will not permit Changing Corporate Structure of Mutual Insurers
a mutual insurer to issue an assessable policy. The The corporate structure of mutual insurers—especially
premiums charged are expected to be sufficient to life insurers—has changed significantly over time.
pay all claims and expenses. Any additional costs Three trends are clearly evident:
because of poor experience are paid out of the
1. Increase in company mergers. We noted ear-
company’s surplus.
lier that the number of active life insurers has
In life insurance, mutual insurers typically pay
declined significantly in recent years. Most
annual dividends to the policyholders. In property
of the decline is due to company mergers and
and casualty insurance, dividends to policyholders
acquisitions. A merger means that one insurer is
generally are not paid on a regular basis. Instead,
absorbed by another insurer or that two or more
such insurers may charge lower initial or renewal
existing insurers are blended into an entirely new
premiums that are closer to the actual amount needed
company. Mergers occur because insurers wish to
for claims and expenses.
reduce their operating costs and general overhead
costs. They also occur because some insurers wish
Assessment Mutual An assessment mutual has
to acquire a line of new insurance, enter a new
the right to assess policyholders an additional
area of business, or become larger and benefit
amount if the insurer’s financial operations are
from economies of scale.
unfavorable. Relatively few assessment mutual
2. Demutualization. Demutualization means that a
insurers exist today, partly because of the practical
mutual insurer is converted into a stock insurer.
problem of collecting the assessment. Those insur-
Some mutual insurers have become stock insur-
ers that still market assessable policies are smaller
ers for the following reasons:3
insurers that operate in limited geographical areas,
such as a state or county, and the coverages offered ■ The ability to raise new capital is increased.
are limited. ■ Stock insurers have greater flexibility to
expand by acquiring new companies or by
Fraternal Insurer A fraternal insurer is a mutual diversification.
insurer that provides life and health insurance to ■ Stock options can be offered to attract and
members of a social or religious organization. This retain key executives and employees.
type of insurer is also called a “fraternal benefit ■ Conversion to a stock insurer may provide tax
society.” To qualify as a fraternal benefit society advantages.
 TYPES OF PRIVATE INSURERS 91

3. Mutual holding company. Demutualization is ■ Critics also argue that a conflict of interest may
cumbersome, expensive, and slow, and it requires arise between top management and the policy-
the approval of regulatory authorities. As an holders. For example, top management may be
alternative, many states have enacted legislation given company stock or stock options for earn-
that allows a mutual insurer to form a hold- ing higher operating profits, which could result
ing company. A holding company is a company in lower dividends or higher premiums.
that directly or indirectly controls an authorized
insurer. A mutual insurer is reorganized as a hold-
Lloyd’s of London
ing company that owns or acquires control of
stock insurance companies that can issue common Lloyd’s of London is not an insurer, but is the
stock (see Exhibit 5.4). The mutual holding com- world’s leading insurance market that provides ser-
pany owns at least 51 percent of the subsidiary vices and physical facilities for its members to write
stock insurer if the latter issues common stock. specialized lines of insurance. It is a market where
members join together to form syndicates to insure
Mutual holding companies have both advantages
and pool risks. Members include some of the world’s
and disadvantages. Proponents present the following
major insurance groups and companies listed on
advantages:
the London Stock Exchange, as well as individuals
■ Insurers have an easier and less expensive way to (called Names), and limited partnerships.
raise new capital to expand or remain competitive. Lloyd’s is also famous for insuring unusual
■ Insurers can enter new areas of insurance more exposure units, such as a prize for a hole-in-one at
easily, such as a life insurer acquiring a property a golf tournament, or injury to a Kentucky Derby
and casualty insurer. horse-race winner. These unusual exposures, however,
■ Stock options can be given to attract and retain account for only a small part of the total business.
key executives and employees. Lloyd’s of London has several important charac-
teristics.4 First, as stated earlier, Lloyd’s technically is
Critics of mutual holding companies, however,
not an insurance company, but is a society of members
present the following counterarguments:
(corporations, individuals, and limited partnerships)
■ Policyholders could be financially hurt by the who underwrite insurance in syndicates. Lloyd’s by
change; the mutual holding structure could result itself does not write insurance; the insurance is actu-
in a reduction of dividends and other financial ally written by syndicates that belong to Lloyd’s. In
benefits to the policyholders. this respect, Lloyd’s conceptually is similar to the
New York Stock Exchange, which does not buy or
sell securities, but provides a marketplace and other
services to its members who buy and sell securities.
Exhibit 5.4 Second, as stated earlier, the insurance is written
Mutual Holding Company Illustration by the various syndicates that belong to Lloyd’s. At the
end of 2010, 85 syndicates were registered to conduct
Mutual business at Lloyd’s. Each syndicate is headed by a man-
Insurance Company aging agent who manages the syndicate on behalf of
the members who receive profits or bear losses in pro-
portion to their share in the syndicate. The syndicates
Mutual tend to specialize in marine, aviation, catastrophe,
Holding Company professional indemnity, and auto insurance coverages.
Also, Lloyd’s is a major player in the international
reinsurance markets. As noted earlier, the unusual
exposure units that have made Lloyd’s famous account
Stock Stock Stock for only a small fraction of the total business. Likewise,
Subsidiary A Subsidiary B Subsidiary C life insurance accounts only for a small fraction of the
total business and is limited to short-term contracts.
92 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

