Insurance Fundamentals
Insurable Interest?
"Insurable interest" refers to the financial interest an individual, company or organization must have in the property, liability, or person being insured. If no risk of financial loss is present, no insurable interest exists thus eliminating the need for insurance coverage.
The two main categories of risk are
"pure risk" and "speculative risk"
QUESTION: Leland has two insurance policies covering his home. Indemnify Insurance carries a $120,000 limit of liability on the home, while Binders Keepers, Inc. carries a limit of $80,000. A fire breaks out in Leland's kitchen and causes $40,000 in damage. Remember, when there are two or more policies covering the same risk, the "other insurance clause", determines the method used to calculate each company's share of the claim. Leland's policy states that the pro-rata share method will be used. Which of the following is the correct amount that will be paid by Indemnify Insurance?
$24,000 EXPLANATION: Using the pro-rata share method, where we divide Indemnify Insurance's share of the loss by the total limit of both policies, multiplied by the loss, leaves Indemnify paying 60% of the loss. 60% of the $40,000 loss, is $24,000.
A certificate of insurance
A certificate of insurance is a general summary of the policy, it is NOT the policy.
What violates the principle of indemnity?
If an insured makes a profit from their loss, the principle of _____________ has been violated.
Are all risks insurable?
No! All risks are NOT insurable!
QUESTION: A condition found in many insurance policies is known as "Transfer of Rights of Recovery Against Others to Us" actually refers to:
Subrogation. EXPLANATION: This condition is another name for "subrogation".
The policy period?
The policy period is stated on the Declarations page and is the period of time when coverage is in effect. The time period between the policy inception and the policy expiration.
The time period after the policy inception and before the policy expiration is known as:
The policy period.
The Law of Large Numbers Explain...
When large groups of similar individuals are combined, we call them "risk pools". Insurance companies hire "actuaries" who make mathematical predictions about things such as how many of the people in any given "risk pool" will have their home destroyed by a tornado, be stricken with cancer, or die in a given year.
QUESTION: A document that temporarily obligates an insurance company to provide coverage while the issuance of a policy is pending is known as:
A binder. EXPLANATION: A coverage binder provides temporary coverage while the insurer underwrites and issues the actual policy.
QUESTION: In order to lawfully write insurance business in a state, an insurance company must hold:
A certificate of authority. EXPLANATION: Insurers need a certificate of authority to be admitted and lawfully transact insurance in a state.
QUESTION: Which of the following is a "general summary" of a policy?
A certificate of insurance. EXPLANATION: A certificate of insurance is a general summary of the policy, it is NOT the policy.
QUESTION: Which of the following is a "general summary" of a policy?
A certificate of insurance. EXPLANATION: A certificate of insurance is a general summary of the policy, it is NOT the policy.
QUESTION: The Insurance Commissioner/Director/Superintendent of a given state would refer to an insurance company formed under the laws of a different state as:
A foreign insurer.. EXPLANATION: The Insurance Commissioner/Director/Superintendent of a given state would refer to an insurance company formed under the laws of a different state as a foreign insurer. For example, the Superintendent in New York would refer to an insurer that was formed under the laws of Arizona as a "foreign insurer".
QUESTION: Margaret is a co-owner of a business. She purchases an insurance policy to cover the property of the business and lists Charlie, the other co-owner, on the policy. There are others covered by the policy that are referred to as employees. For the purposes of this policy, Charlie is considered to be:
A named insured. EXPLANATION: Charlie is a named insured on the policy because his name is listed, but he is NOT the first named insured.
QUESTION: Which of the following statements best describes the term "fiduciary".
A person who is entrusted with the assets of another. EXPLANATION: Insurance companies, agents, producers and adjusters have a fiduciary responsibility to their clients in the collection and handling of premiums, claim payments, and return of unearned premium. All of these items are "assets" that the fiduciary has been entrusted to handle.
The cancellation of an insurance policy occurs:
At different times and for different reasons.
QUESTION: Where in the insurance contract can an insured find the terms used throughout the policy and an explanation as to what they mean within the context of the policy?
Definitions. EXPLANATION: The Definitions section explains the important terms used throughout the contract to prevent ambiguity.
A written modification of an insurance policy is known as a(n):
Endorsement form. EXPLANATION: An endorsement is used to add, subtract or modify the coverage. Endorsements are added to the policy in writing and take precedent over the original contract wording.
QUESTION: Which of the following is used to bring a standardized insurance form into compliance with state laws?
Endorsements.. EXPLANATION: Endorsements to the standardized forms are used to change the coverage, bringing it into compliance with state laws.
