Overview: The Insurance Industry Players
The insurer (or principal) is the company that issues a policy of insurance. Insurance companies can be classified based on ownership, domicile (location of incorporation), and authorization to transact business.
These categories are not mutually exclusive - the same company can be described by where it's located, who owns it, and what type of agents it appoints.
Start Here: 5 Things You MUST Know
Stock vs Mutual: Stock companies pay dividends to shareholders (taxable); Mutual companies pay dividends to policyowners (nontaxable)
Domicile = Where incorporated, NOT where they do business
Agent = Represents the INSURER; Broker = Represents the INSURED
Certificate of Authority = License to transact insurance in a state
Reinsurance = Insurance for insurance companies (spreading risk)
1. Types of Insurers
Classification by Ownership
Stock Companies
- •Owned by: Stockholders (shareholders)
- •Managed by: Officers elected by stockholders
- •Policies issued: Nonparticipating (no dividends to policyowners)
- •Dividends: Paid to STOCKHOLDERS (taxable, not guaranteed)
Real-World Example:
Allstate is a stock company. When Allstate makes profits, those profits can be distributed as dividends to people who own Allstate stock. Policyowners who buy Allstate insurance don't receive dividends - only shareholders do.
Mutual Companies
- •Owned by: Policyowners (the insureds)
- •Policies issued: Participating (may receive dividends)
- •Dividends: Return of excess premiums to POLICYOWNERS
- •Tax treatment: Dividends are NONTAXABLE (return of premium)
Real-World Example:
State Farm is a mutual company. When you buy State Farm insurance, you become a partial owner. If the company collects more in premiums than needed, the excess may be returned to policyowners as a dividend (not taxable - it's YOUR money coming back).
| Feature | Stock Company | Mutual Company |
|---|---|---|
| Owners | Stockholders | Policyowners |
| Policy Type | Nonparticipating | Participating |
| Dividends To | Stockholders | Policyowners |
| Dividends Taxable? | YES (taxable income) | NO (return of premium) |
| Dividends Guaranteed? | NO | NO |
Classification by Domicile (Location of Incorporation)
Critical Concept!
Domicile refers to where an insurer is incorporated, NOT where the insurer conducts business. An insurer can do business in all 50 states but only has ONE domicile.
Domestic
Incorporated in THIS state (NJ)
Foreign
Incorporated in ANOTHER US state or territory
Alien
Incorporated OUTSIDE the United States
Real-World Scenario: Same Company, Different Classification
The Setup: ABC Insurance Company was incorporated in New York. It sells policies in NY, NJ, PA, and CT.
Classification: From NEW YORK's perspective, ABC is DOMESTIC. From NEW JERSEY's perspective, ABC is FOREIGN. Same company - different classification depending on which state is asking!
Certificate of Authority
Before insurers may transact business in a state, they must apply for and be granted a Certificate of Authority (license) from the state department of insurance and meet financial requirements.
Authorized (Admitted)
Insurers who meet financial requirements and are approved to transact business in the state. They're legally allowed to sell insurance.
Unauthorized (Nonadmitted)
Insurers NOT approved to do business in the state. Most states prohibit them from operating except through licensed surplus lines brokers.
2. Types of Producers
Insurance Agent
A producer authorized in writing by an insurance company to solicit, negotiate, or sell insurance contracts, or collect premiums on its behalf.
- •Represents the INSURER
- •Can countersign policies
- •Acts on behalf of the company
Example:
Tom works for XYZ Insurance Company. He's authorized by XYZ to sell their policies and collect premiums. Tom is an agent of XYZ.
Insurance Broker
A producer who negotiates for an insurance contract on behalf of a client (the insured or prospective insured).
- •Represents the INSURED
- •Helps client find coverage
- •Earns commission, brokerage fee, or other consideration
Example:
Sarah helps her client find the best homeowners policy. She shops multiple insurers to find the right coverage. Sarah is acting as a broker for her client.
Insurance Consultant
A person who, for a fee, offers advice, counsel, or opinion regarding the benefits, advantages, or disadvantages of any insurance policy.
