The Insurance Industry and Business Ethics



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Erik Cohen Business Ethics 26 September 2011 The Insurance Industry and Business Ethics The Insurance industry is a perfect example of the use of “grey areas” in the culture of business ethics in the United States. Within my research and years of experience in the field of insurance the use of business ethics couldn’t be of greater importance then the companies that provide the actual policies themselves. Even with all of the regulations the Insurance Department puts on the insurance companies, agents, brokers, and adjusters there are still areas where discrepancies in the code of business practices exist.

I will explain some of the insurance company’s ways of motivation, monetary compensation, underwriting rules, business strategies, and the “grey areas” or lack of business ethics of the professional agents and brokers who sell their products. The birth of Insurance in the United States was in 1732 in one of the American colonies at Charleston SC and then New York City in 1787 (Encyclopedia). “Insurance developed rapidly with the growth of British commerce in the 17th and 18th cent.

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Prior to the formation of corporations devoted solely to the business of writing insurance, policies were signed by a number of individuals, each of whom wrote his name and the amount of risk he was assuming underneath the insurance proposal, hence the term underwriter. ” (Press) According to the Columbia Electronic Encyclopedia, since the late 19th century there has been a growing tendency for the United States to increase their interest in insurance, especially with protecting workers against sickness and disability, either temporary or permanent, destitute old age, and unemployment.

The U. S. government has also experimented with various types of crop insurance which began the Federal Crop Insurance Act of 1938. In World War II the government provided life insurance for members of the armed forces; since then it has provided other forms of insurance such as pensions for veterans and for government employees. (Stalson) After 1944 the supervision and regulation of insurance companies, previously an exclusive responsibility of the states, became subject to regulation by Congress under the interstate commerce clause of the U. S. Constitution.

Many insurance companies have since expanded, many insurance companies have merged, and multiple-line companies now lead the insurance industry. In 1999, Congress repealed banking laws that had prohibited commercial banks from being in the insurance business; this measure was expected to result in expansion by major banks into the insurance arena. (Press) In recent years insurance premiums (particularly for liability policies) have increased rapidly, leaving unprecedented numbers of Americans uninsured. Many blame the insurance conglomerates, contending that U. S. itizens are paying for bad risks made by the companies. Insurance companies place the burden of guilt on law firms and their clients, who they say have brought unreasonably large civil suits to court, a trend that has become so common in the United States that legislation has been proposed to limit lawsuit awards. Catastrophic earthquakes, hurricanes, and wildfires in late 1980s and the 90s have also strained many insurance company’s reserves. (Press) This global multi trillion dollar industry has for the first time in the past three decades declined “with non-life premiums falling by 0. % and life premiums falling by 3. 5%”. (Maslakovic) Although the stock market and insurance investment returns decreased due to the bankruptcy of Lehman Brothers[-;0] and the rescue of AIG[-;1] by the federal government in September 2008 the financial crisis has shown that the insurance industry has the sufficient capital to maintain its function. In 2008 there was study created by Marko Maslokavic which stated that North America produced $1,346 billion dollars of premium and Asia produced $933 billion of premium which accounts for 40% of the worlds insurance.

What I found interesting from this research is that North America and Japan are only 7% of the global population which shows the level of importance insurance plays a role in both places. With this massive and growing insurance industry New York State created The New York State Insurance Department to regulate its functions. “The Insurance Department was created in 1859 by the New York State Legislature[-;2], and assumed the functions of the Comptroller and Secretary of State relating to insurance. (Department) The Insurance Department is responsible for supervising and regulating all insurance business in New York State. The Department’s mission is to: ·Ensure the continued sound and prudent conduct of insurers’ financial operations; ·Provide fair, timely and equitable fulfillment of insurer obligations; ·Protect policyholders from financially impaired or insolvent insurers; ·Eliminate fraud, other criminal abuse and unethical conduct in the industry; and ·Foster growth of the insurance industry in the State. Department) According to the NYSID, the department carries out its regulatory function by issuing licenses to agents, brokers, consultants, reinsurance intermediaries, adjusters, and bail bondsmen. The NYSID audits insurers to verify if their financial stable, they also make sure the insurers’ treatment of policyholders and claimants is fair, and that they have a reasonable underwriting practice.

