C2M1 - Principles of Insurance

Name the steps in the Risk Management Process

1. Identify and Establish Risk Management Goals 2. Gather Pertinent Data to Determine Risk Exposures 3. Analyze & Evaluate the Information to Identify Risk Exposures 4. Develop a Risk Management Plan 5. Communicate the Recommendations 6. Implement the Recommendations 7. Monitor the Recommendations for Needed Changes

A clients risk management plan is composed of ____ elements. Name them.

3 social insurance public insurance private insurance

How many basic methods are there for handling risk?

4

How many elements of insurable risk are there? Name them.

4 • There must be a sufficiently large number of homogeneous exposure units to make losses reasonably predictable (i.e., the law of large numbers). • The loss resulting from the risk must be definite and measurable. • The loss must be fortuitous or accidental. • The loss must not be catastrophic to the company.

Insurance agents generally have obligations to the following ___ parties:

4 • insurers, • individuals, • the public, and • the state(s) in which they perform business.

How many steps are there in the Risk Management Process?

7

There are ___ methods that insurance companies use to limit liability losses. Name them.

7 1. Insurable Interest 2. Actual Cash Value of the loss 3. Policy limits or face value 4. Other insurance 5. Coinsurance 6. Deductibles 7. Subrogation

In the insurance industry, the ___ major types of producers are:

7 • independent agents, • captive agents, • career agents, • producing general agents, • brokers, • surplus-line or excess-line brokers or agents, and • solicitors

With respect to an insurance companies attempts to limit liability, discuss deductibles.

A deductible is a retained risk. It is the portion of insured losses that the insured is expected to pay before the insurance company pays anything.

What is a 'Fundamental risk'? Give examples

A fundamental risk affects a large group of people. Examples include recessions and earthquakes.

In the insurance world, what is a producing general agent:

A producer that • generally produces the majority of their income by selling insurance personally, • does not have specified territories, and • has authority to hire agents to work for them if they wish. PGA contracts usually contain no prohibition against representing other insurers, although the insurer often does require a minimum dollar amount of new business premium production in order for the PGA to

In the insurance world, what is an independent agent?

A producer that • generally represent several insurance companies doing business under the American or independent agency insurance system. • They decide where they will place their business, dividing the policies they sell among those various companies they represent while, ideally, basing that on the needs of the client and the suitability of the companies.

In the insurance world, what is a career agent?

A producer that • Is usually a life insurance agent in a general agency or a company-owned office under the agency management or the branch office systems. • Some career agents are also captive agents, but in many situations career agents maintain selling contracts with other companies to better serve clients. Career agents often choose this form of operation because of the support provided by the agency and the company. • Career agents have production requirements in order to maintain their career agent contracts.

In the insurance world, what is a captive agent?

A producer that • sells property and liability insurance for companies that are known as direct writers. • Represents only one company or one group of companies under common ownership. • Most do not allow their agents to contract with other insurance companies. • Some may allow their agents to place business with other companies only after they have declined the business.

What is a PGA?

A producing general agent

With respect to insurance, discuss Actual Cash Value

Actual cash value (ACV), which is used with property losses, is the replacement cost minus depreciation.

What is Step 3 of the Risk Management Process called?

Analyze and Evaluate the Information to Identify Risk Exposures

Discuss step 1 of the Risk Management Process

As you help your clients identify and establish goals relating to risk management, there are four primary issues your clients should address: 1) How much loss could be tolerated in the current financial situation? 2) What general and specific risks does the client face? 3) Compare the potential financial loss and consequences to the probability of the risk. Then determine the appropriate action. 4) Determine the amount of income that can be used for risk mitigation.

Name the methods for handling risk

Avoidance Reduction Retention Transfer

Discuss insurance and the "asset accumulation" phase of the life cycle.

Clients generally need: - health, - disability, - life, and - property and casualty insurance Life insurance and disability insurance may need to be emphasized more heavily if there are dependents.

Discuss insurance and the "conservation or protection" phase of the life cycle.