Third, new individual members or Names who members; each member of the reciprocal insures the
belong to the various syndicates now have limited other members and, in turn, is insured by them. Thus,
legal liability. Individual Names earlier had unlim- there is an exchange of insurance promises—hence the
ited legal liability and pledged their personal fortune name reciprocal exchange.
to pay their agreed-upon share of the insurance In addition, a reciprocal is managed by an
written as individuals. However, because of cata- attorney-in-fact. The attorney-in-fact is usually a
strophic asbestosis liability losses in the early 1990s, corporation that is authorized by the subscribers to
many Names could not pay their share of losses and seek new members, pay losses, collect premiums, han-
declared bankruptcy. As a result, no new Names with dle reinsurance arrangements, invest the funds, and
unlimited legal liability are admitted today. perform other administrative duties. However, the
Corporations with limited legal liability and attorney-in-fact is not personally liable for the pay-
limited liability partnerships are also members of ment of claims and is not the insurer. The reciprocal
Lloyd's of London. Corporations and partnerships exchange is the insurer.
were permitted to join Lloyd’s in order to raise new Most reciprocals are relatively small and account
capital, which has substantially increased the ability for only a small percentage of the total property and
of Lloyd’s to write new business. casualty insurance premiums written. In addition,
Members must also meet stringent financial most reciprocals specialize in a limited number of
requirements. Individual members are high net lines of insurance. However, a few reciprocals are
worth individuals. Each member, whether indi- multiple-line insurers that are large.
vidual or corporate, must supply capital to support
its underwriting at Lloyds. All premiums go into a
Blue Cross and Blue Shield Plans
premium trust fund, and withdrawals are allowed
only for claims and expenses. Members must also Blue Cross and Blue Shield plans are another
deposit additional funds if premiums do not cover type of insurer organization. In most states, Blue
the claims, and the venture is a loss. A central Cross plans generally are organized as nonprofit,
guarantee fund is also available to pay claims if the community-oriented prepayment plans that pro-
members backing a policy go bankrupt and cannot vide coverage primarily for hospital services. Blue
meet their obligations. Shield plans generally are nonprofit, prepayment
Finally, Lloyd’s is licensed only in a small number plans that provide payment for physicians’ and
of jurisdictions in the United States. In the other surgeons’ fees and other medical services. In recent
states, Lloyd’s must operate as a nonadmitted insurer. years, most Blue Cross and Blue Shield plans have
This means that a surplus lines broker or agent can merged into single entities. However, a few sepa-
place business with Lloyd’s, but only if the insurance rate Blue Cross plans and Blue Shield plans are still
cannot be obtained from an admitted insurer in the in operation.
state. Despite the lack of licensing, Lloyd’s does a Although most members are insured through
considerable amount of business in the United States. group plans, individual and family coverages are
In particular, Lloyd’s of London reinsures a large also available. Blue Cross and Blue Shield plans also
number of American insurers and is an important sponsor health maintenance organizations (HMOs)
professional reinsurer. and preferred provider organizations (PPOs).
In the majority of states, Blue Cross and Blue
Shield plans are nonprofit organizations that receive
Reciprocal Exchange
favorable tax treatment and are regulated under spe-
A reciprocal exchange is another type of private cial legislation. However, to raise capital and become
insurer. A reciprocal exchange (also called an more competitive, some Blue Cross and Blue Shield
interinsurance exchange) can be defined as an plans have converted to a for-profit status with
unincorporated organization in which insurance is stockholders and a board of directors. In addition,
exchanged among the members (called subscribers). many nonprofit Blue Cross and Blue Shield plans
In its basic form, insurance is exchanged among the own profit-seeking affiliates.
 AGENTS AND BROKERS 93

Health Maintenance Organizations states: Massachusetts, New York, and Connecticut.

