The two main types of ownership are stock companies and mutual companies, but there are others. Stock companies are publicly owned companies whose stock generally trades in one of the stock markets. Stock companies are owned by their shareholders - the purchasers of the company's stock. Allstate is a stock company. Mutual companies are owned by their policyholders. State Farm Mutual Automobile Insurance Company is a mutual company.

Insurers also differ by how they sell their policies. Direct writers do not use agents to sell their policies. Two examples are USAA and GEICO. These companies sell insurance over the phone through sales representatives. Most insurers, however, sell their policies through agents. Captive agent insurers sell their policies through agents who only sell for that company. State Farm, Farmers, and most Allstate agents are captive agents. Independent agent insurers sell their policies through independent agents that represent more than one insurer. Progressive, SAFECO, and Travelers are examples.

Market Segments. Most insurance markets consist of several submarkets: preferred, standard, nonstandard, residual, and surplus lines. Preferred companies have the lowest rates and sell to the consumers perceived to represent the lowest risk. Standard companies sell to consumers perceived to represent average risks. Nonstandard companies have the highest rates of these three types of companies and sell to consumers perceived to represent the highest risk. The preferred, standard, and substandard markets are known collectively as the "voluntary market" or the "admitted market." Those consumers unable to obtain coverage in these three markets must turn either to a residual market mechanism or to surplus lines companies.

Residual market mechanisms were created to provide some type of insurance to those consumers who could not obtain it in the voluntary market. Most states have some residual market for private passenger automobile insurance. The automobile insurance residual markets are typically called "insurance plans" or "risk pools." For residential property insurance, some states have "FAIR" (Fair Access to Insurance Requirements) plans, which are similar in structure to automobile insurance risk pools. Most FAIR plans were created in the 1960's and 1970's following the incidence of urban riots and charges of insurance redlining. A number of coastal states now have property insurance residual markets for catastrophe events, including hurricane and earthquake. These residual markets are relatively new, some having been created in the last few years.

Not all states have residual market mechanisms and many of those that do limit the types of coverages available. Residual market mechanisms operate in one of two ways. In some, consumers are insured through a pool with state-set rates and all insurers share the profits or losses from all such policies. Alternatively, these consumers are assigned to an insurance company that must accept the risk at a state-set rate and the profit or loss on the policy. Consumers normally pay higher rates in a residual market and receive limited benefits.

Surplus lines carriers, also known as "off shore" and "non-admitted" insurers, are not regulated by the state. These insurers are permitted to insure only those consumers who are unable to purchase coverage in the admitted market. These insurers present several disadvantages to the consumer. Rates are usually much higher than admitted companies, policy forms are not regulated, no state guaranty coverage is provided if the company goes broke, and the absence of solvency regulation increases the chances that the company will be unable to pay its claims.

Most insurance "companies" are really a group of insurance companies. Normally, an insurer group owns preferred, standard, and nonstandard companies with correspondingly higher rates. Each of the companies in the insurer's group has decreasingly restrictive underwriting guidelines. When a consumer goes into State Farm, for instance, he or she may be placed in State Farm's preferred company if the consumer meets the most restrictive underwriting guidelines. Otherwise, State Farm will insure the consumer in either the standard company or substandard company, or deny coverage altogether.

For most consumers, auto and homeowners coverage is obtained in the standard and preferred markets. These two markets normally sell the large majority of insurance policies in a state. For consumers forced into the substandard, residual, or surplus lines markets, however, insurance is unavailable in the standard and preferred markets. The insurance availability problem includes both the inability to obtain insurance at all and the inability to purchase insurance in the standard and preferred markets.

Underwriting Guidelines. Underwriting is the process by which an insurer determines whether it will accept or reject an applicant and, if acceptable, at what price. Underwriting guidelines are the standards on which the insurer makes the underwriting decision. Insurers provide underwriting guidelines to insurance agents (or sales representatives for direct writers) for the agent to make the initial decision as to whether to offer coverage and at what price. An underwriter in the insurer's home office reviews applications to ensure they meet the underwriting guidelines. Insurers also use underwriting guidelines to determine whether the company will renew an existing policy.

Underwriting guidelines range from very detailed and objective written rules (e.g. limitations on insuring homes under a specified value) to broad and subjective forms of guidance for the agent or underwriter (e.g. limitations on insuring consumers with "bad morals"). Some of the more common underwriting guidelines for auto and homeowners insurance are listed in Table 1.

Not all discrimination is wrong or illegal. Some discrimination is clearly proper, such as refusing to sell homeowners insurance to the class of consumers who have been convicted of arson. Other discrimination is clearly improper, such as refusing to sell to the class of African-American consumers.

