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Fact Sheets

Glossary

Actual cash value

Insurance under which the policyholder receives an amount equal to the replacement value of damaged property minus an allowance for depreciation. Unless a homeowners policy specifies that property is covered for its replacement value, the coverage is for actual cash value.

Arbitration

A procedure in which an insurance company and an insured agree to settle a dispute over a claim settlement by accepting as binding a decision made by a disinterested person who is selected by two appraisers - each of whom is appointed by one of the parties to the dispute.

Assigned risk plans

All 50 states and the District of Columbia have facilities in which drivers can obtain auto insurance, if they are unable to buy it in the regular or "voluntary" market. Every insurer licensed in the state must participate in these facilities, which are variously known as assigned risk plans or joint underwriting facilities, and often referred to as the residual market. When residual market premiums are too low to cover its losses, insurers are usually assessed to make up the difference. These additional costs are passed on to all their customers. (Source: Automobile Insurance Plans Service Office) Residual markets also exist for other types of coverage, including property insurance in locations where the risk of riot, theft, vandalism, arson, or severe storm damage is substantial. (See beach and windstorm plans)

Auto insurance premium discounts

The surest way for a driver to save money on auto insurance is to shop around. Premiums vary widely from one company to another. Many insurance companies also give premium discounts to drivers who: have a good driving record, have taken driver education courses, are between the ages of 50 and 74, car pool, insure several cars on one policy, buy homeowners or renters insurance from the same company, install anti-theft devices in their cars, or drive cars with safety features like automatic seat belts and air bags.

Beach and windstorm plans

Like FAIR Plans, which provide basic property insurance coverage, these are state-sponsored insurance pools that sell property coverage for the peril of windstorm to people unable to buy it in the voluntary market because of their high exposure to risk . Seven states along the Atlantic and Gulf Coasts have Beach and Windstorm Plans that cover residential and commercial properties against hurricanes and other windstorms. In all but one of these states (Alabama) insurance company participation in the plans is mandatory. The value of insured property in hurricane- risk areas is now so great that, depending on where it strikes, one hurricane could be as financially devastating to the property/casualty industry as a major California earthquake. In 1992, for example, Hurricane Andrew caused $15.5 billion in insured losses - the industry's biggest single catastrophic loss up to that time. But if Hurricane Andrew had struck 20 miles farther north than it did, the total insured loss could easily have been three times as great. An industry-sponsored group called the Natural Disaster Coalition has urged the adoption of a federal reinsurance program. Under the Natural Disaster Coalition's proposal, insurers would pay premiums in exchange for federal reinsurance to assume catastrophic losses after a specified threshold was reached. (Source: Property Claim Services Division, American Insurance Services Group, Inc.) (See reinsurance)

Combined ratio

The combined ratio is the percentage of each premium dollar a property/casualty insurer spends on claims and expenses. An example: In 1990, auto insurers' combined ratio for liability coverages was 118 percent. This means that $1.18 went in claims and expenses for every $1 of premium earned. When the combined ratio is over 100, the insurer has an underwriting loss. A combined ratio under 100 means an underwriting profit. In 1990, for example, the insurance industry paid 94 cents in private passenger auto collision and comprehensive claims and expenses for every $1 of premium it earned for the coverages. The combined ratio was 94 percent. (See loss ratio; expense ratio; investment income)

County Mutual Insurance Companies

County Mutual insurance companies were formed by Texas law in 1911. The maximum number of county mutual insurers allowed by law in Texas is 24. These companies are authorized to write specific forms of domestic property and Chapter 17 of the Texas Insurance Code which governs County Mutual insurers. By definition, county mutual insurers are owned by their policyholders, which are ultimately responsible for the operations and management of the company. Originally formed to provide a unique solution for high-risk drivers, these companies address the issue of affordability and availability of auto insurance in Texas and reduce the number of drivers insured through the Texas Automobile Insurance Plan Association.