Clients still need: - health, - disability, - life, and - property and casualty insurance They may also want to start exploring long-term care insurance. In most cases, clients should purchase this type of insurance at younger ages to lock in lower premiums while still healthy enough to qualify for coverage.

With respect to an insurance companies attempts to limit liability, discuss coinsurance

Coinsurance may be a splitting of costs, or it may refer to a minimum percentage of insurance that is required to avoid being penalized for inadequate property insurance when there are partial losses.

What is Step 5 of the Risk Management Process called?

Communicate the Recommendations

With Respect to the Risk Management Process, discuss the third step of Step 1.

Compare the potential financial loss and consequences to the probability of the risk. Then determine the appropriate action. In general, people base their judgments on recent events and historical memory. Clients need help to understand that premiums are charged based on the probability of events occurring and anticipated costs of claims, plus underwriter costs and profits. Insurance companies are underwriting the probability of risk. Premiums are adjusted to account for frequency and severity. The reason disability insurance is so costly is due to the high likelihood of an individual becoming disabled and the severity of financial risk. Having clients determine what they can afford to risk and then accumulating reserves so they can afford to risk more can manage premiums. People who try to manage premiums by guessing at risk probability often end up with unpleasant surprises.

Discuss step 4 of the Risk Management Process

Consider alternative risk treatment approaches for each risk exposure and select the most appropriate option. In this step, it is very important to involve your client in developing a risk management plan to ensure a seamless implementation. Consider the options discussed in the upcoming section of this module titled Risk Management Strategies. Future modules covering life insurance, disability, long-term care, health, and property and liability will address analysis and selection in more detail.

With Respect to the Risk Management Process, discuss the fourth step of Step 1.

Determine the amount of income that can be used for risk mitigation. Clients may have heard the general recommendation to save 15% of their income. What they are likely not familiar with is that a family will spend an average of at least 10% of their income in risk protection. For those without subsidized health insurance, the costs can be much higher. Young families and retirees may have more money allocated to risk protection than accumulation.

What is Step 4 of the Risk Mitigation process called?

Develop a Risk Management Plan

Discuss insurance and the "distribution or gifting" phase of the life cycle.

Disability insurance - no longer needed/available Life insurance - may not be as crucial Health insurance - crucial Long-term care insurance - crucial Property & casualty - needs to be maintained to protect wealth

Discuss the insurance industry and state and federal regulation

Each state regulates their state's insurance industry, however federal laws may influence this regulation

What is the difference between a fundamental and particular risk?

Fundamental risks affect a large group of people. Examples include recessions and earthquakes. Particular risks affect individuals or small groups of people.

What is Step 2 of the Risk Management process called?

Gather Pertinent Data to Determine Risk Exposures

Discuss the major parts of step 2 of the Risk Management Process

Gather Pertinent Data to Determine Risk Exposures Comprehensive risk management includes gathering client information in the following areas. Property • Actual policies for homeowners, automobile, watercraft, inland marine or floater policies, and any other property coverage policies should be collected. • Inventory of possessions and animals. An inventory will allow you to recognize which possessions may exceed the internal policy limits and/or exceed the amount of loss clients are willing to accept. Many people don't think about animals as being possessions, but they are potential causes of loss both from property damage or injury to others. • Upgrades and changes to the home or possessions that may not have been communicated to the insurance company should be reviewed. Personal Illness and Injury • Actual policies for medical, disability, accident, cancer, long-term care, or other specialty coverage should be collected. You should also evaluate medical payment sections of homeowners, auto, and umbrella policies. • Know the hobbies and activities your clients and their families like to engage in, as they may be excluded by insurance or add additional risk. Liability • Automobile, homeowners, watercraft, or other special forms of insurance and extended coverage policies all will impact liability protection. • Statements of financial position, business valuations, tax returns, and pay stubs will allow you to assess the protection needed. • Volunteer activities, hobbies, professional duties, and information about the jobs held will assist you with assessing the liability issues that could arise from nonpossessions.

With Respect to the Risk Management Process, discuss the first step of Step 1.