Those practices in the middle require a two-step analysis. First, does the underwriting guideline violate broad public policy? Is the guideline simply a surrogate for another prohibited characteristic? Second, does the underwriting guideline identify a characteristic of the consumer, vehicle, or property that is demonstrably and uniquely related to risk of loss? The second test typically requires detailed insurance data upon which to perform statistical and actuarial analyses. The data must be sufficiently detailed to enable the analyst to identify the unique contribution of the underwriting guideline or rating factor in question. Identifying the unique contribution is necessary to ensure that the underwriting guideline is simply not correlated (i.e., a surrogate) for another known underwriting guideline or rating factor - including prohibited rating factors. Such an analysis enables the analyst to to determine whether the practice unfairly discriminates against consumers who do not satisfy the underwriting guideline.

Finally, the ways insurers use underwriting guidelines to discriminate is not limited to the mere denial of coverage, as described at left.

Underwriting guidelines are important because they determine both the availability and affordability of insurance to groups of consumers. Insurance data are critical in the review of underwriting guidelines because the data will show whether the underwriting guideline properly identifies a group of consumers for whom the expected costs of the transfer of risk are higher or lower.

Rating Factors and Premium Calculations. Calculating a premium for auto and homeowners insurance is a two-part process. First, the underwriting process determines the base rate for the coverage. The base rate for each company will differ, as will the base rate for the different insurers within the company group. Thus, the base rates between Allstate and State Farm will differ, but the base rates between State Farm's preferred and substandard companies will also differ.

Second, the premium calculation involves the application of a series of rating factors to the rate base. Rating factors are the factors that change the base rate because the insurer or state has determined that the factor represents a difference in risk. For instance, a brick home represents a lower risk for fire than a wood frame house, so a discount factor is applied to the base rate for brick homes. Rating factors can cause the rate to increase (surcharges) or decrease (discounts).

Rating factors differ by state and by insurer. Common rating factors for auto insurance include coverage amount, territory (usually county of residence), use of car (pleasure only, business use), age of drivers, type of car, amount of deductibles, at-fault accidents, car symbol, surcharges, and various discounts. Common rating factors for homeowners insurance include coverage amount, territory (usually county), type (brick or frame), amount of deductibles, and various discounts.

Primer on Insurance Terminology and Ratemaking. Insurance ratemaking is the process of establishing rates for the insurance coverage to be offered during the period in which the rates will be in effect. Stated another way, ratemaking is the estimation of future costs associated with the transfer of risk from a consumer to the insurance company. Ratemaking is prospective; rates are established as estimates of future costs. Ratemaking generally also involves the grouping of different consumers into different risk classifications. For private passenger automobile and residential property insurance, consumers may pay different rates based upon characteristics of the consumer, vehicle, property, and/or coverage.

Rate Standards. Rates are developed to meet both legal and actuarial standards. In some instances, the legal and actuarial standards differ. When that occurs, the legal standards take precedence.

The common legal standard is that rates must be just, reasonable, adequate, not excessive and not unfairly discriminatory for the risks to which they apply. Rates satisfy that standard if the rate is a sound estimate of future costs of coverage offered and if consumers of the same class and essentially the same hazard are offered the same rates.

Rates are generally developed by actuaries working for, or on behalf of, insurance companies. A certified actuary is a person who is a member of the Casualty Actuary Society, but membership is usually not mandatory. Membership in the CAS is based upon passing a series of tests. It is important to point out that membership in the CAS does not impart consistent or good judgment to actuaries. Two actuaries analyzing the same data can, and often do, come up with widely divergent rate results. While ratemaking is a complex subject and activity, a consumer advocate can often identify the key ratemaking assumptions and question those assumptions.

The Costs Associated with the Transfer of Risk. There are four general categories of costs in the ratemaking process - losses, loss settlement expenses, other expenses, and profit.

Losses. Losses are the amounts an insurance company pays for claims made under the insurance contract. Paid losses are losses already paid. Reserves are the amounts set aside to pay for losses that have occurred but have not been settled. Case reserves are the reserves set aside for a specific known claim, bulk reserves are reserves set aside for a block of known claims, and incurred but not reported (IBNR) reserves are set aside for claims that have not been made yet, but for which the loss has occurred.

Loss Adjustment Expense. Loss adjustment expenses, or claim settlement costs, are the costs of settling claims. There are two types of loss adjustment expenses (LAE) - allocated loss adjustment expenses (ALAE) and unallocated loss adjustment expenses (ULAE). ALAE are the claim settlement expenses attributable to specific claims, while ULAE are more general claim settlement expenses associated with the overall claim settlement process and not attributable to specific claims. For instance, the cost of hiring an attorney to defend a specific claim would be ALAE, but the salary of the in-house supervisor of the claims department would be ULAE.

Expenses. Expenses include commissions and fees paid to agents and brokers, other acquisition expenses associated with the acquisition of business other than commissions and brokerage fees, taxes, licenses and fees other than federal income tax, and general administrative and operational expenses. Expenses are often categorized as variable or fixed. Variable expenses change with the amount of premium. For example, a 10% agent commission or a 2.5% premium tax is a variable expense. Fixed expenses would include general administrative and operational expenses that do not vary with premium volume over the period the rates will be in effect.