Today, SBLI is also sold to consumers over the phone
HMOs are organized plans of health care that
or through Web sites in those states, and to con-
provide comprehensive health-care services to their
sumers who reside in other states as well, including
members. HMOs provide broad health-care services
Maine, New Hampshire, New Jersey, Pennsylvania,
to a specified group for a fixed prepaid fee; however,
and Rhode Island. The objective of SBLI is to pro-
many HMOs today also have cost-sharing provi-
vide low-cost life insurance to consumers by holding
sions, such as deductibles and copayments, and cost
down operating costs and the payment of high sales
control is heavily emphasized. In addition, the choice
commissions to agents. SBLI is discussed in greater
of health-care providers may be restricted, and less
detail in Chapter 11.
costly forms of treatment are often provided. The
characteristics of HMOs will be discussed in greater
detail in Chapter 16.
AGENTS AND BROKERS
A successful sales force is the key to success in the
Other Private Insurers
financial services industry. Most insurance policies
In addition to the preceding, other types of private sold today are sold by agents and brokers.
insurers merit a brief discussion. These include cap-
tive insurers and savings bank life insurance.
Agents
Captive Insurers As noted in Chapter 3, a captive When you buy insurance, you will probably purchase
insurer is an insurer owned by a parent firm for the the insurance from an agent. An agent is someone
purposes of insuring the parent firm's loss exposures. who legally represents the principal and has the
There are different types of captive insurers. A single authority to act on the principal’s behalf. The princi-
parent captive (also called a pure captive) is an insurer pal represented is the insurance company.
owned by one parent, such as a corporation. The cap- An agent has the authority to represent the insurer
tive can be an association captive, which is owned by based on express authority, implied authority, and
several parents. For example, business firms that belong apparent authority. Express authority refers to the
to a trade association may own a captive insurer. specific powers that the agent receives from the insurer.
Captive insurers are becoming more important Implied authority means the agent has the authority
in commercial property and casualty insurance, to perform all incidental acts necessary to exercise the
and thousands of captive insurers exist today. As powers that are expressly given. Apparent authority is
noted in Chapter 3, captive insurers are formed the authority the public reasonably believes the agent
because (1) a parent firm may have difficulty in possesses based on the actions of the principal.5 The
obtaining insurance; (2) some captives are formed principal is legally responsible for the acts of an agent
offshore to take advantage of a favorable regulatory whenever the agent is acting within the scope of express,
environment; (3) the parent’s insurance costs may be implied, or apparent authority. This includes wrongful
lower; (4) a captive insurer makes access to reinsur- and fraudulent acts, omissions, and misrepresentations
ers easier; (5) the captive insurer may be a source of so long as the agent is acting within the scope of his or
profit to the parent if other parties are insured as well; her authority granted or implied by the principal.6
and (6) there may be income-tax advantages to the There is an important difference between a prop-
parent under certain conditions. The characteristics erty and casualty insurance agent and a life insurance
of captives have already been discussed in Chapter 3, agent. A property and casualty agent has the power to
so additional treatment is not needed here. bind the insurer immediately with respect to certain
types of coverage. This relationship can be created by
Savings Bank Life Insurance Savings Bank Life a binder, which is temporary insurance until the policy
Insurance (SBLI) refers to life insurance that was is actually written. Binders can be oral or written.
sold originally by mutual savings banks in three For example, if you telephone an agent and request
94 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

INSIGHT 5.1
Show Me the Money—How Much Do Insurance Sales Agents Earn?
The median annual wage of insurance sales agents was of the commission depends on the type and amount of insur-
$46,770 in May 2010. The median wage is the wage at which ance sold and on whether the transaction is a new policy or a
half the workers in an occupation earned more than that renewal. When agents meet their sales goals or when an agency
amount and half earned less. The lowest 10 percent earned meets its profit goals, agents usually get bonuses. Some agents
less than $25,940, and the top 10 percent earned more than involved with financial planning receive a fee for their services,
$115,340. rather than a commission.
Many independent agents are paid by commission only. Insurance sales agents usually determine their own hours
Sales workers who are employees of an agency or an insur- of work and often schedule evening and weekend appointments
ance carrier may be paid in one of three ways: salary only, for the convenience of their clients. Some sales agents meet with
salary plus commission, or salary plus bonus. clients during business hours and then spend evenings doing
In general, commissions are the most common form of paperwork and preparing presentations to prospective clients. Most
compensation, especially for experienced agents. The amount agents work full-time and some work more than 40 hours per week.

Insurance Sales Agents

Median annual wages, May 2010

Insurance Sales Agents $46,770

Total, All Occupations $33,840

Sales and Related $24,370

Occupations

Note: All Occupations includes all occupations in the U.S. Economy.

