CHARACTERISTICS OF TRADITIONAL GROUP INSURANCE Traditionally, group insurance has been characterized by a group contract, experience rating of larger

groups, and group underwriting. Perhaps the best way to define group insurance is to compare its characteristics with those of individual insurance, which is underwritten on an individual basis. The purpose of group insurance underwriting is twofold: - To minimize the problem of adverse selection (those who are most likely to have claims are also those who are most likely to seek insurance) - To minimize the administrative costs associated with group insurance - Because of group underwriting, coverage can be provided through group insurance at a lower cost than through individual insurance. However, there are certain general underwriting considerations applicable to all or most types of group insurance that affect the contractual provisions contained in group insurance contracts as well as insurance company practices pertaining to group insurance. These general underwriting considerations include the following: - The reason for the existence of the group - The stability of the group - The persistency of the group - The method of determining benefits - The provisions for determining eligibility - The source and method of premium payments - The administrative aspects of the group insurance plan - The prior experience of the plan - The size of the group - The composition of the group - The industry represented by the group - The geographic location of the group Reason for Existence Probably the most fundamental group underwriting principle is that a group must have been formed for some purpose other than to obtain insurance for its members. Such a rule protects the group insurance company against the adverse selection that would likely exist if poor risks were to form a group just to obtain insurance. Groups based on an employer-employee relationship present little difficulty with respect to this rule. Stability Ideally, an underwriter would like to see a reasonable but steady flow of persons through a group. A higher-than-average turnover rate results in increased administrative costs for the insurance company as well as for the employer. If turnover exists among recently hired employees, these costs can be minimized by requiring employees to wait a period of time before becoming eligible for coverage. However, such a probationary period does leave newly hired employees without protection if their previous group insurance coverage has terminated. Persistency An underwriter is concerned with the length of time a group insurance contract will remain on the insurance company's books. Initial acquisition expenses, often including higher first-year

commissions, frequently cause an insurance company to lose money during the first year the group insurance contract is in force. Only through the renewal of the contract for a period of time, often three or four years, can these acquisition expenses be recovered. For this reason, firms with a history of frequently changing insurance companies or those with financial difficulty are often avoided. Determination of Benefits In most types of group insurance, the underwriter requires that benefit levels for individual members of the group be determined in some manner that precludes individual selection by either the employees or the employer. If employees could choose their own benefit levels, there would be a tendency for the poorer risks to select greater amounts of coverage than the better risks would select. Similarly, adverse selection could also exist if the employer were able to choose a separate benefit level for each individual member of the group. As a result, this underwriting rule has led to benefit levels that are either identical for all employees or determined by a benefit formula that bases benefit levels on some specific criterion, such as position or salary. Benefits based on salary or position may still lead to adverse selection because disproportionately larger benefits are provided to the owner or top executives who may have been involved in determining the benefit formula. Consequently, most insurance companies have rules for determining the maximum benefit that may be provided for any individual employee without evidence of insurability. Additional coverage either is not provided or is subject to individual evidence of insurability. Determination of Eligibility The underwriter is also concerned with the eligibility provisions that are contained in the group insurance plan. Many group insurance plans contain probationary periods that must be satisfied before an employee is eligible for coverage. In addition to minimizing administrative costs, a probationary period also discourages persons with known medical conditions from seeking employment primarily because of a firm's group insurance benefits. This latter problem is also addressed by the requirement that an employee be actively at work before coverage commences or, particularly with major medical coverage, by limiting coverage for preexisting conditions to the extent allowed by federal and state laws. Premium Payments Group insurance plans may be contributory or noncontributory. Members of contributory plans pay a portion, or possibly all, of the cost of their own coverage. When employees pay the entire portion, the plans are often referred to as fully contributory or employee-pay-all plans. Under noncontributory plans, the policyholder pays the entire cost. Because all eligible employees are usually covered, noncontributory plans are desirable from an underwriting standpoint because adverse selection is minimized. In fact, most insurance companies and the laws of many states require 100 percent participation of eligible employees under noncontributory plans. In addition, the absence of employee solicitation, payroll deductions, and underwriting of late entrants into the plan results in administrative savings to both the policyholder and the insurance company, thus favoring the noncontributory approach to the financing of group insurance benefits. Administration To minimize the expenses associated with group insurance, the underwriter often requires that the employer carry out certain administrative functions. These commonly include communicating the plan to the employees, handling enrollment procedures, collecting employee contributions on a payroll-deduction basis, and keeping certain types of records. In addition, employers are often involved in the claims process. Underwriters are concerned not only with the employer's ability to carry out these functions but also with the employer's willingness to

