An insurance Broker works on behalf of, and is compensated by, the client to transact insurance with, but not on behalf of, an insurance company.  Life and health insurance can be transacted through both agents and brokers, though most states only allow for the licensure of insurance agents, while brokers are more common with property and casualty insurance.

Passing an insurance licensing exam and obtaining an insurance license are the first steps into the insurance industry.  The next step an insurance agent must take is to obtain ‘express authority’ by contracting with each insurance company the agent intends to sell insurance on behalf of and becoming ‘appointed’ by those insurance companies.

Producer Appointments

An Appointment is a legal contract between an insurance company and a licensed agent by which the insurance company gives an agent the Express Authority to conduct insurance business on behalf of the insurer in exchange for compensation, referred to as Commission.

An agency contract defines the terms in which both the agent and insurance company will interact with each other as well as to the industry.

This generally includes the advertising and solicitation guidelines for the company, medical underwriting guidelines to help ensure correct application submission from the field, commission structure for the agent and any other specific regulations of the company, as well as the rights of the agent, under the contract.

In addition to the ‘express authority’ given to an agent through the company’s contract, marketing and selling insurance products, as well as maintaining clients is often performed on a ‘presumed authority’ basis.  Two types of presumed authority are ‘implied’ and ‘apparent’ authority.

Types of Agent Authority

1.  Express Authority – Defined as the contractual agreement between an insurance company and an agent to market and sell the insurer’s products.  An agent’s express authority is clearly defined in words through the company’s contract, or appointment, with the agent.

2.  Implied Authority – Defined as the general business practices that an agent could perform that is not necessarily part of the agent’s contract, but could be acceptable by the insurer.

For instance, while an agent’s contract does not include collection of premium beyond the initial payment, if an agent collects and remits ongoing premium payments to an insurer on behalf of a client and the insurer accepts the premium, it is then implied that the agent has the authority to collect ongoing premium.

Since the company does not authorize the agent to collect and remit ongoing premium, the company views the agent as working on the client’s behalf.  If the agent were not to remit this premium to the company, the agent, not the company, would be liable for the lost premium payment.

3.  Apparent Authority – Defined as being a vague and somewhat misleading authority an agent has, based solely on the actions of the agent and the ‘apparent’ acceptable response of the insurer.

This type of authority refers to the possibility of a situation where an applicant is under the impression that the agent has the authority to act on behalf of the insurer, even though no expressed authority actually exists.

Legally, even if no expressed contract exists, or the agent has not yet been appointed, an insurer can be liable for an agent’s actions if the insurer supplies the agent with marketing material or other items with the company’s name or logo.  This concept is known as the Presumption of Agency, or the presumption from a potential customer’s point-of-view, that an agent is conducting business on behalf of an insurer, given the materials he or she presents to the potential customer or the clothing he or she wears bearing the company’s name or logo.

Following the ‘presumed authority’ standpoint, the courts will usually side on behalf of the customer if it can be adequately presumed from the customer’s point of view that the agent was acting on behalf of the insurer, due to the impression he or she gave the customer.

If an agent acts alone and purposely sells insurance without the proper appointment from the insurance company he or she is promoting, the insurance company would not be liable for such actions, and the agent would bare the full extent of any penalty incurred from any unauthorized acts.

Errors and Omissions Insurance (E&O)

Just as an insurance agent sell health insurance to clients, Errors and Omission Professional Liability Insurance protects the insurance agent from claims against he or she as a result of failing to adequately provide professional service to a client.  For example, if a customer were to file a lawsuit against their insurance agent, regardless of nature, this errors and omission (E&O) insurance will defend the agent against the claim and cover any losses, if it should occur, up to pre-determined dollar amounts as prescribed in the E&O policy, usually in the millions of dollars.

In short, this type of insurance is for agents who sell insurance, and it is a very important to maintain to protect against personal financial loss from any claims related to the sales of insurance products.  The best measure to avoid any type of client-related lawsuit is to follow the legal and ethical standards of the industry.

A core concept that our insurance school teaches is the concept of insurance risk and corporate profitability in the insurance marketplace.  The majority of private commercial insurance companies in America are considered to be either stock or mutual insurance companies.  While both types of organization provide insurance to consumers, they differ in how they operate.