Source: U.S. Bureau of Labor Statistics, Occupational Employment Statistics

Source: Excerpted from Bureau of Labor Statistics, U.S. Department of Labor, Occupational Outlook Handbook, 2012–13 Edition, Insurance Sales Agents, on the
Internet at [Link] (visited March 30, 2012).

insurance on your motorcycle, the agent can make Brokers

the insurance effective immediately. In contrast, a life
In contrast to an agent who represents the insurer, a
insurance agent normally does not have the author-
broker is someone who legally represents the insured
ity to bind the insurer. The agent is merely a soliciting
even though he or she receives a commission from the
agent who induces persons to apply for life insurance.
insurer. A broker legally does not have the authority to
The applicant for life insurance must be approved by
bind the insurer. Instead, he or she can solicit or accept
the insurer before the insurance becomes effective.
applications for insurance and then attempt to place the
Finally, some college students have an interest in
coverage with an appropriate insurer. But the insurance
insurance sales as a career. Insight 5.1 discusses the
is not in force until the insurer accepts the business.
earnings of insurance agents for 2010.
 TYPES OF MARKETING SYSTEMS 95

As stated earlier, a broker is paid a commission by modified, and new marketing models have emerged.
insurers where the business is placed. Many brokers are It is beyond the scope of the text to discuss all dis-
also licensed as agents, so that they have the authority tribution methods in detail. However, the major life
to bind their companies when acting as agents. insurance distribution systems used today can be
Brokers are extremely important in commercial classified as follows:7
property and casualty insurance. Large brokerage
■ Personal selling systems
firms have knowledge of highly specialized insurance
■ Financial institution distribution systems
markets, provide risk management and loss-control
■ Direct response system
services, and handle the accounts of large corporate
■ Other distribution systems
insurance buyers.
Brokers are also important in the surplus lines
Personal Selling Systems The majority of life
markets. Surplus lines refer to any type of insurance
insurance policies and annuities sold today are
for which there is no available market within the state,
through personal selling distribution systems, which
and the coverage must be placed with a nonadmitted
are systems in which commissioned agents solicit and
insurer. A nonadmitted insurer is an insurer not licensed
sell life insurance products to prospective insureds.
to do business in the state. A surplus lines broker is a
Life insurance and annuities are complex products,
special type of broker who is licensed to place business
and knowledgeable agents are needed to explain and
with a nonadmitted insurer. An individual may be
sell the various products. Personal selling distribution
unable to obtain the coverage from an admitted insurer
systems include the following:
because the loss exposure is too great, or the required
amount of insurance is too large. A surplus lines broker ■ Career agents. Career agents are full-time agents
has the authority to place the business with a surplus who usually represent one insurer and are paid
lines insurer if the coverage cannot be obtained in the on a commission basis. These agents are also
state from an admitted company. called affiliated agents because they sell primar-
Finally, brokers are important in the area of ily the life insurance products of a single insurer.
employee benefits, especially for larger employ- Under this system, insurers recruit new agents
ers. Large employers often obtain their group life and provide financing, training, supervision, and
and medical expense coverages through brokers. As office facilities. Commissions on the sale of life
indicated earlier, brokers also play a major role in insurance typically range from 40 to 90 percent
the marketing of property and casualty insurance to of the first-year’s premium. Renewal commis-
large national accounts. sions for policies in force are much lower, such
as 2 to 5 percent, and are paid for a limited
number of years. Despite aptitude tests, the attri-
tion rate for new life insurance agents is high.
TYPES OF MARKETING SYSTEMS The five-year retention rate is typically less than
Marketing systems refer to the various methods for 15 percent for many insurers.
selling and marketing insurance products. These meth- ■ Multiple Line Exclusive Agency System. Under
ods of selling are also called distribution systems. this system, agents who sell primarily property
Insurers employ actuaries, claims adjusters, underwrit- and casualty insurance also sell individual life
ers, and other home office personnel, but unless insur- and health insurance products. These agents are
ance policies are profitably sold, the insurer’s financial also called captive agents. Under this system,
survival is unlikely. Thus, an efficient distribution sys- agents represent only one insurer or group of
tem is essential to an insurance company’s survival. insurers that are financially interrelated or under
common ownership. For example, an agent may
sell an auto or homeowners policy to a client.
Life Insurance Marketing
Depending on the client’s needs and insurance
Distribution systems for the sale of life insurance have products available, the agent can also sell life
changed dramatically over time. Traditional methods insurance, health insurance, annuities, mutual
for selling life insurance have been substantially funds, individual retirement accounts, and other
96 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