- •Charges a fee for advice
- •May not sell policies directly
- •Independent advice
NOT included:
Bank trust officers, attorneys, and CPAs who provide general financial counsel (if no commission or brokerage fee is paid)
Key Distinction: Agent vs Broker
AGENT = Works for INSURER
"I work for ABC Insurance. Let me tell you about our great policies."
BROKER = Works for INSURED
"I work for YOU. Let me shop around and find you the best policy from any company."
3. Insurance Transactions
The term insurance transaction includes any of the following (by mail or any other means). A person may NOT sell, solicit, or negotiate insurance in this state unless licensed for that line of authority.
Solicitation
Attempting to sell insurance or asking/urging a person to apply for a specific type of insurance from a particular insurer.
Negotiations
Directly conferring with or offering advice about a policy's benefits, terms, or conditions.
Sale
Exchanging a contract or policy of insurance for money or its equivalent, on behalf of an insurer.
Advising
Advising an individual concerning coverage or claims.
Insurance-Related Conduct (NJ Law)
NJ law defines additional activities as "insurance-related conduct":
• Selling, soliciting, negotiating, and binding insurance policies
• All communication with insureds about policy terms and conditions
• Office management policies affecting insureds
• Processing claims
• Transmitting funds between insured, producers, premium finance companies, and insurers
4. Reinsurance
What is Reinsurance?
Reinsurance is a contract under which one insurance company (the reinsurer) indemnifies another insurance company for part or all of its liabilities. The purpose is to protect insurers against catastrophic losses.
How Reinsurance Works
Ceding Insurer
(Original insurer - gives risk)
Reinsurer
(Assuming insurer - takes risk)
Ceding Insurer
The originating company that procures insurance on itself from another insurer. They "cede" (give) the risk to the reinsurer.
Example:
ABC Insurance writes $500 million in hurricane coverage. That's too much risk to hold alone, so ABC "cedes" half to Big Re Insurance.
Reinsurer (Assuming Insurer)
The other insurer that "assumes" (takes on) part of the risk from the ceding insurer.
Example:
Big Re Insurance agrees to take $250 million of ABC's hurricane risk. If a hurricane causes $400 million in losses, Big Re pays half.
Retrocession (Extended Reinsurance)
When a reinsurer has taken on too many risks and must spread some of its liabilities to other reinsurers. It's "reinsurance for reinsurers."
Original Insurer
Reinsurer
Retrocessionaire
(Reinsurer's reinsurer)
Cheat Sheet
Print for quick referenceStock Company
Owned by stockholders, taxable dividends
Mutual Company
Owned by policyowners, nontaxable dividends
Domestic
Incorporated in THIS state
Foreign
Incorporated in ANOTHER US state
Alien
Incorporated OUTSIDE the US
Certificate of Authority
License to transact insurance
Agent
Represents INSURER
Broker
Represents INSURED
Ceding Insurer
Gives risk to reinsurer
Exam Trap Alerts
1. Stock vs Mutual Dividends
Stock company dividends go to STOCKHOLDERS and are TAXABLE. Mutual company dividends go to POLICYOWNERS and are NONTAXABLE (return of excess premium). Neither is guaranteed!
2. Domicile vs. Where They Do Business
Domicile = WHERE INCORPORATED, not where they sell policies. An insurer can sell in all 50 states but only has ONE domicile (where incorporated).
3. Foreign Does NOT Mean International
"Foreign" = another US state. A company from France is ALIEN. A company from California is FOREIGN to NJ. Don't confuse "foreign" with international!
4. Agent vs Broker - Who Do They Represent?
AGENT = works for the INSURER. BROKER = works for the INSURED. The exam loves testing this distinction. Remember: agents represent the company, brokers represent you.
5. Reinsurance Terms
CEDING = giving away risk. ASSUMING = taking on risk. Retrocession = reinsurance for reinsurers (when a reinsurer needs its own reinsurance).
Quick Reference Summary
Stock Companies
Owned by stockholders, nonparticipating policies, taxable dividends
Mutual Companies
Owned by policyowners, participating policies, nontaxable dividends
Domicile Classification
Domestic (NJ), Foreign (other US), Alien (non-US)
Certificate of Authority
Required license to transact insurance in a state
Agent vs Broker
Agent = insurer; Broker = insured
Reinsurance
Ceding gives risk, Reinsurer assumes it