cooperate with the insurance company. Prior Experience For most insurance companies, a large portion of newly written group insurance consists of business that was previously written by other insurance companies. Therefore, it is important for the underwriter to ascertain the reason for the transfer. If the transferred business is a result of dissatisfaction with the service provided by the prior insurance company, the underwriter must determine whether the insurance company can provide the type and level of service desired. Because an employer is most likely to shop for new coverage when faced with a rate increase, the underwriter must evaluate whether the rate increase was due to excessive claims experience. Often, particularly with larger groups, excessive claims experience in the past is an indication of the same type of experience in the future. Occasionally, however, the prior experience may be due to circumstances that will not continue in the future, such as a catastrophe or large medical bills for an employee who has died, totally recovered or terminated employment. Finally, the underwriter must be reasonably certain that the employer will not present a persistency problem by changing insurance companies again in the near future. Size The size of a group is a significant factor in the underwriting process. With large groups, prior group insurance experience can usually be used as a factor in determining the premium, and considerable flexibility also exists with both rating and plan design. In addition, adjustments for adverse claims experience can be made at future renewal dates under the experience-rating process. The situation is different for small groups. In many cases, coverage is being written for the first time. Administrative expenses tend to be high in relation to the premium. There is also an increased possibility that the owner or major stockholder might be interested in coverage primarily because he or she, or a family member, has a medical problem that will result in large immediate claims. As a result, contractual provisions and the benefits available tend to be standardized to control administrative costs. Also, because past experience for small groups is not necessarily a realistic indicator of future experience, most insurance companies use pooled rates under which a uniform rate is applied to all groups that have a specific coverage. Because excessive claims experience for a particular group is not charged to that group at renewal, more restrictive underwriting practices relating to adverse selection are used. These include less liberal contractual provisions and, in some cases, individual underwriting of group members. Composition The age, sex, and income of employees in a group will affect the experience of the group. As employees age, the mortality rate increases. Excluding maternity claims, both the frequency and duration of medical and disability claims also increase with age. At all ages, the death rate is lower for females than for males. However, the opposite is true for medical expenses and disability claims. Even if maternity claims are disregarded, women as a group tend to be hospitalized and disabled more frequently and require medical and surgical treatment more often than men. Industry The nature of the industry represented by a group is also a significant factor in the underwriting process. In addition to different occupational hazards among industries, employees in some industries have higher-than-average health insurance claims that cannot be directly attributed to their jobs. Therefore, insurance companies commonly make adjustments in their life and health insurance rates based on the occupations of the employees covered as well as the industries in

which they work. In addition to occupational hazards, the underwriter must weigh other factors as well. Certain industries are characterized by a lack of stability and persistency and thus may be considered undesirable risks. The underwriter must also be concerned with what impact changes in the economy will have on a particular industry. Geographic Location The size and frequency of health insurance claims varies considerably among geographic regions and must be considered in determining a group insurance rate. For example, medical expenses tend to be higher in the Northeast than in the South, and higher in large urban areas than in rural areas. Certain geographic regions also tend to have a higher frequency of disability claims. A group with geographically scattered employees also poses more administrative problems and probably results in greater administrative expense than a group in a single location. In addition, the underwriter must determine whether the insurance company has the proper facilities to service policyholders at their various locations.

CHARACTERISTICS OF SOCIAL INSURANCE Even though there are variations in social insurance programs and exceptions to the rule always exist, social insurance programs tend to have the following distinguishing characteristics: - Compulsory employment-related coverage - Partial or total employer financing - Benefits prescribed by law - Benefits as a matter of right - Emphasis on social adequacy Compulsory Employment-Related Coverage Most social insurance programs are compulsory and require that the persons covered be attachedeither presently or by past serviceto the labor force. If a social insurance program is to meet a social need through the redistribution of income, it must have widespread participation. Partial or Total Employer Financing While significant variations exist in social insurance programs, most require that the cost of the program be borne fully or at least partially by the employers of the covered persons. This is the basis for including these programs under the broad definition of employee benefits. The remaining cost of most social insurance programs is paid primarily by the persons covered under the programs. With the exception of Medicare and certain unemployment benefits, the general revenues of the federal government and state governments finance only a small portion of social insurance benefits. Benefits Prescribed by Law Although benefit amounts and the eligibility requirements for social insurance benefits are prescribed by law, benefits are not necessarily uniform for everyone. They may vary by such factors as wage level, length of covered employment, or family status. These factors are incorporated into the benefit formulas specified by law, and covered persons are unable to either increase or decrease their prescribed level of benefits. Benefits as a Matter of Right

Social insurance benefits are paid as a matter of right under the presumption that a need for the benefits exists. This feature distinguishes social insurance programs from public assistance or welfare programs under which applicants, to qualify for benefits, must meet a needs test by demonstrating that their income or assets are below some specified level. Emphasis on Social Adequacy Benefits under social insurance programs are based more on social adequacy than on individual equity. Under the principle of social adequacy, benefits are designed to provide a minimum floor of income to all beneficiaries under the program, regardless of their economic status. Above this floor of benefits, persons are expected to provide additional resources from their own savings, employment, or private insurance programs. This emphasis on social adequacy also results in disproportionately large benefits in relation to contributions for some groups of beneficiaries. Under some programs, high-income persons, single persons or small families, and the young are subsidizing low-income persons, large families, and the retired. If social insurance programs were based solely on individual equity, benefits would be actuarially related to contributions, just as they are under private insurance programs. While this degree of individual equity does not exist, there is some relationship between benefits and income levels (and thus contributions). Within certain maximum and minimum amounts, benefits are a function of a person's covered earnings under social insurance programs. However, the major emphasis is on social adequacy.

