Unit 2 Chapter 1 & 2 Insurance

Mutual Company Insurers

- A mutual company is an insurance company that is owned by the policyholders, not shareholders -The policyholders elect the Board of Directors for a mutual company

Stock Insurers

-An insurance company that issues stock and is owned by shareholders with the intent of earning a profit -Stock insurer collects premiums, pays operating expenses and may return dividends to shareholders based on the performance of the company

Evaluating the Identified Risks for the Frequency and the Severity of the Loss

-Analyze the risks based on loss frequency and severity -Loss frequency is the probability or chance that a loss will occur -Loss severity measures the dollar magnitude or the absolute dollar amount of the expected financial loss if it were to occur -Only those risks that have very severe financial consequences but occur infrequently are appropriate to transfer or insure

Express Authority

-Authority given to the agent through agency agreements (written document) -The insurer is responsible for acts of an agent based on express authority

Apparent Authority

-Authority that the public perceives due to business cards, sign on the wall and letterhead but no authority actually exists because the agency agreement expired. NOTE- Main difference between implied and apparent authority is that with implied authority , the agent is still authorized to write polices for the insurance company but under apparent authority, that authority has expired and no longer exists.

Implied Authority

-Authority the public perceives -Agent accepts premium payments -Insurer is responsible even if the client is misled -Examples of implied authority include: *Signs on the door *Business cards on the desk *Letterhead *Acceptance of premiums

Brokers

-Brokers are legal representatives of an insured and act in the best interest of the insured. -A broker may sell insurance policies from any one of a number of different insurance companies -Since the broker does not represent the insurer, they may not bind an insurer

Agency Relationship and Types of Authority

-Express Authority -Implied Authority -Apparent Authority

The underwriter may manage adverse selection during the life of a policy:

-Front End: Require physical for life insurance -During a policy: Deductibles, Co-Insurance -Back End: Raise premiums

Waiver

-Is relinquishing a known legal right. If an insurer waives a legal right, they may not deny paying a claim based on the insured violating or breaching that right.

Reinsurance

-Means by which an insurance company transfers some or all the risk to another insurance company

Implementing the Risk Management Plan Selected

-Planner should work closely with client to insure implementation of appropriate risk management techniques -Simply identifying and selecting the risk management technique is insufficient without implementation

Valuation of Insured Losses

-Replacement Cost (RC) -Actual Cash Value (ACV) -Appraised or Agreed Upon Value

Deductibles

-Stated amount the insured must pay before the insurer will pay benefits Deductibles help eliminate small claims and reduce premiums and are used mainly for property, health and auto policies

Adverse Selection

-The tendency of higher than average risks to purchase or renew insurance policies - Premiums depend upon a balance between favorable and unfavorable risks in the pool -Adverse selection is managed through underwriting and denying insurance on the front end or raising premiums on the back end

Estoppel

-Where through a legal process, you are denied a right you might otherwise be entitled to under the law. Estoppel applies when one party relies on information from another party and that information causes harm to the party that relied on the information. The party that made the statements can be estopped from denying the statements.

Agent

-a legal representative of the insurer and act on behalf of insurer -an agent enters into agreements on behalf of the insurer Examples include: General Agent -That represents one insurer Independent Agent -That represents multiple, unrelated insurers *Agents are only permitted to sell the policies written by their company. Agents have the authority to bind the insurer to an individual. *An agent may immediately issue a temporary binder on an auto policy over the telephone. *An insurance agent may not immediately bind an insurer when selling a life insurance policy. The insurer must approve the life insurance application before coverage is issued. *

Determining the Objectives of the Risk Management Program

1) Determine the objectives of the risk management team 2) Identify all possible pure risk exposures of the client 3)Evaluating the identified risks for the probability and severity of the loss 4)Determining the alternative for managing the risks: Retaining Reducing, Avoiding, Transferring 5) Implementing the risk management plan selected 6) Periodically evaluating and reviewing the risk management program

Hazard

A condition that increases the likelihood of a loss occurring; such as moral, morale, and physical hazard

Physical Hazard

A tangible condition that increase the probability of a peril occurring, such as: icy roads, poor lighting, defective equipment

Suicide Exclusion

A typical exclusion under a life insurance policy is if the insured commits suicide within the first two years of the policy. Premiums will be returned in the event of the insured committing suicide.

