Insurance is a method of managing the financial risk associated with covered losses caused by specific perils. This process works by transferring the risk of loss from the insured to the insurer in exchange for the payment of a premium. Insurance operates effectively because of the law of large numbers, which allows insurers to predict future losses with greater accuracy when a large number of similar exposure units are insured. By spreading risk across many policyholders, insurers are able to estimate potential losses and provide financial protection against covered claims.
Most insurance coverage is obtained from private insurance companies through the voluntary market, also known as the standard market, where insurers choose which risks they are willing to insure. When coverage is unavailable through the voluntary market, insurance may also be obtained through government insurance programs or residual market mechanisms, which serve as markets of last resort for higher-risk or hard-to-insure applicants.
There are several types of private insurance companies. A stock insurance company is owned by its shareholders or stockholders, while a mutual insurance company is owned by its policyholders. A fraternal benefit society is a nonprofit or charitable organization that provides insurance benefits to its members, typically based on a common affiliation or membership. A reciprocal insurance company is an unincorporated association in which subscribers agree to insure and share each other's risks. In addition, insurance companies may purchase reinsurance, which is insurance obtained by insurers to help protect themselves against large or catastrophic losses.
A domestic insurer is an insurance company organized under the laws of the state in which it operates. A foreign insurer is an insurance company formed under the laws of another state, district, or U.S. territory. An alien insurer is an insurance company organized under the laws of a country outside the United States. An insurer is considered admitted, or authorized, in a state when it has received a certificate of authority from that state's department of insurance permitting it to transact insurance business there. Non-admitted or unauthorized insurers that are allowed to provide coverage for risks that admitted insurers are unwilling or unable to insure are known as surplus lines insurers.
Insurers rely on underwriters to evaluate and select risks that fall within the insurer's acceptable range of expected losses. The insurance application serves as the primary source of information used during the underwriting process. Underwriters review the application along with other relevant information sources to determine the applicant's insurability and assess the level of risk presented.
Insurance rates are developed by the insurer's actuarial department using statistical analysis and financial data. Rates must comply with state regulatory standards and cannot be inadequate, excessive, or unfairly discriminatory. Because insurance regulation is primarily handled at the state level, states may use different methods for approving insurance rates. Under the file and use method, insurers may begin using rates immediately after filing them with the state insurance regulatory authority. Under the use and file method, insurers may implement rates first as long as the rates are filed with the regulatory authority within a specified period after use. Under the prior approval method, insurers must receive approval from the state regulatory authority before the rates may be used.
An insurance agent transacts insurance business on behalf of an insurer, while a broker represents the interests of the insured or insurance applicant. An exclusive, or captive, agent represents a single insurer or insurer group, whereas an independent agent may represent multiple insurance companies. Through the law of agency, an agent is granted authority to act on behalf of the insurer, and the insurer may be held legally responsible for the agent's authorized contractual actions. In addition, agents have a fiduciary duty to properly handle and protect funds belonging to others, such as premium payments collected on behalf of insurers.
Authority specifically granted in an agency contract is known as express authority. Authority that is not directly stated but is reasonably necessary for the agent to carry out assigned duties is referred to as implied authority. Authority that exists when an insurer allows the public to believe an agent has authority beyond the contract, without taking steps to correct that impression, is called apparent authority. All three forms of authority—express, implied, and apparent—can legally bind the insurer.
The insurance industry in the United States is primarily regulated at the state level. This regulatory structure is based on the McCarran-Ferguson Act, which established that insurance regulation should remain largely under state authority and that the insurance industry would generally not be subject to certain federal antitrust laws when regulated by the states. State insurance laws are created by the legislative branch of government and enforced by the executive branch through the state's Commissioner, Director, or Superintendent of Insurance.
Although insurance is primarily regulated by the states, the insurance industry is also subject to several important federal laws and regulations. The Fair Credit Reporting Act (FCRA) protects consumer privacy by regulating how insurers and other businesses collect, use, and maintain consumer credit information and credit reports. The Gramm-Leach-Bliley Act (GLBA) gives consumers the right to opt out of certain information-sharing practices and requires insurers to provide privacy notices when a customer relationship begins and annually thereafter. In addition, the Do Not Call provisions under the Telemarketing Sales Rule allow consumers to opt out of receiving telemarketing calls and establish rules governing when and how telephone solicitations may be made.
The Terrorism Risk Insurance Act (TRIA) established a temporary federal program designed to provide reinsurance support for losses resulting from acts of terrorism. Because terrorism-related losses can be extremely catastrophic and difficult for private insurers to absorb alone, the program helps stabilize the insurance market and maintain the availability of coverage. TRIA is intended to protect both the public and the insurance industry and primarily applies to commercial property and casualty insurers. The Terrorism Insurance Program is administered by the U.S. Secretary of the Treasury, who is responsible for determining whether an event qualifies as an act of terrorism under the program.
Insurance fraud involves intentionally making material misrepresentations, false statements, or concealing important information with the purpose of deceiving another party. Insurance fraud is prohibited under federal law and may result in criminal penalties, including fines, imprisonment, or both. Federal law also restricts individuals convicted of felonies involving dishonesty or breach of trust from participating in the business of insurance unless they obtain a 1033 Waiver of Consent. If a person who is required to obtain this waiver fails to do so and still engages in insurance activities, they may face both criminal and civil penalties.