17.2 Rates, Forms, Solvency, and Guaranty Associations

Rate Regulation Standards

Every state requires that property and casualty rates be adequate, not excessive, and not unfairly discriminatory. Memorize all three prongs together; the exam often asks which is NOT a standard.

• Adequate — high enough to keep the insurer solvent and pay claims.
• Not excessive — not unreasonably high for the risk transferred.
• Not unfairly discriminatory — same rate for the same loss exposure; classification must rest on actuarially supportable differences (not race, religion, or national origin).

Rate Filing Systems

States use different methods for getting rates approved. Know the differences cold:

Insurers commonly belong to advisory/rating organizations such as ISO (Insurance Services Office) and NCCI (workers' compensation), which file loss costs; each insurer then applies its own loss cost multiplier to set final rates.

Worked Example: Loss Cost Multiplier

ISO files a loss cost of $0.85 per $100 of payroll for a class. An insurer's loss cost multiplier (LCM) is 1.45 (covering expenses and profit). The insured's payroll is $500,000.

• Rate per $100 = $0.85 x 1.45 = $1.2325
• Premium = ($500,000 / 100) x $1.2325 = 5,000 x $1.2325 = $6,162.50

Now apply a workers' comp experience modifier (mod) of 0.90 (better-than-average losses):

• Modified premium = $6,162.50 x 0.90 = $5,546.25

A mod below 1.0 is a credit (rewards low losses); a mod above 1.0 is a debit (penalizes high losses). Expect at least one experience-mod calculation.

Policy Forms and Approval

Policy forms (the contract wording) are also filed and, in most lines, must be approved before use. Standardized forms keep coverage comparable across insurers. The most-referenced P&C forms on the national exam come from ISO, including:

• HO-3 (Homeowners Special Form) — open perils on the dwelling, named perils on contents.
• CP 00 10 (Building and Personal Property Coverage Form) and CP 00 90 (Commercial Property Conditions).
• CG 00 01 (Commercial General Liability Coverage Form, occurrence).
• CA 00 01 (Business Auto Coverage Form) and PP 00 01 (Personal Auto Policy).

Know that an HO-3 insures the dwelling on an open-perils basis but personal property on a named-perils basis — a classic distractor flip.

Solvency Regulation

To stay solvent an insurer must hold adequate reserves (loss reserves and unearned premium reserves) and capital and surplus. Regulators monitor solvency through:

• Risk-Based Capital (RBC) — an NAIC formula setting the minimum capital relative to the insurer's risk; falling below trigger levels invites regulatory action up to mandatory control.
• Financial examinations every 3–5 years.
• The IRIS ratios used as early-warning screens.

An insurer admitted/authorized to do business holds a certificate of authority. A nonadmitted (surplus lines) insurer is not licensed in the state but may write hard-to-place risks through a surplus lines broker when admitted markets decline the risk.

Guaranty Associations

When an admitted insurer becomes insolvent, the state guaranty association pays covered claims up to statutory limits (commonly $300,000 per occurrence for P&C lines, varying by state). Key trap points:

• Guaranty associations cover policies of admitted/licensed insurers only — not surplus lines insurers.
• Funding comes from assessments on solvent member insurers, not from a standing state fund or taxpayers.
• Advertising guaranty-association protection to sell a policy is an unfair trade practice in most states.

Worked Example: Coinsurance Penalty

Property forms use a coinsurance clause (often 80%) to encourage insuring to value. The recovery formula is: (Carried Limit / Required Limit) x Loss − Deductible, capped at the carried limit.

A building is worth $500,000 at replacement cost. The 80% coinsurance requirement = $400,000. The insured carries only $300,000, with a $1,000 deductible. A covered fire causes $120,000 in damage.

• Coinsurance ratio = $300,000 / $400,000 = 0.75
• Indemnity before deductible = $120,000 x 0.75 = $90,000
• Payable = $90,000 − $1,000 = $89,000

The insured absorbs $31,000 as a coinsurance penalty for underinsuring. Had they carried $400,000, the ratio would be 1.0 and the loss paid in full less the deductible.

Worked Example: ACV vs. Replacement Cost

Actual cash value (ACV) = Replacement Cost − Depreciation. A roof costs $20,000 new, has a 20-year life, and is 10 years old.

• Depreciation = 10/20 = 50%, or $10,000
• ACV settlement = $20,000 − $10,000 = $10,000

Under a replacement cost valuation the insurer pays the full $20,000 (less any deductible), often holding back depreciation until repairs are actually completed. Auto liability uses split limits such as 100/300/50: $100,000 per person bodily injury, $300,000 per accident bodily injury, and $50,000 property damage. If three people are injured for $80,000 each, the per-person cap pays $80,000 each but the $300,000 per-accident limit caps total BI at $300,000 — not $240,000-plus uncapped.