Stock Insurance Company

(Non-participating Company)
A stock insurance company is a private insurance organization whose main purpose is to make a profit for its stockholders.  This type of insurer is considered to be a non-participating company because the insured policyowners do not own the company nor do they receive any dividends it returns.

Stock insurers do not issue participating policies; therefore, two groups exist: shareholders and policyowners – though a shareholder could also be a policyowner.

Mutual Insurance Company

(Participating Company)
A mutual insurance company is one in which insured policyowners are also the company’s stockholders (owners).  Mutual insurers issue participating policies, in which policyowners share in the company’s ownership and receive dividends of the divisible surplus of the company’s profits.

More simply put, if you were to purchase insurance from a mutual insurer, you would be both a customer (insured) and an owner (shareholder).  Dividends are simply an annual reimbursement of the excess of premiums that remain after the company has set aside the needed reserves, and has made deductions for claims and expenses.

De-mutualizaiton  – A mutual insurance company has the ability to change its corporate structure to a stock company status, often to help increase capital needs that is more easily accomplished as a stock insurance company.  This process is called ‘de-mutualization.’

Mutualization – Just as a mutual insurance company can ‘de-mutualize’, a stock insurance company can also change its corporate structure to become a mutual insurance company, a process called ‘mutualization.’

Reinsurance

The concept of ‘reinsurance’ is the sharing of risk between an insurance company and a re-insurance company, known as a Reinsurer, to provide additional insurance coverage for risks that are too large for the single insurer to adequately cover.

When an insurance company cannot assume an entire risk of an applicant’s request at the time of application, the insurance company will transfer part of the risk to a reinsurer.  A reinsurance agreement provides the details of the agreed reinsurance policy and a reinsurance premium is paid by the insurer to the reinsurer in exchange for the additional coverage.

As an example, if a company applies for a large insurance policy equaling $20 million and an insurance company is only able to cover a single loss up to $10 million, the insurer will purchase additional insurance from a reinsurer for the remaining $10 million to adequately cover the applicants $20 million request.

An important topic insurance training covers is the function of an insurance company and the legal construction of an insurance policy.  Insurance is a form of ‘risk management’ used to protect the financial well-being of an individual, company, or other entity in the event of unexpected financial loss.  While health, life, and disability insurance provides a financial safety net against the unexpected financial loss associated with illness, disability, or death, the goal of an insurance company is to maintain profitability for it’s shareholders.

Risk Protection

Some small risks can be managed with personal or company finances; however, larger, more catastrophic expenses are best handled by transferring the risk to an insurance company.  The insurer will assume the cost resulting from the insured’s risks, and in exchange, the insurer charges a monthly premium (monthly payment) to the insured.  This is accomplished by purchasing an ‘insurance policy.’

An insurance policy is a binding agreement designed to protect against financial loss, and as a legal contract, it reflects the insurer’s responsibilities of covering such loss.

A life insurance policy is designed to pay a stated sum to the designated policy beneficiary in the unlikely event that the insured dies within the policy’s coverage period.  A health insurance policy is designed to indemnify an insured for medical treatment in the event of an accident, illness, or disease.  And a disability insurance policy is designed to indemnify an insured by replacing lost income during a time of disability.  In all cases, Indemnity refers to the insurance proceeds that are paid to the insured or beneficiary in the event of a loss. 

Insurable Interest

The legality of any insurance policy is based on the concept of insurable interest.  In other words, in order to obtain insurance, an ‘interest’ must exist between two parties where one party has the potential to suffer a loss in the event that a particular outcome occurs (which was covered by the insurance policy).

Insurable interest occurs between two parties that, upon the loss of one party, the remaining party will have suffered some sort of loss.

Examples of Insurable Interest

• The loss of a loved one, such as a blood relative (spouse, parent, grandparent, children, grandchildren)
• The loss of a business partnership that would result in financial hardship if a key member were to be removed from the business

In contrast to insurable interests, insurance cannot be purchased on strangers, friends, associates of no financial significance, or the like where the potential for gain, instead of loss, were to occur.

