FIN 3610

FIN 3610

When appropriate, provide a citation and a copy of your source.

1. a. Describe the basic characteristics of stock insurers.

A stock insurer is a corporation owned by stockholders who participate in the profits and losses of the company. The stockholders elect a board of directors who appoint the executive officers to run the company. The board of directors has the ultimate responsibility for the company’s financial success.

b. Describe the basic features of mutual insurers.

A mutual insurer is a corporation owned by the policyholders. The policyholders elect the board of directors who appoint the executives to manage the company. Because relatively few policyholders bother to vote, the board of directors has effective management control of the company. A mutual insurer may pay a dividend or give a rate reduction in advance. In life insurance, a dividend is largely a refund of a redundant premium that can be paid if the mortality, investment, and operating experience of the company is favorable. Dividends, however, cannot be guaranteed.

c. Identify the major types of mutual insurers.
Mutual insurers include advance premium mutuals and assessment mutuals.

2. Property and casualty insurance can be marketed under different marketing systems. Compare the independent agency system with the exclusive agency system with respect to each of the following:

a. Number of insurers represented by the agent

The independent agent represents several insurers. The exclusive agent represents only one insurer or a group of insurers under common ownership.

b. Ownership of policy expirations

Under the independent agency system, the agency owns the expirations or renewal rights to the business. Under the exclusive agency system, agents usually do not own the expirations renewal rights to the policies. However, some insurers may grant limited ownership of the expirations while the agency contract is in force; this interest terminates when the agency contract is terminated. In addition, the contract usually permits the insurer to buy the expiration list from the exclusive agent to establish its value if the agency contract is terminated. In contrast, under the independent agency system, the agency has complete ownership of the expirations.
c. Differences in the payment of commissions
Independent agents are compensated by commissions that vary by line of insurance. The commission rate on renewal business is typically the same as that paid on new business. If a lower renewal rate is paid, the insurer may lose business, because the agent would place the insurance with another insurer at the time of renewal. Exclusive agency insurers generally pay a lower commission rate on renewal business than on new business. This approach gives the agent a financial incentive to write new business that pays a higher commission rate. In contrast, as noted earlier, insurers using the independent agency system typically pay the same commission rate on new and renewal business.

3. You have just learned that “the number of life insurers has declined sharply during the past decade because of the increase in company mergers and acquisitions, demutualization of insurers, and formation of mutual holding companies.”

a. How many life insurers are there currently in the U.S.? How many life insurance companies were there in 1970? Provide a citation and a copy of your source. Need answer..

b. Why have mergers and acquisitions among insurers increased over time?
Mergers and acquisitions have increased because insurers wish to reduce their operating costs and overhead expenses; also, mergers and acquisitions occur because some insurers want to acquire a new line of insurance or enter a new area of business.

c. What is the meaning of demutualization?
Demutualization means that a mutual insurer is converted into a stock insurer.

d. Briefly explain the advantages of demutualization of a mutual life insurer.
Demutualization increases the ability of an insurer to raise new capital, provides greater flexibility to expand, makes it possible to grant stock options to key employees, and may provide tax advantages

e. What is a mutual holding company?
Because demutualization is slow, some mutual insurers have been reorganized as a holding company. A holding company is a company that directly or indirectly controls an authorized insurer. A mutual insurer is reorganized as a holding company that owns or acquires control of a stock insurance company that could issue common stock. The mutual holding company would own at least 51 percent of the subsidiary stock insurer if the latter issues common stock.

f. What are the advantages of a mutual holding company to an insurer?
Holding companies make it easier for insurers to raise new capital, to enter new areas of insurance more easily, and to grant stock options to key employees.

4. Commercial Insurance is a large stock property and liability insurer that specializes in the writing of commercial lines of insurance. The board of directors has appointed a committee to determine the feasibility of forming a new subsidiary insurer that would sell only personal lines of insurance, primarily homeowners and auto insurance. The new insurance company would have to meet certain management objectives. One member of the board of directors believes the new insurer rather than as a stock insurer. Assume you are an insurance consultant who is asked to serve on the committee. To what extent, if any, would each of the following objectives of the board of directors be met by formation of a mutual property and casualty insurer? Treat each objective separately.

a. Commercial Insurance must legally own the new insurer.
A mutual insurer has no stockholders and is legally owned by the policyholders. Thus, the objective of legal ownership by Commercial Insurance would not be met if the new subsidiary were organized as a mutual insurer. The new subsidiary should be organized as a stock insurer, and Commercial Insurance should own the common stock of such insurer.

b. The new insurer should be able to sell common stock periodically in order to raise capital and expand into new markets.
It is difficult to raise new capital as a mutual insurer because there are no stockholders. If additional capital is needed in the future, the new subsidiary should be organized as a stock insurer. New common stock could be sold to existing stockholders to raise the additional capital needed.

c. The policies sold should pay dividends to the policyholders.
A mutual property and casualty insurer would meet this objective. If the operating experience is favorable, a dividend to the policyholders could be paid.

d. The new insurer should be licensed to do business in all states.
A mutual property and casualty insurer would meet this objective if the licensing requirements in all states are met. A stock insurer would also meet this objective.