Classes of Insurances Requiring Specialized Knowledge

The insurance sector is made up of companies that offer risk management in the form of insurance contracts. The basic concept of insurance is that one party, the insurer, will guarantee payment for an uncertain future event. Meanwhile, another party, the insured or the policyholder, pays a smaller premium to the insurer in exchange for that protection on that uncertain future occurrence.

As an industry, insurance is regarded as a slow-growing, safe sector for investors. This perception is not as strong as it was in the 1970s and 1980s, but it is still generally true when compared to other financial sectors.

Mutual vs. Stock Insurance Companies

Insurance companies are classified as either stock or mutual depending on the ownership structure of the organization. There are also some exceptions, such as Blue Cross/Blue Shield and fraternal groups which have yet a different structure. Still, stock and mutual companies are by far the most prevalent ways that insurance companies organize themselves.

Worldwide, there are more mutual insurance companies, but in the U.S., stock insurance companies outnumber mutual insurers.

A stock insurance company is a corporation owned by its stockholders or shareholders, and its objective is to make a profit for them. Policyholders do not directly share in the profits or losses of the company. To operate as a stock corporation, an insurer must have a minimum of capital and surplus on hand before receiving approval from state regulators. Other requirements must also be met if the company’s shares are publicly traded. Some well-known American stock insurers include Allstate, MetLife, and Prudential.

A mutual insurance company is a corporation owned exclusively by the policyholders who are “contractual creditors” with a right to vote on the board of directors. Generally, companies are managed and assets (insurance reserves, surplus, contingency funds, dividends) are held for the benefit and protection of the policyholders and their beneficiaries.

Management and the board of directors determine what amount of operating income is paid out each year as a dividend to the policyholders. While not guaranteed, there are companies that have paid a dividend every year, even in difficult economic times. Large mutual insurers in the U.S. include Northwestern Mutual, Guardian Life, Penn Mutual, and Mutual of Omaha.

What Is Insurance Float?

One of the more interesting features of insurance companies is that they are essentially allowed to use their customers’ money to invest for themselves. This makes them similar to banks, but investing happens to an even greater extent. This is sometimes referred to as “the float.”

Float occurs when one party extends money to another party and does not expect repayment until after a circumstantial event. This mechanism essentially means insurance companies have a positive cost of capital. This distinguishes them from private equity funds, banks, and mutual funds. For investors in stock insurance companies (or policyholders in mutual companies), this means the potential for lower-risk, stable returns.

Insurance and Selling Financial Products

Insurance plans are the principal product of the sector. However, recent decades have brought a number of corporate pension plans to businesses and annuities to retirees.

This places insurance companies in direct competition with other financial asset providers on these types of products. Indeed, many insurance agents are now branded as full-service financial advisors offering both protection products as well as investments, financial planning, and retirement planning. Many insurance companies now have their own broker-dealer either in-house or in partnership.