When speaking about life insurance, insurable interest must exist at the time of application, but is not required to still exist at the time of an insured’s death.

This determines who may purchase a policy, but does not affect who will benefit from the policy. For instance, if a married couple purchased life insurance on each other and at a later date they divorced, they would still continue to serve as each other’s beneficiary if one were to die, and would still be eligible to collect the contract’s death benefit.

When an insurance company ‘underwrites’ a health or life insurance application, it assesses the risks associated with the applicant.  As a licensed insurance agent, it is important to understand that the goal of an insurance company is to maintain a profit while providing financial protection to its customers.  In order to measure the amount of risk that is associated with the applicant, the insurer’s underwriting department reviews the application according to its ‘underwriting guidelines.’

Simply stated, an insurance company determines an applicant’s eligibility and premium amount based on the total overall risk, and how it is classified according to the company’s risk limits and standards.

Underwriters are individuals who are employed by the insurance company to review and determine whether an applicant is acceptable or declinable, based on the medical history of the applicant.  The ‘underwriting guidelines’ used to determine the class of risk associated with an applicant can vary from each insurer, according to the amount of risk the insurer can assume.

Each applicant is ‘rated’ according to sex, age, height, weight, medical conditions, medical history, smoking status, occupation, and even hobbies (riding motorcycles, rock climbing, etc).  The policy’s risk classification and associated premium rate (monthly cost) are determined using this rating system.

4 Classifications of Risk:

1.  Preferred Risk – This class of risk is reserved for people with good health and good habits.  Based on age, height, weight, and smoking status, individuals that fit within this classification are considered a low or ‘preferred’ risk, and will often pay less premium than a standard risk policy.

2.  Standard Risk – Simply means an applicant has been approved for the policy as applied.  This classification is the average, or normal classification for the majority of applicants.  Insurance companies commonly promote ‘anticipated rates’ based on a standard risk classification.

3.  Sub-standard Risk – This class of risk includes applicants with pre-existing conditions that are within the risk acceptance levels of the insurer, and can include a higher premium payment to offset the increased risk.  This risk class can also exclude certain benefits of the policy, or types of medical conditions from receiving coverage in order to prevent abnormal loss to the insurance company.  An applicant rated as ‘substandard risk’ is commonly in poor health, has already manifested a preexisting condition that is beyond the standard risk classification (based on the underwriting review), or might engage in a dangerous hobby or occupation.

4.  Declined Risk – Unfortunately, some risks are uninsurable and are not accepted by the majority of the insurance industry.  These risks can include specific life-threatening conditions, a combination of multiple conditions, or even an applicant’s extreme weight limit.  An insurer will try to increase premium or exclude a risk in order to accept an applicant (remember profit); however, some risks are beyond the risk acceptance levels of the insurer and are declined.  Keep in mind that every insurer is different and each follows its own underwriting guidelines, so just because an applicant is declined or rated as ‘substandard’ by one insurance company does not mean that the next insurer will result in the same outcome.

Remember, an insurance agent’s responsibility is to provide the best available options to an applicant (often times from several insurance companies), weigh the pros and cons of each option, and help the individual accurately apply for the insurance.  When the insurer knows the correct and complete background of an applicant, it can provide the best result for both parties.

Industry Regulation

A major form of self-regulation, the National Association of State Commissioners (NAIC), is widely recognized as a major influence in the insurance industry.  NAIC is not a federal or state legislative body, nor does it regulate insurance law, even though its members are the insurance commissioners (i.e., the chief insurance regulators) of each state in the U.S.

Founded in 1871, the National Association of Insurance Commissioners was created as a non-governmental organization that has since created and maintained a uniform set of laws for states to follow in an attempt to standardize multiple-state insurance laws.  Though it has created a set of ‘by-laws’ to help centralize the state-run insurance industry, NAIC, itself, does not actually regulate insurance law.  The states regulate their respective insurance laws as well as abide by any relevant federal laws.

The NAIC is composed of insurance commissioners from each of the 50 states, the District of Columbia, and surrounding U.S. territories.  These members are either elected to their post, or appointed by their states’ governor and are represented by an executive committee comprised of the President, President-Elect, Vice President and Secretary-Treasurer of the NAIC.  These governing members are elected on an annual basis by NAIC members.

