Module 1 C1 & C2 Insurance - Intro and Characteristics of Insurance

Parol evidence rule p.27

"What is written prevails" Any oral agreements prior to writing the contract have been incorporated into the written contract. Oral agreements that are not reflected in the written contract are not valid.

Three main types of hazard p.21

1) Physical hazard (a tangible condition or circumstance that increases the probability of a peril occurring and/or the severity of damages that result from a peril, 2) Moral hazard (a character flaw or level of dishonesty a person possesses that causes or increases the chance for loss), and 3) Morale hazard (indifference to losses based on the existence of insurance).

What are the requisites for an insurable risk? p.22

A risk that is ideally situated to be an insured risk meets the following requirements: • It has a large number of homogeneous exposures. • The insured losses must be accidental from the insured's point of view. • The insured losses must be measurable and determinable. • The loss must not be financially catastrophic to the insurer. • The loss probability must be determinable. • The premium must be reasonable and affordable.

Differences between actual cash value, replacement cost, and appraised value p.41-42

Actual cash value represents the depreciated value of the property. Actual cash value is used to value the amount of coverage for a personal auto or personal property. Replacement cost represents the amount to repair or replace property, without any deduction for depreciation. Replacement cost is the method used to value damage to a personal residence under a property insurance policy. Appraised value is used for hard to value items and where the insured may own property that exceeds standard limits of property insurance policy.

Differences between agents and brokers p.34

Agents are legal representatives of an insurer and act on behalf of an insurer. Agents are only permitted to sell the policies written by their company. Agents have the authority to bind the insurer to an individual. Brokers are legal representatives of an insured and act in the best interest of the insured. A broker may sell insurance polices from any one of a number of different insurance companies. Since the broker does not represent the insurer, they may not bind an insurer.

Differentiate between a rider and an endorsement p.38

An endorsement is a modification or change to the existing property insurance policy. A rider is a modification or change to a life or health insurance policy.

When must an insurable interest exist for property, liability, and life insurance? p.27

An insurable interest for property and liability insurance must exist both at the inception of the policy and at the time of loss. An insurable interest for life insurance need only exist at the inception of the policy.

Purpose of a deductible p.39

Deductibles are the first dollar in loss that the insured is responsible to pay. Deductibles may be a flat dollar amount such as $250, $500 or $1,000. A deductible may also be a percentage of the covered loss, which is typical for flood insurance or homeowner's insurance in states like Florida. The purpose of a deductible is to reduce the filing of small claims, reduce premiums and eliminate moral / morale hazard.

6 typical sections of an insurance contract p.36-37

Definition, Declaration, Description, Perils, Exclusion, Condition • The definition section of an insurance policy defines key words, phrases or terms used throughout the insurance contract. • The declarations section describes exactly what property is being covered. For property insurance, the declaration page will describe the property, address, owner of the property, name of the insured, amount of coverage, deductible and premium. For life insurance, the declaration page will contain the insured's name, face value of the policy, term or length of the policy and the issue date. • The description section describes exactly what is being 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. • 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. • The exclusion section of an insurance policy will exclude certain perils, losses and property. Perils are excluded because they may be uninsurable perils, there is a moral hazard or they are a potentially financially catastrophic to the insurer. • Conditions are provisions in an insurance policy that require an insured to perform certain duties. If the policy conditions are violated, the insurer may refuse to pay the claim.

Conditional acceptance p.26

If a prospective insured had completed an auto insurance application and attached a check for the premium. The insurance agent conditionally accepts the policy, upon final review by the underwriter.

Personal Risk Management Process

Involves identifying, evaluating, and managing pure risk exposures faced by a client. The six step process includes: (1) Determining the objectives of the risk management pro- gram, (2) Identifying the client's risk exposure, (3) Evaluating the identified risks for probability of occurrence and severity of loss, (4) Determining the alternatives for managing the risks and selecting alternatives for each risk, (5) Implementing risk management selected recommendations, and (6) Periodically reviewing the risk management program.

Peril p.20

Proximate or actual cause of a loss. Common perils include accidental death, disability caused by sickness or accident, and property losses caused by fire, windstorm, tornado, earthquake, burglary, and collision.

Differences between pure risk and speculative risk p.11

Pure risk is the chance of loss or no loss occurring. With pure risks, there is no chance of experiencing a gain. Examples of pure risk include, either your car is in an accident and damaged or it's not. Speculative risk is the chance of loss, no loss or a profit. Speculative risk is the risk that an investor takes when buying a stock or an entrepreneur takes when starting a business. Insurance is not available for speculative risks because most speculative risks are willingly entered into for the purposes of earning a profit.

Define representation, warranty, and concealment p.29-30

Representation is a statement made by the applicant during the insurance application process. A representation can be an oral statement or information disclosed on an insurance application such as age, gender, occupation, marital status and family medical history. A warranty is a promise made by the insured that is part of the insurance contract. The warranty can be a promise to perform or take a certain action. Concealment is when the insured is intentionally silent regarding a material fact during the application process. The insurer has the right to void an insurance contract based on material concealments by the insured.

Responsibilities of an underwriter p.38

Responsible for evaluating risks and determining whether the risk is insurable or non-insurable. The underwriter is also responsible for managing adverse selection. Adverse selection is the tendency of those that need insurance to seek it out.