The NYSID is responsible for regulating insurance carrier’s rates, retirement systems, pension funds, reviews policyholders’ complaints, and supervises the liquidation, rehabilitation, and conservation of insolvent insurers. Furthermore, the Department is in charge of approving corporate formations, mergers, and consolidations. There are many different parts of the insurance industry and insurance companies, but I will focus on the sales portion and the business ethics that encompass it.

There are three kinds of insurance sales professionals: Insurance Managing General Agents, Insurance Brokers, and Insurance Agents. The Insurance Managing General Agent is defined legally as “an individual or business entity appointed by an insurer to solicit applications from agents for insurance contracts or to negotiate insurance contracts on behalf of an insurer and, if authorized to do so by an insurer, to effectuate and countersign insurance contracts. ” (Commission) An Insurance Broker can offer multiple insurance products from multiple insurance carriers.

Brokers are required to have a broker’s license which usually means the broker will have more education or experience than an agent. “Brokers also have a higher duty, in most states, to their clients. Brokers have the duty to analyze a business and secure correct and adequate coverage for the business. This is a higher duty than the pure administrative duty of the agent. ” (Boop) Brokers normally charge an administrative fee or a “2119c fee” when purchasing a policy through them. An Insurance Agent is an insurance professional that serves as a middle-man etween the insurance company and the insured. The Insurance Agent represents and works for the insurance company which in turn has the interest of the insurance company first not the insured’s. “Agents have no duty to conduct a thorough examination of your business or to make sure you have appropriate coverage. Rather, it is your obligation to make sure you have purchased needed coverage. ” (Boop) The insurance companies in NYS have gotten approval for a few years now to sell homeowners insurance policies that include a “hurricane deductible” or “catastrophic wind” deductible.

When this deductible is engaged it is a huge burden that is put on the insured to pay such a large deductible before the insurance company will help pay for damages from a named hurricane. As stated in a letter sent out by Cohen Insurance Agency, LLC: To limit their exposure to catastrophic losses from natural disasters, many insurers in New York State are selling homeowner’s insurance policies with percentage deductibles for storm damage instead of the traditional dollar deductibles, which are used for other types of losses such as fire damage and theft.

With a policy that has a $500 standard deductible, for example, the policyholder must pay the first $500 of the claim out of pocket. But percentage deductibles are based on the home’s insured value. So if a house is insured for $300,000 and has a 2 percent deductible, the first $6,000 of a claim must be paid out of the policyholder’s pocket. Insurance companies determine the level of the hurricane or windstorm or wind/hail deductible and where it should apply, except in Florida where state law dictates these variables.

Insurers’ hurricane deductible plans must be reviewed and approved by the state insurance department. (Cohen) What I think is unfair and is an example of poor business ethics is when the insurance companies come to inspect the insured homes, then decide to increase the value of the dwelling, this in turn increases the hurricane deductible. The current standard hurricane deductible is 5% with most insurance companies. Few offer a 2% deductible for hurricane but charge a higher premium.

Each company has their own formula as to how much the rebuild value of a house will be. So one insurance company calculates a house to be rebuilt in case of a total loss for $250,000 ($12,500 deductible, assuming a 5% deductible) and another company would calculate $300,000 ($15,000 deductible, assuming a 5% deductible). I have been told by different insurance companies’ underwriters that some use a general replacement cost formula of $150 to $200 per square foot. As you can see this can cause an insured to pay a higher premium then needed.

The insured’s hurricane deductible would have also increased unnecessarily due to the replacement cost of the house which is decided by the insurance company. Another unfair practice in the current times of home values continually declining is that some insurance companies have endorsements on homeowners policies that increase the dwelling amount anywhere from 2%-4% each year and that in turn increases the insured premium and increases the hurricane deductible which allows the insurance company to have a lower probability of a claim exceeding the limit of the deductible.

