Types of Insurers
Insurance companies come in different organizational forms, each with distinct ownership structures, profit objectives, and operational characteristics. Understanding these differences is important for the exam and your career.
Overview of Insurer Types
| Type | Ownership | Profits | Policyholders | Common Examples |
|---|---|---|---|---|
| Stock Company | Stockholders | To stockholders as dividends | Customers only | Prudential, MetLife, Aflac |
| Mutual Company | Policyholders | To policyholders as dividends | Owners | State Farm, New York Life, MassMutual |
| Fraternal Society | Members | To members as benefits | Members of organization | Knights of Columbus, Woodmen of the World |
| Reciprocal Exchange | Subscribers | Shared among subscribers | Insure each other | USAA, Farmers Exchange |
| Lloyd's Association | Individual underwriters | To underwriters | Clients | Lloyd's of London |
| Captive Insurer | Parent company | To parent company | Parent company/affiliates | Many large corporations |
Stock Insurance Companies
A stock insurance company is organized as a corporation and owned by stockholders—just like any other publicly traded company.
Key Characteristics
- Ownership: Stockholders who may or may not be policyholders
- Profit motive: Operated for profit; primary goal is stockholder return
- Governance: Board of directors elected by stockholders
- Dividends: Profits paid to stockholders, not necessarily policyholders
- Capital: Raised by selling stock
How It Works
- Stockholders invest capital and assume the risk of the business
- If the company is profitable, stockholders receive dividends
- If the company fails, stockholders may lose their investment
- Policyholders are customers, not owners
Common Examples: Prudential, MetLife, Aflac, Cigna
Mutual Insurance Companies
A mutual insurance company is owned by its policyholders. There are no stockholders—the people who buy insurance policies are the owners.
Key Characteristics
- Ownership: Policyholders are the owners
- Profit motive: Operated for the benefit of policyholders
- Governance: Board elected by policyholders (one policy = one vote)
- Dividends: Surplus returned to policyholders as dividends
- Capital: Built from premiums and retained earnings
How It Works
- When you buy a policy, you become a part-owner of the company
- Profits (called "surplus") are returned to policyholders as dividends
- Dividends may be taken as cash, applied to premiums, or left to accumulate
- Policyholders can vote on company matters
Participating vs. Non-Participating Policies
| Policy Type | Dividends | Premium Level | Typically Issued By |
|---|---|---|---|
| Participating | Eligible for dividends | Higher initial premium | Mutual companies |
| Non-Participating | No dividends | Lower, fixed premium | Stock companies |
Important: Dividends from mutual insurance companies are considered a return of premium, not taxable income.
Common Examples: State Farm, New York Life, Northwestern Mutual, MassMutual
Fraternal Benefit Societies
A fraternal benefit society is a special type of mutual organization that provides insurance exclusively to members of a fraternal, religious, or social organization.
Key Characteristics
- Ownership: Members of the fraternal organization
- Membership requirement: Must belong to the sponsoring organization
- Products: Primarily life and health insurance
- Tax status: Exempt from federal income tax (nonprofit)
- Organization: Lodge system with ritualistic ceremonies
How It Works
- Must be a member of the fraternal organization to purchase insurance
- Operated for the benefit of members, not profit
- Often provides additional member benefits beyond insurance
- Has a representative form of government
Common Examples: Knights of Columbus, Modern Woodmen of America, Thrivent Financial
Reciprocal Exchanges
A reciprocal exchange (also called an inter-insurance exchange) is an unincorporated group of individuals or businesses that agree to insure each other.
Key Characteristics
- Ownership: Subscribers (the individuals/businesses being insured)
- Structure: Unincorporated; managed by an attorney-in-fact
- Insurance: Each subscriber insures all other subscribers
- Liability: Subscribers share in profits and losses proportionally
How It Works
- Members (called "subscribers") agree to share each other's risks
- An attorney-in-fact manages daily operations
- Each subscriber is both an insurer and an insured
- Assessments may be levied if losses exceed premiums collected
Common Examples: USAA, Farmers Exchange, Erie Insurance Exchange
Lloyd's of London
Lloyd's of London is not an insurance company but rather a marketplace where individual underwriters (called "Names" or members) join together in syndicates to insure risks.
Key Characteristics
- Structure: Insurance marketplace, not an insurance company
- Underwriters: Individual members personally liable for losses
- Syndicates: Groups of underwriters specializing in certain risks
- Specialty: Known for insuring unusual or hard-to-place risks
- Broker access: Business conducted through Lloyd's brokers only
How It Works
- Brokers bring insurance risks to Lloyd's
- Individual underwriters decide whether to accept portions of risks
- Multiple underwriters may share a single large risk
- Each underwriter is personally liable for their share of losses
Important Note: American Lloyd's associations exist in some states but are completely separate from Lloyd's of London.
Notable Coverages: Lloyd's has insured unusual risks including:
- Betty Grable's legs
- Keith Richards' hands
- The Titanic
- Satellite launches
- Large sporting events
Captive Insurance Companies
A captive insurance company is an insurance company created and wholly owned by a parent organization to insure the risks of that parent and its affiliates.
Key Characteristics
- Ownership: Parent company/corporation
- Purpose: Insure the parent's own risks
- Control: Parent controls coverage, claims, and investments
- Location: Often domiciled in favorable regulatory jurisdictions
- Types: Single-parent captives, group captives, association captives
Why Companies Form Captives
- Reduce insurance costs for hard-to-insure risks
- Gain direct access to reinsurance markets
- Retain underwriting profits within the organization
- Customize coverage not available commercially
- Better control over claims management
How It Works
- Parent company creates a separate insurance subsidiary
- Subsidiary insures risks of parent and related entities
- Premiums flow to the captive instead of external insurers
- Profits remain with the parent organization
Common Users: Large corporations, hospitals, municipalities
Self-Insurance
While not technically an insurer type, self-insurance deserves mention as an alternative to traditional insurance.
Key Characteristics
- The organization retains and funds its own risks
- No transfer of risk to an outside insurer
- Requires significant financial resources
- Often used for employee health benefits
- May purchase stop-loss coverage for catastrophic claims
Common Users: Large corporations, government entities
Key Takeaways
- Stock companies are owned by stockholders; profits go to stockholders
- Mutual companies are owned by policyholders; surplus returned as dividends
- Fraternal societies provide insurance only to members of fraternal organizations
- Reciprocal exchanges are subscribers who insure each other, managed by an attorney-in-fact
- Lloyd's of London is a marketplace, not a company; individual underwriters accept risk
- Captive insurers are formed by parent companies to insure their own risks
In a mutual insurance company, who owns the company?
A reciprocal exchange is managed by a(n):
Which type of insurer is organized as a corporation owned by stockholders who may or may not be policyholders?
Fraternal benefit societies are characterized by all of the following EXCEPT:
2.1 Contract Law Basics
Chapter 2: Insurance Contracts