In addition to the Executive Committee, the NAIC is composed of seven additional committees including:

Life Insurance and Annuities

Health Insurance and Managed Care

Property and Casualty Insurance

Market Regulation and Consumer Affairs

Financial Regulation Standards and Accreditation

Financial Condition Committee

International Insurance Relations Committee.

NAIC’s ‘by-laws’ promote uniformity throughout the insurance industry and enable insurance companies to better comply with the laws and regulations set forth in all states in which they conduct insurance business.  The association has influenced the industry by introducing uniform regulation including:

Model Life Insurance Solicitation regulation

Viatical Settlement Model regulation

Model Life Insurance Replacement regulation

Model Group Life Insurance  provisions

Model Health Policy provisions

Long-term Care Insurance Model regulation

Individual retirement accounts, or IRAs, were enacted by Congress in 1974 as part of the Employee Retirement Income Security Act (ERISA).  IRAs are popular tax-deferred retirement plans that provide individuals with a method of investing their income and saving money for retirement.  As a licensed insurance agent, it is important to understand the benefits of each type of IRA.  Two types of IRAs include the ‘traditional IRA’ and a ‘Roth IRA.’

Traditional IRA

Simply known as an IRA, individuals and self-employed business owners have the opportunity to save money for retirement while receiving a current tax break.  As the amount contributed accumulates, it grows tax deferred until it is withdrawn at retirement.  Contribution amounts may be fully or partially deducted from current income, which results in a lower current income tax for the individual.

Any individual under the age of 70½ who has earned income can participate in an IRA.  Contribution levels allow up to 100% of an individual’s annual income, but cannot exceed contribution limits set each year by the federal government.  Any contribution that exceeds annual limits will be subject to a 6% “excise” tax.  Individuals who are 50 years or older are allowed to make “catch up” contributions that exceed normal annual limits.

Withdrawal from an IRA owner’s account must begin no later than April 1st following the year an individual reaches 70½ years old.  From this time on, a minimum amount must be withdrawn every year from the IRA to avoid a penalty tax on such difference.

If an individual withdraws IRA funds prior to reaching age 59½, the withdrawal will be viewed as income, and not only will it be taxed as income, it will also be subject to a 10% penalty fee because it is being withdrawn prematurely.  Exceptions to this penalty tax include withdrawals for a first-time home purchase, higher education expenses, or to cover qualified medical expenses.

Roth IRA

As a result of the Taxpayer Relief Act of 1997, the Roth IRA was created.  Roth IRAs work in an opposite manner to traditional IRAs in that they use post-tax dollars instead of pre-tax dollars for contributions.  They accumulate, build interest, and upon withdrawal, funds are not taxed.

While the maximum amount of annual contribution is the same as with a traditional IRA, a Roth IRA does not have restrictions on participant status if an individual is also covered by an employer’s plan, or already owns a traditional IRA.  Also, owners of a Roth IRA do not have to wait until they turn 70½ in order to begin withdrawals.  However, if an individual owns both a traditional IRA and a Roth IRA, his or her maximum annual contribution limit is considered to be collective for both types, not for each IRA.

Withdrawals from Roth IRAs can be either qualified, one of which that provides for tax-free distribution of earnings, or nonqualified, in which earnings are subject to tax.

Qualified withdrawals are allowed for individuals over age 59½, disabled individuals, or beneficiaries of IRA individuals who have died, though funds must be held in the account for a minimum of five years.  IRA funds can also be withdrawn without penalty for first time homeowners.

Nonqualified withdrawals are similar to traditional IRAs and the interest or earnings portion of the fund is taxed as income as well as assessed a 10% penalty tax for premature withdrawal.

Health Savings Accounts, simply called “HSAs,” are a form of health insurance that combines a health ‘savings account’ with a High Deductible Health Plan (HDHP).

Still relatively new to the market, these tax-advantaged medical savings plans are often purchased by self-employed individuals and small employers to provide tax deducted funding as well as tax free withdrawals if used towards qualified medical expenses.  HSAs, were enacted into law in January 2004 by the 108th Congress as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 under Title XII, Section 1201.