Waiver may impact the insurer's ability to deny a claim

A waiver is relinquishing a known legal right. If an insurer waives a legal right, it may not deny paying a claim based on the insured violating or breaching that right.

Distinguishing Characteristics of Insurance Contacts

Adhesion Aleatory Unilateral Conditional

Coinsurance formule

Amount of Insurance Carried/ Coinsurance * Loss- Deductible

Stock Insurers

An insurance company owned and controlled by a group of stockholders whose investment in the company provides the safety margin necessary in issuance of guaranteed, fixed premium, nonparticipating policies.

The Principle of Insurable Interest Identify the difference in insurable interest as between property, liability insurance and life insurance.

An insured must have an emotional or financial hardship resulting from damage, loss, or destruction. For Property and Liability Insurance the insured must have an insurable interest at the time of policy inception and at time of loss For Life Insurance- only needs an insurable interest at time of policy inception. -Assume a spouse is married for 20 years then divorced

High Freq, High Severity

Avoid Risk

Reinsurer

Company accepting the risk transfer

Ceding company

Company transferring the risk

Important Features of Insurance Contracts

Definitions of terms used in the contract, declarations, description of what is insured, perils covered, exclusions, and conditions

Conditions

Details the duties and rights of the insured and insurer

Appraised or agreed upon Value

Determined jointly by insured and insurer -Appraiser may valuate -Typically used for art and antiques

Subjective Risk

Differs based upon an individual's perception of risk

Objective Risk

Does not depend on an individual's perception. Objective risk measures the difference between an actual loss from expected loss. The probability of loss is the chance of a loss occurring Probability of loss measures the long-run freq with which an event occurs It is a useful measure for the insurer because it quantifies the expected cost of claims The insurer must apply a premium to that probability of loss The more measurable the loss, the more efficient the premiums Life insurance is very efficient, long term care insurance is not

Other Provisions

Errors in Age of Sex Suicide Exclusion Payment of Benefits Grace Period

T/F An insurable interest for life insurance must exist both at the inception of the policy and at the time of the loss

False

T/F Insurance contracts are aleatory in nature, which means the dollar amount exchanged are even.

False

T/F Typically contracts may be terminated with the consent of one party

False

T/F If a minor enters into a contract, the minor may only void the contract within 30 days of entering the agreement

False , a minor can void a contract at any time

T/F The suborgation clause asserts that an insurer will only compensate the insured to the extent the insured has suffered an actual financial loss

False, The principle of indemnity asserts that an insurer will only compensate the insured to the extent the insured has suffered an actual financial loss. A subrogation clause in an insurance policy requires that the insured relinquish a claim against a negligent third party, if the insurer has already indemnified the insured.

T/F A loss exposure that would be financially catastrophic to the insured is an uninsurable risk.

False, if it's financially catastrophic to the INSURER

T/F Subjective risk is the variation of actual amount of losses that occur over a period of time compared to the expected amount of losses.

False, objective risk is the variation of actual amount of losses that occur over a period of time compared to the expected amount of losses

T/F Risk reduction is the process of avoiding pure risk that is high in freq and low in severity.

False, risk reduction is the process of REDUCING pure risk that is high in freq and low in severity

T/F Physical hazard is indifference to a loss created because the insured has insurance.

False, this is morale hazard.

T/F Risk transfer involves transferring a high frequency and high severity risk to a third party, such as an insurance company.

False, what is described is avoidance, avoid high frequency and high severity risk to a third party. Risk transfer involves TRANSFERRING a low frequency and high severity risk to a third party like an insurance company.

T/F Actual cash value is the method used to value damage to a personal residence under a property insurance policy.