How much loss could be tolerated in the current financial situation? Having to make $5,000 of major repairs to a house or spending $5,000 on a major medical deductible or $5,000 on a car accident out of pocket have the same financial impact. All of these cost the client $5,000. If the client cannot afford the loss in one area, why would they be able to afford the loss in another? The cost of property loss is easier to identify. The same concept applies to deductibles for liability policies and even elimination periods for disability or long-term care insurance. Life insurance and longevity issues are harder to quantify. The second part of the loss equation becomes the extent of the lifestyle the person wants to protect. To avoid paying life insurance premiums, is the client comfortable with a surviving spouse and children needing to reduce their lifestyle? The planner must explore the boundaries the client wants to set. These conversations will be explored in more detail in later modules.

How does risk retention effect a financial plan?

How much risk clients decide to retain could influence the size of their emergency fund, cash flow planning, life and disability coverage, and investment model.

What is Step 1 of the Risk Management Process called?

Identify and Establish Risk Management Goals

With respect to the Risk Management Process, what is Step 6 called?

Implement the Recommendations

Discuss Risk Transfer

In order to transfer risk, there must be a party willing to accept the risk in return for a payment. Insurance companies accept the risks of their policyowners in exchange for premium payments. Understanding the elements that make a risk insurable will help you identify areas in which your clients can use risk transfer strategies. Most of the time, the risk will be transferred to an insurance company, but that is not always the case.

With respect to the Risk Management Process, discuss "Analyze and Evaluate the Information to Identify Risk Exposures"

It is Step 3 of the process. Processing information to identify risk exposures by evaluating clients' assets and activities. Identify risks according to 3 basic types of exposures: 1) Asset-related: loss of the asset itself, loss of use of the asset, and other associated losses. 2) Risk of liability based on contract law related to the asset or activity (e.g., acquisition of an asset resulting in liability to a lender, a club membership contract putting certain responsibilities on the client, etc.). 3) Risk of liability based on tort law (i.e., liability for a loss resulting from the use of an asset or from an activity—a boating accident, practicing one's profession, etc.). After identifying risks, evaluate whether each is one the client can afford to retain or whether risk mitigation techniques are needed. If you decide a client cannot afford to accept the risk, then alternative solutions for addressing the risk need to be evaluated.

With respect to the Risk Management Process, what is Step 7 called?

Monitor the Recommendations for Needed Changes

Discuss step 5 of the Risk Management Process

Often, the risk management plan is communicated to clients as part of a comprehensive financial plan. However, if you are solely developing a risk management plan, you would communicate your recommendations once the plan is developed.

What are the other names for a producing general agent?

PGA Personal Producing General Agent

What is a 'Particular risk'?

Particular risks affect individuals or small groups of people.

Discuss pricing (with respect to insurance)

Performed by actuaries who use several factors to determine premium (anticipated losses is most important factor). Two important assumptions in these loss statistics: 1) the elements of an insurable risk have been met, and 2) adverse selection can be controlled

What is private insurance? Give examples.

Private insurance is insurance marketed by private insurance companies. Some of these types of coverage may be mandatory as a result of state laws or lender requirements. For example, states may require automobile liability insurance coverage if you choose to register a motor vehicle. Examples of private insurance include auto, disability, health, long-term care insurance, property insurance, liability insurance, and life insurance.

Discuss step 3 of the Risk Management Process

Processing information to identify risk exposures by evaluating clients' assets and activities. Identify risks according to 3 basic types of exposures: 1) Asset-related: loss of the asset itself, loss of use of the asset, and other associated losses. 2) Risk of liability based on contract law related to the asset or activity (e.g., acquisition of an asset resulting in liability to a lender, a club membership contract putting certain responsibilities on the client, etc.). 3) Risk of liability based on tort law (i.e., liability for a loss resulting from the use of an asset or from an activity—a boating accident, practicing one's profession, etc.). After identifying risks, evaluate whether each is one the client can afford to retain or whether risk mitigation techniques are needed. If you decide a client cannot afford to accept the risk, then alternative solutions for addressing the risk need to be evaluated.

What is public insurance? Give examples.