Deductible

The amount of loss paid by the policyholder. A deductible can be a specified dollar amount, a percentage of the claim amount, or a specified amount of time that must elapse after the loss before the insurance policy starts paying benefits. Insurers typically offer a choice of deductibles in each policy. The bigger the deductible, the lower the premium charged for the same amount of coverage. A policy with no deductible is called first dollar coverage and, when available, is very expensive.

Direct writers

Insurance companies that sell directly to the public, via their own employees or by exclusive agents.

Dividends to policyholders

Many life insurance policies and some property/casualty policies pay annual dividends to their owners. Dividends are a partial premium refund, not a taxable distribution. They're not guaranteed. Policies that pay dividends are called participating policies.

Expense ratio

The percentage of each premium dollar the insurer spends on expenses - overhead, marketing, and commissions. An insurer that spends 25 cents of each $1 of premium on expenses has a 25 percent expense ratio. (See combined ratio, loss ratio)

Farmowners-ranchowners insurance

A package policy, like homeowners insurance, that protects the policyholder against a number of named perils and liabilities. Typical far owners and ranchowners policies cover a dwelling and its contents, as well as barns, stables and other structures.

Financial responsibility law

A state law requiring that all automobile drivers show proof that if involved in an auto accident, they can pay damages up to a specific minimum amount . The requirement varies from state to state, and is usually met by carrying a minimum amount of auto liability insurance.

Fronting

A procedure in which a primary carrier acts as the insurer of record by issuing a policy, but then passes the entire risk to a reinsurer in exchange for a commission.

Typically, the fronting insurer is licensed to do business in the particular state or country where the risk is located, and the reinsurer is not. Fronting is a service insurers provide to corporate policyholders with multinational operations. The reinsurer that ultimately assumes the risk is often a captive - an insurer wholly-owned by the corporate policyholder and created primarily to cover its parent's risks. Alternatively, the reinsurer is sometimes an independent carrier that cannot sell insurance directly in a particular country, because local coverage by law must be bought from a government-owned insurance company. (See reinsurance)

Inland marine insurance

Nowadays, this coverage has very little to do with water. Years ago, when goods were mainly transported by water, the coverage referred to insurance for goods transported on the nation's inland waterways. Inland marine is a broad category of coverage that includes insurance for articles in transit, as well as bridges, tunnels and other means of transportation and communication . It also includes "floater" policies, which cover personal property, jewelry, furs, fine arts and other items whose value is above the standard homeowners policy limits for personal effects and household items.

Insolvency

Deciding whether an insurer is insolvent, i.e., unable to pay its debts , is far from simple, partly because insurance company solvency standards vary from state to state, and partly because the adequacy of reserves to pay future claims is a matter of opinion. A state insurance regulatory body which deems a company in financial peril has a series of available legal options. It can take action to place the company in conservatorship, rehabilitation, or liquidation. (The difference between conservatorship and rehabilitation is one of degree: The state insurance department guides the operations of a company in conservatorship, and directs those of a company in rehabilitation.)

Typically, the first sign of problems is a company's failure to pass four or more of 11 financial tests regulators administer as a routine procedure. The insurance regulator can order the company to take whatever steps he or she thinks necessary to correct the problem, such as raising its rates, restructuring its investment portfolio, and increasing its capital. These remedial actions usually aren't made public to avoid precipitating the equivalent of a run on the bank. If the company's situation doesn't improve, the regulator can seek a court order to place it in conservatorship or rehabilitation, and take additional steps to shore it up, such as suspending claims payments, placing a stay on lawsuits against the company, and looking for additional sources of capital. The final step is liquidation, in which the insurance department sells the company's assets and settles its claims. The process of liquidation varies from state to state. In every state, however, the insurer's obligations to policyholders have first priority, ahead of all other creditors' claims for payment. Insurance-to-value Insurance written in an amount approximating the value of the insured property. (See reinsurance)

Investment income

Insurers have two major sources of income - underwriting (i.e., premium income less claims and expenses) and the investment earnings of assets. Investment income is critical to the financial stability of both property/casualty and life insurers. For property/casualty companies, investment earnings help to balance underwriting losses. (Investment income is what enables insurers to stay profitable during years of heavy and unexpected losses caused by hurricanes, earthquakes and other natural catastrophes, for example.) For life insurers, investment earnings build policy cash reserves, and thus are an integral part of cash value life insurance policies, which consist of an investment account as well as an insurance benefit.