False. Replacement cost is the method used to value damage to a PERSONAL RESIDENCE under property insurance policy. Actual cash value is used to value the amount of coverage for a personal auto or personal property.

Description of what is insured

For a life or health insurance policy, the name of the insured is included in this section. For a property and casualty policy, the address of the property is in the description.

Perils

Immediate and actual cause of loss, such as fire, wind tornado, earthquake, burglary, & collision

Mutual Consent

Implies that both parties to the contract have a mutual understanding regarding what the contract covers and they are in agreement as to the terms of the contract. Typically, contract may be terminated by mutual consent of both parties.

Copayments

In additions to deductibles, common with health insurance Insured pays a portion of the losses incurred

Errors in Age or Sex

In the event of a misstatement of age or sex, the death benefit payable under a life insurance policy will be based upon the actual (or accurate) age of the insured at policy inception

Declarations

Includes name of the insured, description of the property, amount of coverage, amount of premium, term of the policy, inception and termination dates

Conditional Acceptance

Insured is deemed to be "insurable" by the insurance company , then coverage begins on the date the insured receives the conditional binding receipt. Typically, the insured must submit a premium payment and completed acceptable application in order for the insured to obtain the receipt. As long as the insured is "insurable" then the insurer is obliged to cover a claim should one occur between the time the application is received and the time the policy is officially issued. If the insured is ultimately denied coverage (due to underwriting- must meet underwriting standards- if premium returned and insured notified that policy was not accepted at appropriate time frame), then the insurer could nullify the coverage, even if a premium was collected.

Conditional

Insured must pay the premium to receive the benefit/ promise to pay. Insurance contracts may be canceled if payments is not received.

Moral Hazard

Is based on character flaw, such as: Filing a false claim

Agent

Legal representatives of an insurer and act on the behalf of the INSURER.

Identify the two categories of legal competence

Minors- can void contract at any time Lacking Sound Mind- Person doesn't have capacity to understand the purpose or terms of the contract.

Aleatory

Money exchanged may be unequal. Insured pays a small premium, may receive large benefit.

Brokers

Not bind insurers the same as agents. These are legal representatives of the insured and act in the best interest of the INSURED.

Unilateral

Only one of the parties to the contract is bound by a promise

Unilateral

Only one promise made by the insurer, which is to pay in the event of a loss. Insured does not have to pay premiums

Exclusions

Outlines specifically what will not be covered, such as: May exclude perils such as war and flood. May exclude losses such as a private hospital room when a semi-private room will do. May exclude specific items such as cash

Causes of Insured Loss

Perils Hazard

Identifying the Risk to Which the Individual is Exposed

Primarily a function of the client's lifecycle position may be subdivided into personal risks: loss of income (untimely death, disability, health issues) increase in the cost of living (disability, health issues) property risks cause the loss of property (automobile, home, or other asset) liability risks that may cause financial loss (injury to another or to property for which the client is determined to be financially responsible).

Distinguish between principle of indemnity and subrogation.

Principle of Indemnity The insured is only entitled to compensation to the extent of the insured's financial loss. The insured cannot make money from an insurance contract. Subrogation Clause - The insured cannot receive compensation from both the insurer and a third party for the same claim. If the insurer pays a claim, only the insurer can sue the responsible party.

Coinsurance

Purpose of coinsurance in a property insurance policy is to require the insured to maintain a state percentage of minimum coverage otherwise the insured must be a coinsurer and proportionaly share in a loss

Periodically Evaluating and Reviewing the Risk Management Program

Reasons to do this - Things change over time, and risk exposures can change as well -Errors in judgment regarding the selected alternatives may occur

Low Freq, Low Severity

Retain Risk

High Freq, Low Severity

Retain/Reduce Risk

Determining the Objectives of the Risk Management Program

Risk management objectives can range from obtaining the most cost effective protection against risk to continuing income after a loss. A client's stated objective may be to insure only those risks that have the potential for causing catastrophic financial loss to the client and to do so at the minimum premium.