products as well. State Farm Mutual and Allstate face-to-face meeting with an agent. Potential customers
are examples of this system. are solicited by television, radio, mail, newspapers,
■ Independent Property and Casualty Agents . and the Internet. Some insurers use telemarketing to
Independent property and casualty agents sell their products while others advertise extensively
are independent contractors who represent on television. Many insurers have Web sites through
several insurers and sell primarily property and which life and health insurance can be sold directly to
casualty insurance. In addition to property and the consumer.
casualty insurance, many independent agents The direct response system has several advantages
also sell life and health insurance to their clients. to insurers. Insurers gain access to large markets;
■ Personal-Producing General Agent (PPGA). Some acquisition costs can be held down; and uncompli-
independent agents place substantial amounts cated products, such as term insurance, can be sold
of business with one insurer and enter into a effectively. One disadvantage, however, is that com-
special financial arrangement with that insurer. plex products are often difficult to sell because an
A personal-producing general agent (PPGA) is an agent’s services may be required.
independent agent who receives special financial
consideration for meeting minimum sales require- Other Distribution Systems Life insurers also use
ments. PPGAs often have the option of recruiting a variety of additional distribution systems to sell
and training sub-agents. In such cases, the PPGA their products. They include the following:
receives an overriding commission based on the
amount of insurance sold by the sub-agents.8 ■ Worksite Marketing. Under this system, indi-
■ Brokers. Life insurance and annuities are also vidual producers go into a business firm, and,
sold by brokers. Brokers are independent agents with the approval of management, conduct sales
who do not have an exclusive contract with any interviews on site with employees interested in
single insurer or an obligation to sell the insur- purchasing life insurance products or annuities.
ance products of a single insurer. Although There are few direct costs or fees to employers,
brokers may place a substantial amount of and this method is especially appropriate for
business with a particular insurer, they have no low-income and middle-income markets.
obligation to sell a certain amount of insurance ■ Stock Brokers. Many stock brokers are also
for that insurer.9 Brokers usually enter into sepa- licensed to sell life insurance products and fixed
rate agency contracts with each insurer in which and variable annuities. As a result, stock brokers
business is placed. can better meet both the investment needs and
life insurance needs of clients.
■ Financial Planners. Financial planners provide
Financial Institution Distribution Systems Many advice to clients on investments, estate planning,
insurers today use commercial banks and other taxation, wealth management, and insurance.
financial institutions as a distribution system to mar- Some financial planners are licensed to sell life
ket life insurance and annuity products. Commerical insurance, and many career life insurance agents
banks are becoming increasingly more important in are also financial planners who offer financial
the marketing of fixed and variable annuities, and to planning in their analysis of needs.
a lesser degree, life insurance.
In addition, other financial institutions and Property and Casualty Insurance Marketing
investment firms, such as Charles Schwab, Fidelity
Investments, and The Vanguard Group, also make The major distribution systems for marketing prop-
life insurance products and annuities available to erty and casualty insurance include the following:
their clients. ■ Independent agency system
■ Exclusive agency system
Direct Response System The direct response system ■ Direct writer
is a marketing system by which life and health insur- ■ Direct response system
ance products are sold directly to consumers without a ■ Multiple distribution systems
 TYPES OF MARKETING SYSTEMS 97

Independent Agency System The independent agency contract is in force. In addition, the contract
agency system, which is sometimes called the American usually permits the insurer to buy the expiration list
agency system, has several basic characteristics. from the exclusive agent to establish its value if the
First, the independent agency is a business firm that agency contract is terminated.10 In contrast, under
usually represents several unrelated insurers. Agents the independent agency system, the agency has com-
are authorized to write business on behalf of these plete ownership of the expirations.
insurers and in turn are paid a commission based on Another difference is the payment of commis-
the amount of business produced. sions. Exclusive agency insurers generally pay a lower
Second, the agency owns the expirations or commission rate on renewal business than on new
renewal rights to the business. If a policy comes up business. This approach results in a strong financial
for renewal, the agency can place the business with incentive for the agent to write new business and is
another insurer if it chooses to do so. Likewise, if the one factor that helps explain the historical growth of
contract with an insurer is terminated, the agency exclusive agency insurers. In contrast, as noted ear-
can place the business with other insurers that the lier, insurers using the independent agency system
agency represents. typically pay the same commission rate on new and
Third, the independent agent is compensated renewal business.
by commissions that vary by line of insurance. The Also, exclusive agency insurers provide strong
commission rate on renewal business generally is support services to new agents. A new agent usually
the same as that paid on new business. If a lower starts as an employee during a training period to
renewal rate were paid, the insurer may lose learn the business. After the training period, the agent
business, because the agent would have a financial becomes an independent contractor who is then paid
incentive to place the insurance with another insurer on a commission basis.
at the time of renewal.
In addition to selling, independent agents perform Direct Writer As stated earlier, insurers that use
other functions. They are frequently authorized to the exclusive agency system are also called direct
adjust small claims. Larger agencies may also provide writers by the trade press and property and casualty
loss control services to their insureds, such as accident insurers. However, there is a technical distinction
prevention and loss control engineers. Also, for some between them. Technically, a direct writer is an
lines, the agency may bill the policyholders and col- insurer in which the salesperson is an employee of
lect the premiums. However, most insurers use direct the insurer, not an independent contractor. The
billing, by which the policyholder is billed directly by insurer pays all the selling expenses, including the
the insurer. This is particularly true of personal lines employee’s salary. Similar to exclusive agents, an
of insurance, such as auto and homeowners. employee of a direct writer usually represents only
one insurer.
Exclusive Agency System Under the exclusive Employees of direct writers are usually com-
agency system, the agent represents only one insurer pensated on a “salary plus” arrangement. Some
or a group of insurers under common ownership. companies pay a basic salary plus a commission
The agent may be prohibited by contract from rep- directly related to the amount of insurance sold.
resenting other insurers. In the property and casualty Others pay a salary and a bonus that represent both
industry, insurers that use this system are also called selling and service activities of the employee. In con-
“direct writers.” However, as discussed later, there is trast, the agents that sell for exclusive agency insurers,
a technical distinction between the exclusive agency such as State Farm and Allstate, generally, are not
system and direct writers. salaried employees but are independent contractors
Agents under the exclusive agency system do not who are paid commissions based on the amount of
usually own the expirations or renewal rights to the business produced.
policies. There is some variation, however, in this
regard. Some insurers do not give their agents any Direct Response System Property and casualty
ownership rights in the expirations. Other insurers insurers also use the direct response system to sell
may grant limited ownership of expirations while the insurance. A direct response insurer sells directly to
98 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