According to the insurance companies this endorsement is in place to make sure that the insured house is fully insured and increase with the cost of inflation. This endorsement is obviously not needed in today’s real-estate market since the prices of houses have fallen. This is just another way for the insurance company to increase its revenue and limit it liability exposure. Many insurance companies have not changed or removed this endorsement from their policies because not enough insured’s, brokers, and agents have complained.

Another immoral example of what insurance companies have done in the past is in 2007 Allstate Insurance Company was non renewing thousand of homeowner’s policies on Long Island for not having multiple policies with them. So for you to retain your homeowner’s policy with Allstate you would need to have an auto insurance or life policy with them as well. This sounds very unfair right? Yes this an immoral business practice and that’s why the Insurance Department stepped in and fined Allstate millions of dollars for violating the insurance departments laws.

The New York State Insurance Department has issued a citation to Allstate Insurance Company and its affiliates. The citation was issued following Allstate’s refusal to comply with a Department Circular Letter issued on August 28, 2007, which directed all property/casualty insurers to discontinue the practice of non-renewing homeowners insurance policies based upon whether or not the policyholder had other insurance business, such as automobile or life insurance, with the insurer or its affiliates.

The Department considers such conditioning of renewals of homeowners insurance to be a violation of the anti-rebating and anti-discrimination provisions of Insurance Law § 2324. The citation directs Allstate to appear at an administrative hearing at the Insurance Department on September 19, 2007 to show cause why a formal order should not be made requiring Allstate to discontinue its practice of conditioning homeowners insurance renewals on the existence of other insurance business, to reinstate policies that were improperly non-renewed, and to pay civil penalties for violating the Insurance Law. Department) The compensation paid by an insurance company to the insurance broker or insurance agent varies according to the insurance company’s policy on paying commissions. I know from personal experience by being an insurance broker that the commission paid by the insurance companies varies from 10% of the annual premium to 20% of the annual premium. This could cause an insurance broker to only sell the higher commissioned policy for higher compensation.

The different commission schedules from different insurance carriers is not the only way they compensate, companies will also give you bonus checks for a certain amount of policies you sell for them within a certain period of time. For example, a company would contact its producers and announce for each policy you sell over the amount you sold the same month last year the company would pay you an extra $50 each plus still paying commission. In other words, if a broker sold 15 auto insurance policies in July of 2010 and if the broker sells 20 auto policies in July of 2011 then the broker would receive a bonus check of $250 plus commissions.

Another way the insurance companies compensate its producers is with profit sharing. Some insurance companies will compensate a producer if they attain a certain volume of premium with that company. For example, if a producer gives a company over $250,000 in premium of business from all of the different types of policies written, then that company will give the producer an additional 2% commission bonus check at the end of the year providing the producer has a favorable loss ratio of less than 35%.

The loss ratio is important for insurance companies because if they have a high loss ratio then they are paying out more money in claims then they have received in insurance premiums. “In insurance[->3], the loss ratio is the ratio of total losses paid out in claims plus adjustment expenses divided by the total earned premiums. For example, if an insurance company pays out $60 in claims for every $100 in collected premiums, then its loss ratio is 60%. Loss ratios for property and casualty insurance[->4] (e. g. motor car insurance[->5]), typically range from 40% to 60%. (Rubin) As you can see by the compensation structure of the insurance companies the broker could if he wanted to only sell the insured’s the higher paying insurance company’s policies. This is probably one of the reasons why the New York State Insurance Department created the producer compensation transparency law regulation 194 as of January 1, 2011. This regulation states that New York producers are required to comply with the requirements to provide the new policy purchaser a compensation notice. The purposes of this Part are: o implement the New York Insurance Law by regulating the acts and practices of insurers and insurance producers with respect to transparency of compensation paid to insurance producers and their role in insurance transactions in this State; and to protect the interests of the public by establishing minimum disclosure requirements relating to the role of insurance producers and the compensation paid to insurance producers. (Department) The transparency producer compensation disclosure includes the verbiage below: Disclosure of producer compensation, ownership interests and role in the insurance transaction.