What is the difference between surety Bonds and Insurance? Many consumers find it difficult to understand the difference between bonds and insurance. Reality is, these two insurance products are very different. The most significant difference is the beneficiary. Traditional insurance is purchased by a policy holder to protect it self from claims of liability. A surety bond is not purchased for the benefit of the policy holder, but for the protection of the third party with whom the policy holder has contracted. A surety bond protects the obligee in the event that the policy holder defaults on fulfilling their contracted work order. With insurance, an individual is required to pay an insurance premium to their insurance provider, which essentially transfers most (it not all) the risk from the individual buying the insurance to the insurance provider. The primary similarity between insurance and a surety bond is the payment of a premium, because whenever an individual pays a bond premium for any surety bond they (the principal) will not transfer risk on the surety, but rather the payment for claims will be the principals responsibility. When dealing with surety bonds, the protection goes to the individual or organization that needs the principal to buy the bond (the obligee). How then does a surety bond differ from an insurance policy? While a surety bond can indirectly, in the broadest sense of the word provide an insurance for the obligee, a surety bond is distinct from that of a traditional insurance policy because a surety bond will have three parties in the contract, which are:

The principal - the primary party who will be performing a contractual obligation The obligee - the party who is the recipient of the obligation The surety - who ensures that the principals obligations will be performed.

While an insurance policy is in principle a two party contract. A normal insurance policy is a legally binding contract between an insurance provider and the individual who purchases the policy, commonly referred to as the policyholder.

Another factor that distinguishes surety bonds from traditional insurance is loss estimation. Insurance companies use mathematical calculations to evaluate potential losses. A surety bond underwriter assesses their risk in terms of zero loss. Insurance firms typically anticipate to make payment for a certain percentage of claims. Having said that, surety companies do not anticipate to make such payments on claims, and instead treat the premiums paid for surety bonds as service charges. The premiums in essence authorize the principal to use the suretys funds for financial backing, which gives the necessary guarantee. In summary, insurance companies are built upon consumers who will probably file claims, and want to make use of their insurance. In the surety bond business, claims are not regarded as inevitable. All parties involved will try to the best of their ability to prevent losses. So bonds are different from insurance policies, but both are equally needed to safeguard us from potential losses and claims. Call us today for a free consultation for all types of Surety Bonds including Court Bonds, License Bonds, Probate Bonds and Permit Bonds. Simon Insurance is based in South Florida and serves clients throughout the United States including Miami, Ft Lauderdale, West Palm Beach, Tampa, St Petersburg, Cape Coral, Orlando and Jacksonville. We encourage you to browse our website and call or email us today to find out how we can assist and help you.

Comparison of Derivatives and Insurance Contracts

An insurance contract can be viewed as a derivative contract where the underlying asset is the value of losses experienced by the insured.

There are both similarities and important differences.

DERIVATIVES

INURANCE

Market Value
Used to hedge risk arising from unexpected changes in market prices Options and futures of interest to hundreds of companies that use commodities

Specific Losses
Hedge risk arising from losses specific to the insured An insurance contract derived from liability or property would be specific to only one firm

Basis risk and extent or risk reduction, basis risk is the uncertainty about effectiveness of a hedge.

More Basis Risk

A firm may experience a drop in profits as derivatives may have lower payoff

Less Basis Risk

Little uncertainty about quality of hedge, ignoring insolvency

Contracting Costs
Less because of moral hazard and adverse selection. Individuals cannot influence the payoff. Outside influence of individual firms results in less costs for investigation and monitoring Higher Loss payoffs influenced by the actions of the insured party. Moral hazard more severe. Firms have more information about expected losses creating adverse selection. Must incur cost to investigate and monitor.

Capital Costs
Bring together user and producer and reduces price risk for both. Do not have to physically trade the commodity. Lower since the matching parities with negatively correlated exposures Losses experienced by one firm do not trigger a simultaneous gain by another. Losses tend to be independent or perhaps positively correlated across firms. From insurance company standpoint, risks reduced thru diversification. Sell to many different policyholders creating higher marketing and underwriting costs

Capital
A small amount of capital needed To ensure contractual performance. Derivatives will require a payment Only when firms cash flow otherwise Would be high Insurers have to hold capital to pay claims and this cost is an additional cost. Must also hold capital to satisfy policyholders

liquidity
Greater Large numbers affected by prices Lower transaction costs Firm can quickly establish a hedge Liquid market Buy or sell quickly Less Modification to provide more of less coverage can take time and create expenses Illiquid market Must wait for someone to pay asking Price or lower price