the public by television, telephone, mail, newspapers, GROUP INSURANCE MARKETING

and other media. Property and casualty insurers also
operate Web sites that provide considerable con- In addition to the preceding, many insurers use group
sumer information and premium quotes. marketing methods to sell individual insurance poli-
The direct response system is used primarily to cies to members of a group. These groups include
sell personal lines of insurance, such as auto and employers, labor unions, trade associations, and other
homeowners insurance. It is not as useful in the mar- groups. In particular, substantial amounts of new
keting of commercial property and casualty cover- individual life insurance, annuities, long-term-care
ages because of complexity of contracts and rating insurance, and other financial products are sold to
considerations. employees in employer–employee groups. Employees
pay for the insurance by payroll deduction. Workers
no longer employed can keep their insurance in force
Multiple Distribution Systems The distinctions by paying premiums directly to the insurer.
between the traditional marketing systems are Life insurers typically sell and service group life
breaking down as insurers search for new ways insurance products through group representatives
to sell insurance. To increase their profits, many who are employees who receive a salary and incen-
property and casualty insurers use more than one tive payments based on group sales, persistency, and
distribution system to sell insurance. These systems profitability of the business.
are referred to as multiple distribution systems. For Some property and casualty insurers use mass
example, some insurers that have traditionally used merchandising plans to market their insurance. Mass
the independent agency system now sell insurance merchandising is a plan for selling individually under-
directly to consumers over the Internet or by televi- written property and casualty coverages to group
sion and mail advertising. Other insurers that have members; auto and homeowners insurance are popular
used only exclusive agents (also called captive agents) lines that are frequently used in such plans. As noted
in the past to sell insurance are now using inde- earlier, individual underwriting is used, and applicants
pendent agents as well. Other insurers are marketing must meet the insurer’s underwriting standards. Rate
property and casualty insurance through banks and discounts may be given because of a lower commission
to consumer groups through employers and through scale for agents and savings in administrative expenses.
professional and business associations. The lines In addition, employees typically pay for the insurance
between the traditional distribution systems will con- by payroll deduction. Finally, employers do not usually
tinue to blur in the future as insurers develop new contribute to the plans; any employer contributions
systems to sell insurance. result in taxable income to the employees.

Case Application
Commercial Insurance is a large stock property and lia- would each of the following objectives of the board of
bility insurer that specializes in the writing of commercial directors be met by formation of a mutual property and
lines of insurance. The board of directors has appointed casualty insurer? Treat each objective separately.
a committee to determine the feasibility of forming a new a. Commercial Insurance must legally own the new
subsidiary insurer that would sell only personal lines of insurer.
insurance, primarily homeowners and auto insurance. b. The new insurer should be able to sell common
The new insurance company would have to meet cer- stock periodically in order to raise capital and
tain management objectives. One member of the board expand into new markets.
of directors believes the new insurer should be legally c. The policies sold should pay dividends to the
organized as a mutual insurer rather than as a stock policyholders.
insurer. Assume you are an insurance consultant who is d. The new insurer should be licensed to do business
asked to serve on the committee. To what extent, if any, in all states.
 REVIEW QUESTIONS 99