This form of medical insurance is exempt from taxation and provides for the accumulation of pre-tax dollars deposited and held in a health savings account that grows and rolls over each year to accumulate a long-term savings fund.  HSA funds are also used to pay for qualified medical expenses, such as doctors visits and prescribed medications, are not considered as gross income, and can be withdrawn from the HSA savings account tax free!  Accumulated funds can also be withdrawn without penalty or tax after the beneficiary (insured) reaches the Social Security retirement age.

The High Deductible Health Plan is defined as “a health plan which has an annual deductible which is not less than $1,000 for self-only coverage, and twice the dollar amount ($2,000) for family coverage, and the sum of the annual deductible and the other annual out-of-pocket expenses required to be paid under the plan (other than for premiums) for covered benefits does not exceed $5,000 for self-only coverage, and twice the dollar amount ($10,000) for family coverage.”

The Health Saving Account is defined as “a trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified medical expenses of the account beneficiary,” i.e, the insured.  The current 2011 contribution limit on an HSA is $3,050 for an individual and $6,150 for a family.

Withdrawing funds from an HSA is usually done with the use of a debit card or check.  In addition to doctors visits and prescription medications, HSA funds can be withdrawn tax-free for any benefits that the plan requires deductible payment, coinsurance, or other covered plan costs.  As of January 2011, non-prescribed over-the-counter medications can no longer be purchased using tax-free funds.

Since its inception, HSA plans have become more popular and are often used by younger, healthier individuals due to lower premium costs, high deductible options, and the ability to accumulate tax-free dollars for retirement.

An annuity is a financial tool that will provide a succession of payments to a policyowner, or annuitant, in exchange for a single lump sum payment or series of payments to the insurer.  In other words, an annuitant pays an insurance company a certain amount which is then credited with a certain rate of interest, and this is how money grows in an annuity.

Annuities are interest bearing, tax deferred savings vehicles designed to provide future income in exchange for a lump sum or series of payments now.

During this growth period, or accumulation period, the rate of interest is not taxed, which allows for a greater accumulation of funds.  Once an annuitant is ready for the policy to start paying out (payout or annuity period), the annuity concludes its accumulation task and benefits are paid at specified periodic intervals.  These payments can either be paid over a certain amount of time, paid at a specific monetary amount per payment or act as a death benefit to an annuitant’s beneficiary.

During the annuity period, benefit payments are made to the annuitant that consists of both repayment of principal and earned interest.  While the principal repayment portion of an annuity payment is not taxed, any interest earned and paid to the annuitant is taxed as ordinary income.  In order to figure out the taxable portion of an annuity payment, an exclusion ratio is used to determine the ratio of taxable to nontaxable proceeds in an annuity payment.  The exclusion ration formula is simply the investment in the contract divided by the expected return.

Immediate vs. Deferred Annuities

An immediate annuity pays out immediately after the first payment period (depends on payment frequency: monthly, quarterly, semi-annual, or annual).  Used when a lump-sum amount is paid into the annuity and the annuitant wants to immediately spread it out over a period of time.

A deferred annuity delays payout to allow interest to compound over a period of time.  Again, a deferred annuity is not taxed so interest builds quicker to allow for a larger return for the annuitant.  A deferred annuity can be paid with a single premium or multiple premium installments and at a later date, paid out as income payments back to the annuitant (along with earned interest).

Annuities vs. Life Insurance

Although similar in concept to a life insurance contract, and often available through life insurance companies, an annuity, is quite the opposite.  Life insurance is concerned with creating an estate, and financially protecting an individual against death, where an annuity on the other hand is designed to protect an individual from outliving their financial resources, through the liquidation of such estate.

The death of a business owner or partner in a business can also bring the end to the business; life insurance plays a vital part in protecting the integrity of a business if such event were to occur.    Life insurance, in the form of a ‘buy-sell’ agreement, provides the necessary protection to ensure the survival of the business and a disbursement of ownership rights to remaining partners or owners.

As a licensed insurance agent, it is important to understand the basic concept of a buy-sell agreement as well as the types of buy-sell agreements available to properly insure against the loss of a business owner or partner.