The Principle of Indemnity
Insurance contracts are governed by the "_______ ________________ ____ _________________". This principle assumes that an insured who has suffered a loss, should only be restored to the approximate financial condition that existed prior to the loss, no better and no worse.
The "return of unearned premium"
Many policies require that UEP be returned on a short-rate basis if the insured cancels the policy mid-term. This allows the insurer to keep a greater percentage of the UEP, than if the insured cancelled after the policy period or if the UEP was returned on a pro-rata basis.
QUESTION: When the insurer pays the proportion that its policy limit bears to the limits of all policies, this is known as:
Pro-rata share. EXPLANATION: When each insurer covering the risk pays the proportion that their limit bears to the limits of all policies, this is known as "pro-rata share".
QUESTION: When the insurer pays the proportion that its policy limit bears to the limits of all policies, this is known as:
Pro-rata share. EXPLANATION: When each insurer covering the risk pays the proportion that their limit bears to the limits of all policies, this is known as "pro-rata share".
QUESTION: Which of the following is NOT a responsibility of the Insurance Commissioner in any given state?
Setting insurance rates. EXPLANATION: The Insurance Commissioner does not set insurance rates. He or she APPROVES the rates that the insurance company sets.
QUESTION: Regulation of the insurance industry in the United States is primarily left to:
State governments. EXPLANATION: The states carry the major burden of regulating insurance affairs with only issues involving fair labor standards and antitrust matters left to the federal government.
QUESTION: Surplus lines insurers must pay a premium tax. ________________ sets the amount of the premium tax.
State law EXPLANATION: State law determines the amount of a surplus lines premium tax.
QUESTION: Which of the following types of insurance companies must charge a premium tax to be remitted to the state each time a policy is sold?
Surplus Lines company. EXPLANATION: Surplus lines companies, as non-admitted companies, must charge a premium tax to insureds and remit that money to the state.
QUESTION: The most widely used property and casualty insurance forms used in the United States today are published by:
The Insurance Services Office, Inc. (ISO).. EXPLANATION: The Insurance Services Office, Inc. publishes the most widely used property and casualty insurance forms used in the United States today.
QUESTION: Which of the following organizations creates and maintains model laws that establish standards for how insurance is offered and delivered in the United States?
The NAIC.. EXPLANATION: The National Association of Insurance Commissioners (NAIC) creates and maintains model laws that establish standards for how insurance is offered and delivered in the United States.
Overinsurance violates?
The Principle of Indemnity.
The predetermined amount of an insurance claim that is paid by the policyholder is known as:
The deductible.
The following are characteristics of an insurable risk:
The loss must be definite and definable; -The loss must be accidental; -The insurance company should be able to calculate the chance of the loss; -The law of large numbers should apply; -The loss must be great enough to create economic hardship; -The insurance must be offered at a reasonable cost; -The loss must not be catastrophic in nature. All of these elements are not required to be present for every risk, but most of them should exist whenever possible.
What is Insurance?
The more traditional definition is: "A method of handling pure risk by spreading it over a large number of similar individuals".
QUESTION: The time period after the policy inception and before the policy expiration is known as:
The policy period. EXPLANATION: The policy period is stated on the Declarations page and is the period of time when coverage is in effect. The time period between the policy inception and the policy expiration.
Speculative Risks
The possibility of financial gain, or profit, exists with these types of risks. ARE NOT INSURABLE!!!
Pure Risks
There is only the possibility of loss. There is no possibility for financial gain. ARE INSURABLE.
QUESTION: All of the following statements are true regarding Public Law 15 (The McCarren-Ferguson Act), EXCEPT:
Under the law, the federal government retains the right to approve insurance forms. EXPLANATION: The federal government does not approve insurance forms, this is left to the state insurance departments.
Insurable interest must exist when?
With property and/or casualty (liability insurance) insurable interest must exist at the time of the loss. With life or health insurance, insurable interest must exist at the time the policy is purchased.
What is Risk
______________ is the possibility that a loss might occur and is the reason that people buy insurance. If a certain event happens, - accident, sickness, or death - loss occurs. The loss can be of life, or the loss of a loved one in the event of death, or the loss of income due to accident or sickness. In the case of property and casualty insurance, a structure may burn or a commercial truck may be involved in an accident.
"Insurance"
________________ is a contract in which an insurance company or government agency provides a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a premium from an "insured person or group".
A proof of loss is NOT known as a loss notice
a loss notice
The "loss notice"
is NOT the formal proof of loss. The loss notice is provided by the insured to the agent or insurer as soon as possible after the loss has occurred.
Charlie is a ________ __________ on the policy because his name is listed, but he is NOT the first named insured.
named insured
QUESTION: All of the following statements are TRUE regarding a proof of loss statement, EXCEPT:
A proof of loss is also known as a loss notice. EXPLANATION: The "loss notice" is NOT the formal proof of loss. The loss notice is provided by the insured to the agent or insurer as soon as possible after the loss has occurred.