A producer shall disclose the following information to the purchaser orally or in a prominent writing at or prior to the time of application for the insurance contract: (1) a description of the role of the insurance producer in the sale; (2) whether the insurance producer will receive compensation from the selling insurer or other third party based in whole or in part on the insurance contract the producer sells; (3) that the compensation paid to the insurance producer may vary depending on a number of factors, including (if applicable) the insurance contract and the insurer that the purchaser selects, the volume of business the producer provides to the insurer or the profitability of the insurance contracts that the producer provides to the insurer; and (4) that the purchaser may obtain information about the compensation expected to be received by the producer based in whole or in part on the sale, and the compensation expected to be received based in whole or in part on any alternative quotes presented by the producer, by requesting such information from the producer. 6) If the purchaser requests more information about the producer’s compensation prior to the issuance of the insurance contract, the producer shall disclose the following information to the purchaser in a prominent writing at or prior to the issuance of the insurance contract. (Department) From working in the insurance industry for the last 15 years I have seen some interesting and unethical business practices from many different insurance companies. Some companies will have their marketing representative’s meet with you and tell you verbally that they do not want to accept any insured that have Progressive because their loss ratios have been coming in higher than other insured’s coming from other insurance companies. They don’t include that wording in the underwriting rules they give you because the NYSID will fine them if they found out about this business practice.

I have had an insurance marketing representatives come into my office and tell me the only way they will write a homeowners insurance policy is if the insured has more than one house to insure and they place all the houses with this one insurance company. This business practice is also illegal according to the NYSID laws. I have seen some insurance carriers say the only way they will write an insured’s home is if they write their auto policy as at the same time. This practice is also against the NYSID laws. There are many other ways insurance companies do business unethically by writing new business, the way they pay on claims, their compensation policies, their inspection procedures, and even the way they treat their employees. Another part of the insurance industry is the unethical practice of the agents and brokers that sell the insurance companies products.

On the New York State Insurance Departments website you can see the disciplinary actions and fines placed on the insurance companies, brokers and agents. Some other illegal business practices shown by insurance brokers are when they give “kickbacks” which is money for helping the agent or broker to write a policy. I have seen property managers of management companies ask for kickbacks for allowing a broker to insure a building they manage. I have seen auto body repair shops offer money to insurance brokers and agents to refer their auto claims to their shops. Insurance companies are in the business to make money and the majority does. Even though they are fined by the New York State Insurance Department it still seems that they deem it worthy to pay the fines compared to the revenue lost.

I feel that like most industries even with the regulations in place to safe guard against unethical business practices there will always be companies and people that defy the laws for monetary gain. Works Cited Boop, Gregory. www. about. com. 2011. 21 September 2011 . Cohen, Erik. “Wind/Hurricane Deductible. ” Ronkonkonkoma: Cohen Insurance Agency, LLC, 10 March 2010. Commission, Kentucky Legislative Research. “Kentucky Legislative. ” 2011. http://lrc. ky. gov/. 21 September 2011 . Department, New York State Insurance. New York State Insurance Department. 2011. 21 September 2011 . Maslakovic, Marko. “Insurance 2010. ” December 2010. www. thecityuk. om. 09 September 2011 . Press, Columbia University. www. infoplease. com. 2007. 12 September 2011 . Rubin, Harvey. Dictionary of Insurance Terms. 4th Ed. Baron’s Educational Series, 2000. Stalson, J. Owen. Marketing Life Insurance: Its History in America . Harvard U. P. , 1942. [-;0] – http://en. wikipedia. org/wiki/Lehman_Brothers [-;1] – http://en. wikipedia. org/wiki/American_International_Group [-;2] – http://en. wikipedia. org/wiki/New_York_State_Legislature [-;3] – http://en. wikipedia. org/wiki/Insurance [-;4] – http://en. wikipedia. org/wiki/Property_insurance [-;5] – http://en. wikipedia. org/wiki/Vehicle_insurance

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