The death of a business owner doesn’t necessarily mean the end to the business.  Buy-sell agreements are used to provide structure in the absence of the business owner or partner.

A ‘buy-sell’ agreement, also known as a ‘buyout’ agreement,  is defined as a financial agreement or arrangement that protects business partners against financial loss by securing a predetermined fair market value share of a partner that, upon a predetermined event such as death, is sold to the remaining partners in the business to ensure the continuation of the business.

2 types of Buy-Sell Agreements:

Cross-Purchase Plan – This type of buy-sell agreement is typically used between two or three partners within a company.  Each partner buys a share of the deceased partner’s interest and is considered the beneficiary of the other partner(s).  A stock-purchase plan is set up in the same manner, but is often used at the corporate level to protect a company’s few shareholders.  Because these plans involve each partner or shareholder owning a policy on each other partner or shareholder, they are usually used by companies with one to three members.  For example, if three partners exist, each partner would own two policies (one on each partner, excluding him or herself) equaling a total of six insurance policies for the company – 3 partners x 2 policies each = 6 total policies.

Entity-Type Plan – In the event that several partners exist, an entity-type plan is often used to simplify the process where the business itself will buy out the deceased partner or owner’s share in the company.  A stock-redemption plan is set up in the same manner, but is often used at the corporate level to protect the interest of several shareholders.  Because this type of plan usually involves several partners or shareholders, the entity, itself, buys out the shares of each member, so only one policy exists.

Buy-sell agreements legally bind business partners or owners into agreeing to purchase each others’ shares of the company at a predetermined price in the event of death, disability, or other predetermined qualifying events such as at a predetermined retirement age.  The following scenario shows how effective having this protection can be: 5 Questions to Ask a Business Owner

When an agent earns the trust of a client, a sale is made — and referrals will follow.

Even more important, clients will refer others to the you, helping to build your book of business.  Something as important as protecting one’s family and financial wealth is worth the comfort of knowing they are in good hands.

Health insurance replacement often occurs for may reasons including better benefits, reduced deductible, reduced premium, and better network coverage.  It was common to switch insurance when moving to a different state due to the limited networks maintained by each insurer, though, now more insurers provide for a national network of coverage to eliminate the need to change insurance due to a change in where one moves or travels.

Policy Replacement vs Policy Retention

Due to the many factors involved with issuing a policy based on an insured’s preexisting health concerns or the benefit advantages of one plan over another, as a licensed insurance agent, you should closely exam the advantages and disadvantages of replacing a health insurance policy.

The following factors should be considered:

1.  Exclusion of preexisting conditions

2.  New plan benefit waiting periods

3.  Limitations of the new policy vs. current policy

4.  Underwriting differences between various insurance companies

The ethical approach must always be to protect the consumer against potential loss.  Often retaining one’s policy is preferred over replacement because it already covers the insured for current conditions, even if the insurance rate might be higher than a replacement policy.  The rate an insured pays is only one factor in deciding to retain or replace a life or health insurance policy.

Some states require replacement health policies to maintain payment of a previous claim that the replaced insurer was covering when replacing health insurance, though it is always in the best interest of the customer to ensure that continual coverage will be provided, without any exclusions of preexisting conditions.  A transfer of benefits statement should be provided to the customer to ensure benefits listed under the old policy will continue under the new policy.

The main goal of replacement is to better benefit the insured than what is currently in force.  Due to the possible exclusion of preexisting conditions and any additional waiting periods, substandard risk applicants should not consider replacement.

Ethical Standards

An agent should always perform in the interest of the insured, as well as the company.  Maintaining good communication throughout the industry will help an agent keep abreast on the newest laws and regulations.  Continuing education requirements are designed to continually educate a producer, which leads to better performance and increased business.  Knowledge and compliance with state and federal law is required as well as an ethical business practice, focusing on the consumer’s needs.

Always focus on the needs of the client!

As the most important person in the marketing, underwriting, and delivery of an insurance policy, it is the responsibility of the agent to be truthful to the consumer in marketing the benefits and truthful to the company regarding underwriting the applicant.  If an applicant is underwritten as substandard, it is the agent’s responsibility to review the policy’s limitations and/or premium increases.