Lloyds

A Lloyds insurer is a corporation formed to market services of a group of underwriters (underwriters can be individuals, but do not have to be). A Lloyds insurer does not technically issue insurance policies or provide insurance protection. Insurance is written by the underwriters, with each assuming a part of every risk. Texas Lloyds are not regulated regarding property rates and have no connection to Lloyds of London.

Loss ratio

The percentage of each premium dollar an insurer spends on claims. An insurer with a 92 percent loss ratio spends 92 cents of each $1 of premium on claims. (See combined ratio; expense ratio)

Loss reserves

Loss reserves are a liability on the insurer's balance sheet, not an actual fund of money. Loss reserves represent the company's best estimate of what it will pay for claims, an estimate that is periodically readjusted. Loss reserves can only be set up for events that have occurred, or are presumed to have occurred.

McCarran-Ferguson

This is the federal law (1945) in which Congress declared that the states would continue to regulate the insurance business. As a result, insurers are granted a limited exemption to federal antitrust legislation . McCarran-Ferguson states that federal antitrust laws are applicable to the insurance business "to the extent that such business is not regulated by state law."

Office of Public Insurance Counsel

The Office of Public Insurance Counsel (OPIC) is an independent Texas state agency that represents the interest of insurance consumers as a class in insurance matters. OPIC represents consumers before the Texas Department of Insurance, the State Office of Administrative Hearings, the courts and other state agencies. OPIC is statutorily required to represent the interests of consumers relating to insurance rates, rules and policies and other issues.

Premium tax

A state tax on premiums paid by its residents and businesses, collected by insurers. Companies that self-insure avoid this tax.

Product liability

A section of tort law that determines who may sue and who may be sued for damages when a defective product injures someone . There are currently no uniform federal laws governing manufacturers' liability. A manufacturer normally is liable when a defective product injures someone. Under the doctrine of strict liability, an injured person does not have to show negligence on the part of the manufacturer. It's sufficient to show that the product is defective and caused the injury.

Rate regulation

There are two basic systems of rate regulation - open competition and prior approval. In prior approval states, insurance companies must file proposed rate changes with the state regulator before putting them into effect. The ratings then may be approved or disapproved. In open competition states, insurance companies may put new rates into effect without prior approval. But the insurance commissioner generally reserves the right to disallow rates within a certain period of time, if they are deemed inconsistent with the principles of regulation - i.e., that rates be adequate, reasonable, and not unfairly discriminatory. (In a file- and-use state, insurers must file rate changes, but don't have to wait for approval to put them into effect.) Big insurers typically file their own rates. Smaller companies often use claims data filed on their behalf by statistical bureaus - industry associations that gather statistical data and prepare policy forms for their members.

Rate suppression

The setting of insurance rates by government regulators at levels below their true economic cost. The two major lines of coverage most affected by rate suppression are private passenger auto insurance and workers compensation, which together accounted for 50 percent of the property/casualty industry's premium volume in 1990. In these two lines of coverage, claim costs have risen faster than in all other lines of property/casualty insurance combined; and in both workers compensation and private passenger auto insurance, claim costs have risen faster than premiums.