SUMMARY Captive insurer (93) Multiple line exclusive

Demutualization (90) agency system (95)
■ There are several basic types of insurers: Direct response system (96) Mutual insurer (88)
Stock insurers Direct writer (97) Nonadmitted insurer (95)
Mutual insurers Exclusive agency system (97) Personal-producing general
Lloyd’s of London Fraternal insurer (90) agent (96)
Reciprocal exchange Holding company (91) Personal selling
Independent agency systems (95)
Blue Cross and Blue Shield Plans
system (97) Reciprocal exchange (92)
Health maintenance organizations (HMOs) Lloyd’s of London (91) Savings bank life insurance
Captive insurers Mass merchandising (98) (SBLI) (93)
Savings bank life insurance Multiple distribution Stock insurer (88)
■ An agent is someone who legally represents the insurer and systems (98) Surplus lines broker (95)
has the authority to act on the insurer’s behalf. In contrast,
a broker is someone who legally represents the insured.
■ Surplus lines refer to any type of insurance for which there REVIEW QUESTIONS
is no available market within the state, and the coverage 1. Describe the basic characteristics of stock insurers.
must be placed with a nonadmitted insurer. A nonadmit-
ted insurer is a company not licensed to do business in the 2. a. Describe the basic features of mutual insurers.
state. A surplus lines broker is a special type of broker who b. Identify the major types of mutual insurers.
is licensed to place business with a nonadmitted insurer. 3. The corporate structure of mutual insurers has
■ Several distribution systems are used to market life changed over time. Briefly describe several trends
insurance. They include: that have had an impact on the corporate structure of
mutual insurers.
Personal selling systems
Financial institution distribution systems 4. Explain the basic characteristics of Lloyd’s of London.
Direct response system 5. Describe the basic characteristics of a reciprocal
Other distribution systems exchange.

■ Several distribution systems are used to market property 6. Explain the legal distinction between an agent and
and casualty insurance. They include: a broker.
Independent agency system 7. Describe briefly the following distribution systems in
Exclusive agency system the marketing of life insurance.
a. Personal selling systems
Direct writer
b. Financial institution distribution systems
Direct response system c. Direct response system
Multiple distribution systems d. Other distribution systems
■ Many insurers use group insurance marketing methods to 8. Describe briefly the following distribution systems in
sell individual insurance policies to members of a group. the marketing of property and casualty insurance.
Employees typically pay for the insurance by payroll deduc- a. Independent agency system
tion. Workers no longer employed can keep their insurance b. Exclusive agency system
in force by paying premiums directly to the insurer. c. Direct writer
d. Direct response system
e. Multiple distribution systems
KEY CONCEPTS AND TERMS 9. Who owns the policy expirations or the renewal rights
Advance premium Assessment mutual (90) to the business under the independent agency system?
mutual (90) Broker (94) 10. What is a mass-merchandising plan in property and
Agent (93) Captive agent (95) liability insurance?
100 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

APPLICATION QUESTIONS 5. Property and casualty insurance can be marketed

under different marketing systems. Compare the inde-
1. A group of investors are discussing the formation of pendent agency system with the exclusive agency sys-
a new property and liability insurer. The proposed tem with respect to each of the following:
company would market a new homeowners policy a. Number of insurers represented by the agent
that combines traditional homeowner coverages with b. Ownership of policy expirations
unemployment benefits if the policyholder becomes c. Differences in the payment of commissions
involuntarily unemployed. Each investor would contrib-
ute at least $100,000 and would receive a proportionate
interest in the company. In addition, the company would
raise additional capital by selling ownership rights to
INTERNET RESOURCES
other investors. Management wants to avoid the expense ■ The American College is an accredited, nonprofit
of hiring and training agents to sell the new policy and educational institution that provides graduate and
wants to sell the insurance directly to the public by selec- undergraduate education, primarily on a distance
tive advertising in personal finance magazines. learning basis, to people in the financial services field.
a. Identify the type of insurance company that best The organization awards the professional Chartered
fits the above description. Life Underwriter (CLU) designation, the Chartered
b. Identify the marketing system that management is Financial Consultant (ChFC) designation, and other
considering adopting. professional designations. Visit the site at
2. Compare a stock insurer to a mutual insurer with [Link]
respect to each of the following:
a. Parties who legally own the company ■ The American Council of Life Insurers (ACLI) represents the
b. Right to assess policyholders additional premiums life insurance industry on issues dealing with legislation
c. Right of policyholders to elect the board of directors and regulation. ACLI also publishes statistics on the life
insurance industry in an annual fact book. Visit the site at
3. A luncheon speaker stated that “the number of life
[Link]
insurers has declined sharply during the past decade
because of the increase in company mergers and acqui-
sitions, demutualization of insurers, and formation of ■ The American Fraternal Alliance is the recognized leader
mutual holding companies.” in the fraternal benefit system. The Fraternal Alliance is
a. Why have mergers and acquisitions among insurers the voice of fraternal benefit societies on legislative and
increased over time? regulatory issues. Visit the site at
b. What is the meaning of demutualization? [Link]
c. Briefly explain the advantages of demutualization
of a mutual life insurer. ■ The American Insurance Association (AIA) is an impor-
d. What is a mutual holding company? tant trade association that represents property and
e. What are the advantages of a mutual holding com- casualty insurers. The site lists available publications,
pany to an insurer? position papers on important issues in property and
4. A newspaper reporter wrote that “Lloyds of London casualty insurance, press releases, insurance-related
is an association that provides physical facilities and links, and names of state insurance commissioners.
services to the members for selling insurance. The Visit the site at
insurance is underwritten by various syndicates who [Link]
belong to Lloyd’s.” Describe Lloyd’s of London with
respect to each of the following: ■ The Insurance Information Institute (III) has an excellent
a. Liability of individual members and corporations site for obtaining information on the property and
b. Types of insurance written casualty insurance industry. It provides timely consumer
c. Financial safeguards to protect insureds information on auto, homeowners, and commercial
 SELECTED REFERENCES 101

insurance, and other types of property and casualty services field, conducts research, and produces a wide
insurance. Visit the site at range of publications. Visit the site at
[Link] [Link]