Insurable interest Explain more...
Additionally, if the insured sold his covered dwelling and it burned after he no longer owned the home, he would no longer have insurable interest in that home. This is because he would no longer suffer a financial loss if the house burned because he no longer owned the home.
Insurable interest example...
An insured could purchase a life insurance policy to cover her business partner's life because the insured would suffer a financial loss if her partner died. Therefore, the insured holds an insurable interest in her business partner's life that exists at the time she purchases the life insurance policy.
QUESTION: To obtain an insurance agent, producer, or adjuster license, an applicant must be:
At least 18 years of age. EXPLANATION: To obtain an insurance license, applicants must have attained the age of 18 at least.
Why Do Insurance Companies Use the Law of Large Numbers?
By using the law of large numbers, insurers can calculate their probable losses and establish accurate premium rates to cover losses and operating expenses.
A written modification of an insurance policy is known as a
Endorsement form An endorsement is used to add, subtract or modify the coverage. Endorsements are added to the policy in writing and take precedent over the original contract wording.
Insurable interest Explain...
For example, an insured can purchase a policy to cover his dwelling for loss from fire because he would suffer a financial loss if his dwelling burned. However, the same insured could not purchase a policy to cover his neighbor's dwelling for loss from fire. This is because the insured would not suffer a financial loss if his neighbor's house burned.
The Law of Large Numbers
Insurance is based on the _________________________. This law shows us that we can predict, fairly accurately, what will happen to a large group of similar individuals in a given time period.
QUESTION: The purpose of licensing surplus lines brokers in a given state is:
To allow them to place business with nonadmitted insurers. . EXPLANATION: Nonadmitted insurers are known as "surplus" or "excess" lines companies. An agent must hold a surplus lines brokers license to transact business with a nonadmitted insurer and only then if the line of insurance is not readily available within the state from admitted insurers.
QUESTION: What is the purpose of an Insurance Guaranty Association?
To pay covered claims of admitted insolvent insurers. EXPLANATION: The purpose of any Guaranty Association is to pay the covered claims of admitted insolvent insurers.
QUESTION: Which of the following statements best describes "the law of agency"?
A relationship in which someone is authorized by contract to represent another party. EXPLANATION: A relationship in which someone is authorized by a contract with a principal to represent them as their agent. An "agent" can be an insurance agent, producer, adjuster, broker, consultant or any other professional who has been contracted to act as the "agent" to the "principal".
QUESTION: All of the following are part of the "entire contract", EXCEPT:
An agreement made between the insured and the agent stated verbally, that the agent will personally service the insured's policy, and it will not be delegated to a staff member is part of the entire contract. EXPLANATION: An agreement made between the insured and the agent stated verbally, that the agent will personally service the insured's policy, and it will not be delegated to a staff member is NOT part of the entire contract. This agreement between the agent and the insured is an outside stipulation.
QUESTION: In most states, which of the following most accurately describes an "admitted insurer"?
An insurer that can transact insurance in the state under a certificate of authority. EXPLANATION: An admitted insurer is one that is authorized by a state insurance department to conduct business in that state. A license, known as a certificate of authority is issued to admitted insurers.
QUESTION: The provision in an insurance contract that outlines the process of bringing a contract dispute before an objective third party for resolution is known as:
Arbitration. EXPLANATION: The arbitration clause or provision in an insurance contract specifies the steps in the process of bringing an insurance contract dispute before an objective third party for resolution. Arbitration clauses are included in both property and liability (casualty) insurance policies.
QUESTION: The nonrenewal of an insurance policy occurs:
At the end of the policy period. EXPLANATION: The insurer "nonrenews" a policy at the end of the policy period. A "cancellation" may occur at different times and for different reasons.
QUESTION: Chris is insured through Binders Keepers Insurance Company and his policy period ends in 12 months. However, Chris has decided that he wants to cancel his policy in order to purchase another one from a company that advertises with cute commercials on television. Chris calls his agent to cancel the policy and is informed that the unearned premium (UEP) on the cancelled policy will be returned to him by mail in a couple of weeks. When Chris receives the check, he is surprised to find that it's made out for less than the amount of unearned premium he should have received. What is the most likely reason for this?
Chris' policy had a provision stating that UEP must be returned on a short-rate basis. EXPLANATION: Many policies require that UEP be returned on a short-rate basis if the insured cancels the policy mid-term. This allows the insurer to keep a greater percentage of the UEP, than if the insured cancelled after the policy period or if the UEP was returned on a pro-rata basis.