Reinsurance

Insurers buy insurance, too. It's called reinsurance. A reinsurer assumes part of a risk - and part of the premium - originally taken by the insurer, which is called the primary company. Reinsurance effectively increases an insurance company's capital and therefore its capacity to sell increased amounts of coverage. Reinsurers have their own reinsurers, called retrocessionaires. Reinsurance is a global business. Some of the world's biggest reinsurance companies are European and Asian firms. The billions of dollars worth of risk assumed by the American insurance industry are spread across an international network of reinsurance and retrocession. As an international business with only corporate clients (who are presumed to be financially sophisticated), reinsurance is less regulated than primary insurance. However, U.S. reinsurers file their financial statements with state regulators and are subject to periodic examination, just as primary insurers are. And in assessing an insurance company's strength, regulators take into consideration the amount of reinsurance it carries, and whether or not its reinsurers are state-licensed. The statutory accounting used by insurance regulators doesn't credit insurers' balance sheets for non-admitted reinsurance - i.e., reinsurance from an unlicensed company - as it does for admitted reinsurance. Passing some or all of its risk to reinsurers doesn't relieve an insurance company of its obligation to pay claims. Reinsurers don't pay the insurance company's policyholder claims; rather, the reinsurer reimburses the insurance company for claims it has paid.

Reinsurance policies

There are two basic kinds of reinsurance: Treaty reinsurance is a standing agreement between an insurer and reinsurer. The reinsurer automatically accepts specific percentages of entire classes of the insurer's business - 20 percent of its book of auto insurance, for example - up to pre-agreed limits. Insurers seek facultative reinsurance for specific individual risks unusual or big enough so that they aren't covered in reinsurance treaties - an oil rig or jumbo jet, for example. The reinsurer isn't bound by contractual obligation to accept any facultative risk, but is free to assess each such risk on its own merits.

Renters insurance

Tenants or renters insurance is a form of homeowners policy. It covers the policyholder's belongings against perils including fire, theft, windstorm, hail, explosion, vandalism, accidental discharge of steam from heating systems, riot or civil commotion, even volcanic eruption. The policy also provides personal liability coverage for damage the policyholder and his or her dependents cause to third parties. Renters policies also provide additional living expenses (also known as loss-of-use coverage) if the policyholder is forced to live elsewhere while his or her dwelling is being repaired. Most renters policies also include some coverage for any improvements the tenant has made to the property, even though he or she doesn't own it.

Replacement cost contents insurance

Insurance that pays the dollar amount needed to replace damaged personal property with items of like kind and quality, without deducting for depreciation.

Replacement cost dwelling insurance

Insurance that pays the policyholder the cost of replacing the damaged property without deduction for depreciation, but limited by the maximum dollar amount indicated on the declarations page of the policy.

Reciprocal

Reciprocal insurance is that resulting from an interchange among persons, known as "subscribers", of reciprocal agreements of indemnity. The interchange is effectuated through an "attorney-in-fact," common to all such persons. Reciprocal insurance companies are not regulated regarding property rates in Texas.

Texas Benchmark Rating System

Texas rate regulated insurance companies that write private passenger auto insurance and/or residential property insurance must secure approval from the Texas Department of Insurance for rates they charge. This procedure, known as the benchmark system, is analogous to an average rate. Insurance companies operating under rate regulation then must file their own rates and allowed to set their rates to be equal to the benchmark rate or within a certain percentage (this percentage or flex band is set by the TDI) of the benchmark rate. The rating statute limits the flex band percentage, up or down, to be no greater than 30 percent.

Third party

In an insurance contract, a third party is anyone other than the policyholder and members of his or her family who are covered in the policy. The insured and the insurer are the first and second parties to the contract. Anyone else is a third party.

Tort

A wrongful act, resulting in injury or damage, on which a civil action may be based. This doesn't apply to breach of contract, for which action would be brought under contract law.

Umbrella policy

Coverage for losses above the limit of an underlying policy. Umbrella coverage applies only to losses over a large dollar amount, but terms of coverage are sometimes broader than those of underlying policies.

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