Chapter 2: Insurance Company Structure & Distribution
Learning Objectives
Understand:
- The three key insurance company departments
- What each department does
- How insurance is distributed/sold
- The underwriting process
- Risk classifications
The Three Key Departments
Every insurance company has these three main departments working together:
ACTUARIAL DEPARTMENT
Role: The Mathematicians
- Uses statistics and math to analyze risk
- Calculates premium rates based on historical loss data
- Determines if a risk is acceptable for the company
- Says: “This person is worth insuring” or “This person is too risky”
UNDERWRITING DEPARTMENT
Role: The Decision Makers
- Reviews new applications
- Decides: APPROVE or DENY each application
- Practices “Adverse Selection” = deliberately rejecting risky applicants to protect the company
- Example: You apply for life insurance as a skydiver; underwriter might reject you as too risky
Key Term: Adverse Selection = Rejecting high-risk applicants to protect the insurance company
CLAIMS DEPARTMENT
Role: The Payout Team
- Processes claims when you file a loss
- Verifies that the claim is legitimate
- Pays the benefits if the claim is approved
How Insurance Gets Sold: Distribution Channels
Insurance companies use different methods to reach and sell to customers. There are 5 types:
| Distribution Type |
What It Is |
Example |
| Exclusive Agency |
Agent works for ONE company only |
A “State Farm Agent” only sells State Farm |
| Direct Writer |
Company sells directly to customers (no agent) |
GEICO (online/phone) |
| Direct Response |
Customer buys via mail, phone, or internet |
TV commercials: “Call now!” |
| General Agency |
Agency represents MULTIPLE companies |
Independent agent selling multiple brands |
| Independent Agency |
Agent represents MULTIPLE companies |
Local insurance broker (customer can shop) |
Memory Trick
Exclusive = ONE company | General/Independent = MANY companies
The Underwriting Process
When someone applies for insurance, underwriters gather information from several sources to decide whether to approve or deny.
MIB (Medical Information Bureau)
- A database of medical history
- Insurance companies report to it and check it
- Used for life and health insurance
Inspection Reports
- Physical inspections
- For property: building condition, security systems
- For people: medical exam results, health status
Agent’s Report
- Information provided by the sales agent who took the application
- Agent observations and recommendations
Nonmedical Application
- A simple form
- Customer fills it out without a medical exam
- Quicker process
Risk Classifications
After reviewing all the information, the underwriter places the applicant into one of four risk categories:
| Classification |
Risk Level |
Premium |
Example |
| Standard |
Normal/Average |
Regular/Normal |
Typical customer with typical risk profile |
| Substandard |
Higher |
Higher |
Smoker applying for life insurance |
| Preferred |
Lower |
Lower |
Excellent health, no accidents, non-smoker |
| Uninsurable |
Too Risky |
N/A (DENIED) |
Company refuses to insure at any price |
Memory Trick
STANDARD = normal | SUB = below/worse (higher risk) | PREFERRED = better (lower risk) | UNINSURABLE = no way!
Key Concept: Adverse Selection
Adverse Selection = The practice of deliberately rejecting applicants whose risk is too high
Why do insurance companies do this?
- To protect profitability
- To maintain a healthy book of business
- To avoid claims that exceed premiums collected
Example:
- You apply for health insurance with a pre-existing serious condition
- Underwriter rejects you as too risky
- This is “Adverse Selection” in action
Key Definitions
- Actuarial: Uses math and statistics to set rates
- Underwriting: Reviews applications and makes approve/deny decisions
- Claims: Processes and pays approved claims
- Adverse Selection: Rejecting high-risk applicants
- Risk Classification: Grouping applicants into Standard/Substandard/Preferred/Uninsurable
CHAPTER 2 QUIZ
Question 1
Which department decides whether to approve or deny a new application?
- A) Claims
- B) Underwriting
- C) Actuarial
- D) Marketing
Show Answer
**Answer: B**
Underwriting makes the yes/no decision on applications. They review the application and supporting information, then approve or deny.
Question 2
What is “Adverse Selection”?
- A) Choosing customers with the best health
- B) Deliberately rejecting applicants who are too risky
- C) Paying claims too quickly
- D) Offering multiple distribution channels
Show Answer
**Answer: B**
Adverse Selection = protecting the company by rejecting high-risk people. The company is being "adverse" (opposed) to selecting them.
Question 3
What is an “Exclusive Agency”?
- A) An agency representing multiple insurance companies
- B) An agent working for only ONE insurance company
- C) A distribution method only for life insurance
- D) A special license type in Michigan
Show Answer
**Answer: B**
Exclusive = ONE company only. Like State Farm agents who only sell State Farm insurance.
Question 4
Which is NOT a standard underwriting information source?
- A) Medical Information Bureau (MIB)
- B) Agent’s Report
- C) Customer’s social media accounts
- D) Inspection Reports
Show Answer
**Answer: C**
Social media is NOT used in standard underwriting. MIB, Agent Reports, and Inspection Reports are all standard sources.
Question 5
What does “Preferred” risk classification mean?
- A) Lower risk, lower premium
- B) Higher risk, higher premium
- C) Average risk, average premium
- D) Unacceptable risk
Show Answer
**Answer: A**
Preferred = lower risk = lower premium. The customer is rewarded with cheaper coverage because they're a better risk.
CRITICAL NUMBERS (from Chapter 2)
None specific to this chapter. Review Chapter 1 critical numbers.
Summary
In this chapter you learned:
- Insurance companies have 3 main departments (Actuarial, Underwriting, Claims)
- There are 5 distribution channels for selling insurance
- Underwriters gather information from 4 main sources
- Risk is classified into 4 categories (Standard, Substandard, Preferred, Uninsurable)
- Adverse Selection means rejecting high-risk applicants
Next: Chapter 3: Contract Law & Agency