Hazard p.20

Specific conditions that increases the likelihood of a loss occurring

Differences between subjective and objective risks p.12

Subjective risk is the risk an individual perceives based on their prior experiences and the severity of those experiences. Individuals will perceive risks differently and their behavior will depend upon how they perceive a risk. If an individual perceives the subjective risk to be high, then the individual will take appropriate steps to reduce the subjective risk. Objective risk is the variation of actual amount of losses that occur over a period of time compared to the expected amount of losses. As the number of loss exposures (or the pool of insureds) increases, objective risk is reduced because the more likely actual results will equal expected claims. Objective risk varies indirectly with the number of loss exposures in an insured pool.

5 Elements of a valid contract p.25

The following elements must be present for a contract to be valid: • Mutual Consent • Offer and Acceptance • Performance or Delivery • Lawful Purpose • Legal Competency of all Parties Think MPOLL

What is the law of large numbers and why it is useful for insurance companies? p.13

The law of large numbers is a principle that states that actual outcomes will approach the mean probability as the sample size increases. 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 occurring, therefore reducing forecasting error. This results in insurance premiums that are efficient in terms of cost to the insured.

Why are insurance companies reinsured?

The primary reason an insurance company may transfer risk is to reduce their exposure to catastrophic financial risk that may result in the company becoming insolvent. A company may decide to transfer some of their risks to create capacity to underwrite new policies.

Differences between the principal of indemnity and a subrogation clause p.27

The principle of indemnity asserts that an insurer will only compensate the insured to the extent the insured has suffered an actual financial loss. The insured cannot make a profit from insurance. The principle of indemnity does not assert that an insured will recoup 100 percent of any loss, as most policies will have deductibles and limits on the amount of losses covered. 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. A subrogation clause entitles the insurer to seek a claim against a negligent third party, for any claims paid to the insured.

Four responses to managing risk p.16

Think ARRT (Avoidance, Reduction, Retention, Transfer) 1) Risk Avoidance (avoiding an activity) Hi S, Hi F 2) Risk Reduction (implementing activities that result in reduction of the frequency and/or severity of losses), Lo S, Hi F 3) Risk Retention (personally retaining the potential for a loss exposure) Lo S, Lo F 4) Risk Transfer (shifting the risk of loss through means such as insurance or a warranty). Hi S, Lo F where S = severity and F = frequency

Purpose of coinsurance p.39

To require the insured to maintain a stated percentage of minimum coverage otherwise the insured must be a coinsurer and proportionately share in a loss. Coinsurance formula (What Ins Pays) (Amt of Ins Carried/Amt of Ins required)*Covered Loss

Law of Agency: Differences between express, implied, and apparent authority. p.32

• Express authority is given to an agent through a formal written document. • Implied authority is the authority that a third party relies upon when dealing with an agent based upon the position held by the agent. When a customer walks into an insurance agent's office, the customer will see the company logo on the front door, signs on the wall of the agent's office with the company's logo and business cards on the agent's desk. • Apparent authority is when the third party believes implied or express authority exists, but no authority actually exists.

10 Typical perils covered under a homeowner's insurance policy p.20

• Fire • Lightning • Windstorm • Hail • Riot • Falling Objects • Weight of ice, snow and sleet • Smoke • Explosion • Theft

9 Typical perils covered under a personal auto policy (pap) p.20

• Fire • Storm • Theft • Collision • Hail • Flood • Contact with a Bird or Animal • Falling Objects • Earthquake • Windstorm

Three levels of state regulation of the insurance industry p.43

• Legislative • Judicial • Executive or State Insurance Commissioner

Goals of the National Association of Insurance Commissioners (NAIC) p.43

• Protect the public • Promote competition • Promote fair treatment of insurance consumers • Promote the solvency of insurance companies • Support and improve state regulation of insurance

Differences between four methods to regulate insurance rates p.44

• Under prior approval law, an insurance company must file the rate increase request with the state insurance commissioner's office. • States that allow a "file and use" law permit an insurance company to file the rate increase with the state insurance commissioner's office but immediately implement the rate increase. • A "use and file" state permits an insurer to increase rates, but they must file the rate increase within a spe- cific time period, as determined by state law. • Open competition laws allow insurers to set their own rates and presume that supply and demand will determine the appropriate rates for various insurance products.

Unique characteristics of an insurance contract (Seven Unique characteristics) p.30

• Unilateral - Only the insurer is making a promise, therefore it is a unilateral contract. • Aleatory - What is paid in by the insured and paid out by the insurer may not be equal amounts. • Adhesive - The insured had no opportunity to negotiate terms; thus ambiguities are charged to the insurer. • Utmost good faith - The insurance applicant is truthful in disclosure of pertinent material facts and the insurer discloses critical contract information. • It is a contract based on the principal of indemnity (insured cannot make a profit from a claim on insurance). • The insured must have an insurable interest. • The coverage is conditioned upon the payment of premiums. Specific Unique Characteristics per product: • Property insurance polices are a contract between the insurer and the insured, therefore the policy cannot be assigned to a third party without the consent of the insured. • Life insurance contracts can be assigned without consent of the insurer because the contract is still between the insurance company and the insured.