Adhesion

Take it or leave it There are no negotiations over terms and conditions Insurance contracts are approved b the State Insurance commissioner and the insured cannot change the terms of the insurance contract. Courts generally favor insured because she/he had no voice in contract terms.

Replacement Cost

The current cost of replacing property with new materials of like kind

Definitions of terms used in the contract

The definition section of an insurance policy defines key words, phrases or terms used throughout the insurance contract

Morale Hazard

The indifference between the person is insured, such as: Leaving a car unlocked

Perils covered

The perils covered section may cover perils on a named peril basis where specific perils are listed as covered in the policy. Alternatively, the policy may cover perils on an open peril basis, which covers all risks of loss that are not specifically excluded in the exclusions section of the policy.

Underwriting

The process of classifying applicants into risk pools, selecting insureds and assigning a premium.

Actual Cash Value

The replacement cost, less depreciation. -Almost all auto policies are ACV

Adhesion

The wording of insurance contracts is non-negotiable

Payment of Benefits

This section will outline where and how the death benefit will be payable to the beneficiary

How estoppel pertains to insurance contracts

Through the legal doctrine of "estoppel", the principal will not be able to deny the insured an insurance contract. Estoppel applies when one party relies on information from another party and that information causes harm to the party who relied on the information. The party who made the statement can be estopped from denying the statements.

Primary reason insurance company may transfer risk

To reduce their exposure to catastrophic financial risk that may result in the company becoming insolvent

Low Freq, High Severity

Transfer and/or Share Risk using Insurance

For a life or health insurance policy, the name of the insured is included in the declarations section.

True

T/F A representation is a statement made by the applicant during the insurance application process

True

T/F Actual losses must be accidental because premiums are based on the probability of a loss occurring based on historical information and claims.

True

T/F If the subject matter of the contract is illegal, then the contract is not enforceable

True

T/F Perils can be specifically covered in an insurance policy on a "named peril" basis where only specific perils listed in the policy are covered

True

T/F Property insurance polices cannot be assigned to a third party without the consent of the insurer.

True

T/F Pure risks include many of the same risks all individuals are exposed to and the types of risk a planner must evaluate and plan for each client.

True

T/F Selecting the appropriate risk management technique is the most critical component of the risk management process

True

T/F The insured is not legally obligated to make a premium payment

True

T/F The law of large numbers is useful for insurance companies because the larger the insured pool, the more likely actual losses will approach the probability of losses.

True

T/F The law of large numbers tells us that the more similar events or exposures, the more likely the actual results will equal the expected results.

True

The exclusion section of an insurance policy will exclude certain perils, losses, and property

True

Determining and Selecting the Best Risk Management Alternatives

Use matrix to analyze each risk

Aleatory

Value exchanged between parties may not be equal

The Principle of Utmost Good Faith Identify the difference between a representation, warranty, and concealment.

Warranty -A promise made by the insured to the insurer. -A breach of warranty is grounds for avoidance e.g. A homeowner who does not purchase a home security system as promised to the insurer, but is then is burglarized. Representation -Statements made by the insured to the insured during the application process. -Must be "material" misrepresentation to void insurance contract. Misrepresenting age on a life insurance application will not void the insurance contract. That situation is addressed in a separate provision in the contract. Concealment -When insured is the silent about a fact that is material to the risk being considered . Example: Ivan is applying for life insurance. On the application the insurance company asks: -Do you smoke? -Do you pilot small planes? -Do you parachute jump? Ivan answers "No" to all the questions but what he does like to do is base jump from tall bridges and buildings. Definitely a material risk to the underwriting process for life insurance.

Grace Period

Will identify the amount of time after the due date of the premium that the policy will stay in force. If the premium is not paid within the grace period, the policy will lapse. The typical grace period is 31-60 days

Riders and Endorsements

Written additions to an insurance contract and typically require additional premium Make it possible to customize an insurance contract and take precedence over conflicting terms in policy

Mutual Company

insurance company owned by its policyholders; the policyholders share in profits made by the company through dividends or reductions in future premiums