QUESTION: If the "other insurance" clause in a policy specifies that more than one policy will share equally in the loss until the lowest policy limit is exhausted and continue in that fashion until all policy limits are exhausted. This is known as:
Contribution by equal shares. EXPLANATION: If more than one policy covers a loss, "contribution by equal shares" will require each policy to share in the loss up to the lowest limit of insurance until the lowest limit policy is exhausted. The remaining companies continue to share the loss equally until each policy is exhausted.
QUESTION: "Ambiguous language" in an insurance policy means language that is all of the following, EXCEPT:
Fortuitous to the insured. EXPLANATION: "Ambiguous language" in an insurance contract means language that is vague, easily misunderstood, or confusing to the insured. Obviously, ambiguous language in a policy would not be fortuitous (advantageous) to the insured.
QUESTION: Before an insured can bring a lawsuit against their insurer to provide coverage under their policy, the insured must:
Fulfill all of their required duties as outlined in the policy. EXPLANATION: The "Legal Action Against Insurer" provision in most standard policies requires that the insured complete their required duties before they can bring a lawsuit against the insurer. The insured's required duties are different depending on whether the policy is a property or casualty policy and the type of coverage provided.
Overinsurance
If an insured purchases an insurance policy that provides more coverage on a risk than the value of the possible loss, this is known as "___________________". Insureds can also create overinsurance by purchasing more than one policy to cover the same loss.
Contribution by equal shares Explain
If more than one policy covers a loss, "contribution by equal shares" will require each policy to share in the loss up to the lowest limit of insurance until the lowest limit policy is exhausted. The remaining companies continue to share the loss equally until each policy is exhausted.
QUESTION: Rick has three insurance policies covering his small commercial building for $700,000. Insurer 1: Carries $400,000 of the coverage. Insurer 2: Carries $200,000 of the coverage. Insurer 3: Carries $100,000 of the coverage. According to the provisions of the policies, the loss will be settled using the contribution by equal shares method. When Rick's building suffers a $500,000 covered loss, which of the following statements is correct on the amount each insurer will pay?
Insurers 1 and 2 will each pay $200,000 and Insurer 3 will pay $100,000. EXPLANATION: With the contribution by equal shares method, all insurers pay an equal amount until the loss is paid or one of the policy limits is exhausted. Because Insurer 3 has the lowest policy limit of $100,000, all three insurers will each pay equal shares of $100,000. This takes care of $300,000 of the $500,000 loss and exhausts the policy limit of Insurer 3. This leaves Insurers 1 & 2 left to pay $200,000. If they each pay an equal share of the $200,000, they will each pay $100,000 on the remainder of the loss. This means Insurers 1 and 2 pay a total of $200,000 each and Insurer 3 paying $100,000 for a total of $500,000.
QUESTION: It has been reported to the Insurance Department in a given state that Callie, a licensee in that state, has violated an insurance law. The Insurance Commissioner will hold a hearing to determine the nature of Callie's behavior. After the hearing, the Commissioner is convinced that Callie has engaged in behavior that violates insurance law. Which of the following is the next step the Commissioner will take?
Issuing a cease and desist order.. EXPLANATION: The first step the Commissioner in any state would take is to issue a cease and desist order. This prevents the offender from engaging in the behavior until the Department can determine all the facts of the case, including whether or not members of the public were damaged financially by the offenses committed.
QUESTION: The "liberalization clause" of an insurance policy:
States that if an insurer decides to broaden its standard policy coverages, then all outstanding policies issued prior to that decision will automatically receive those new coverages at no additional premium. EXPLANATION: If an insurer broadens (liberalizes) its standard policy, current policyholders will receive the broadened coverage without paying an additional premium.
QUESTION: The "liberalization clause" of an insurance policy: Your answer:
States that if an insurer decides to broaden its standard policy coverages, then all outstanding policies issued prior to that decision will automatically receive those new coverages at no additional premium. EXPLANATION: If an insurer broadens (liberalizes) its standard policy, current policyholders will receive the broadened coverage without paying an additional premium.
QUESTION: What is the main purpose of government regulation of the insurance industry?
To protect the insurance consuming public. EXPLANATION: The purpose of government regulation of the insurance industry is to protect insurance consumers.
QUESTION: Libby completed an application for a new residential policy to cover her home, stating that she does not use the dwelling for business purposes. However, Libby has been conducting business operations from the home and has hired several employees who work out of the home. She also has several clients per day coming to the home for business purposes. When Libby's insurer finds out about the additional business exposures, they decide to take action. Which of the following actions is Libby's insurer most likely going to take?
Void her policy to inception.. EXPLANATION: Libby made a material misrepresentation in the application. Her policy will most likely be voided to its inception.