■ The Insurance Information Institute (III) also publishes ■ Lloyd’s of London provides a considerable amount of
an online fact book on the financial services industry. information about its history and chronology, global
The publication provides detailed financial information insurance operations, financial results, and key events
on the role of insurers in the financial services industry. on its Web site. The site also provides information to
Visit the site at the news media. Visit the site at
[Link]/financial [Link]

■ The Institutes (also known as the American Institute for ■ The National Association of Mutual Insurance
CPCU) is an independent, nonprofit organization that Com panies is a trade association that represents
offers educational programs and professional certifica- mutual property and casualty insurance companies.
tion to people in all segments of the property and casu- Visit the site at
alty insurance business. The organization awards the [Link]
professional CPCU designation and other designations.
Visit the site at ■ Towers Watson is one of the world’s largest actuarial and
[Link] management consulting firms. Towers Watson provides
a substantial amount of information on the insurance
■ The Insurance Journal is a definitive online source of industry and advises other organizations on risk financing
timely information on the property/casualty industry. A and self-insurance. Visit the site at
free online newsletter is available that provides breaking [Link]
news on important developments in property and casu-
alty insurance. Visit the site at
[Link]
SELECTED REFERENCES
■ [Link] provides a considerable amount of timely Black, Kenneth, Jr., and Harold D. Skipper, Jr. Life
information on the insurance industry. The stories Insurance, 13th ed. Upper Saddle River, NJ: Prentice-
reported are directed toward insurance consumers. Hall, 2000, chs. 23–24.
Consumers can get premium quotes on life, health, The Financial Services Fact Book 2012, New York:
auto, and homeowners insurance. Visit the site at Insurance Information Institute, 2012.
Graves, Edward E., ed. McGill’s Life Insurance, 8th ed. Bryn
[Link]
Mawr, PA: The American College, 2011; chs. 22–23.
The Insurance Fact Book 2012, New York: Insurance
■ InsWeb offers insurance quotes from the nation’s
Information Institute, 2012.
strongest insurers. You can obtain quotes for auto and
Life Insurers Fact Book, 2011, Washington, DC: American
homeowners insurance, term life insurance, individual
Council of Life Insurers, 2011.
health insurance, and other products as well. Visit the
LOMA (Life Office Management Association), Insurance
site at
Company Operations, 3 rd ed., Atlanta, GA: LL
[Link] Global, Inc. 2012, Ch. 11.
Viswanathan, Krupa S., and J. David Cummins,
■ LIMRA is the principal source of industry sales and “Ownership Structure Changes in the Insurance
marketing statistics in life insurance. Its site provides Industry: An Analysis of Demutualization,” Journal of
news and information about LIMRA and the financial Risk and Insurance, Vol. 70, No. 3 (September 2003),
pp. 401–437.
102 CHAPTER 5 / TYPES OF INSURERS AND MARKETING SYSTEMS

NOTES 8. LOMA, Insurance Company Operations, 3rd ed.,

p. 11.8.
1. Insurance Information Institute, The Insurance Fact 9. Ibid., p. 11.8.
Book 2012, (New York: Insurance Information 10. Constance M. Luthardt and Eric A. Wiening, Property
Institute, 2012), p.v. and Liability Insurance Principles, 4th ed., 5th print-
2. Ibid. ing (Malvern, PA: American Institute for Chartered
3. Edward E. Graves, ed., McGill's Life Insurance, 8th ed. Property Casualty Underwriters/Insurance Institute of
(Bryn Mawr, PA: The American College, 2011), America), 2005, p. 4.11.
pp. 22.9–22.11.
4. This section is based on Lloyd's Quick Guide 2011,
Lloyd’s of London at [Link] and Lloyd’s of
London, Wikipedia, the free encyclopedia.
5. Edward E. Graves, and Burke A. Christensen, McGill’s Students may take a self-administered test on
Legal Aspects of Life Insurance, 7th ed. (Bryn Mawr, this chapter at
PA: The American College, 2010), pp. 6.3–6.5. [Link]/rejda
6. Ibid., p. 6.7.
7. This section is based on LOMA (Life Office
Management Association). Insurance Company
Operations, 3rd ed. (Atlanta, GA: LL Global, Inc.
2012), Ch. 11; and Graves, McGill’s Life Insurance,
Ch. 23.