Public insurance is designed to enhance public trust in financial institutions. Similar to social insurance, public insurance is usually mandatory and administered by the government or by quasigovernmental institutions. The Federal Deposit Insurance Corporation (FDIC), Pension Benefit Guaranty Corporation (PBGC), and Securities Investor Protection Corporation (SIPC) all administer types of public insurance.

Discuss pure risk. Give an example.

Pure risk involves only the chance of loss or no loss; in other words, there is no chance of gain. Pure risks are insurable. Example: The possibility that a person's home will burn represents a pure risk because there is no chance of gain but only the chance of loss or no loss.

What are some examples of reasonable risk retention?

Reasonable risk retention could include not insuring antiques, jewelry, and damage to an older vehicle. Self-employed individuals may choose to retain risks related to some of their business equipment, office overhead, or other risks.

Discuss step 7 of the Risk Management Process

Recommendations need to be monitored for two reasons. 1) Things change over time (both the client's situation and available coverage options). 2) To catch new or missed risk exposures, obtain missing information, and correct previous mistakes.

With respect to risk management, if there is a high probability/frequency of a risk, and the severity of the risk is also high, which method(s) is/are best for addressing that risk?

Risk avoidance Risk reduction

Discuss Risk Control

Risk control is a risk management technique that seeks to minimize the risk of loss. This method includes Risk avoidance Risk reduction

Discuss Risk Financing

Risk financing is a risk management technique that pays the costs of losses incurred. This method includes: Risk Retention Risk Transfer

Discuss Risk Transfer

Risk is primarily transferred by insurance, but can also be accomplished through waivers or subcontracting. With insurance, the risk of loss is transferred to an insurance company in exchange for a relatively small cost, the premium. Health, life, disability, and liability risks are examples that are generally transferred.

With respect to risk management, if there is a low probability/frequency of a risk, and the severity of the risk is also low, which method(s) is/are best for addressing that risk?

Risk retention

With respect to risk management, if there is a high probability/frequency of a risk, but the severity of the risk is low, which method(s) is/are best for addressing that risk?

Risk retention Risk reduction

With respect to risk management, if there is a low probability/frequency of a risk, but the severity of the risk is high, which method(s) is/are best for addressing that risk?

Risk transfer

Discuss self insurance requirements

Self-insurance is a method of risk retention that has several requirements. • The organization should have enough homogeneous exposure units to make losses somewhat predictable. • Adequate funds must be accumulated to cover plan losses. • The self-insurer must be able to administer the insurance functions, such as analysis of potential claims, disbursement of payments to providers, and objective determination of claim validity, as efficiently as an insurance company would. • The self-insurer must be able to competently manage investment of the self-insurance fund. Relatively few firms are large enough to establish a self-insurance plan for major costs such as health insurance and employee life and disability coverage.

Discuss self insurance broadly.

Self-insurance is not truly insurance because there is no sharing of risk. However, the term self-insurance is used to define business use of risk retention. Large businesses use risk retention and financial planners typically rely upon a specialist to make sure that the business risks are covered for their clients who are business owners.

What is social insurance? Give examples

Social insurance is mandatory insurance administered by the government, with benefits mandated by law. The purpose of social insurance is to protect people from large fundamental risks. Examples include Social Security, Medicare, Medicaid, and workers' compensation

Discuss risk retention due to inability to transfer risk

Sometimes clients may be unable to transfer risk to an insurance company (ex: poor health precludes a life insurance policy), forcing client to rely on risk avoidance, reduction, and retention. Developing a list of strategies and concepts will help your clients.

Discuss speculative risk. Give an example.

Speculative risk involves both the chance of loss and the chance of gain. Speculative risks are not insurable. Gambling is a classic example of speculative risk because it presents both the chance of loss and the chance of gain

What is the difference between a static and a dynamic risk?

Static risks, such as earthquakes and floods, result from factors other than changes in the economy. They tend to occur with regularity and can be insured. Dynamic risks are the result of changes in the economy, such as changes in the business cycle or inflation. Insurance does not typically cover dynamic risks.

With respect to the Risk Management Process, discuss "Communicate the Recommendations"

Step 5 of the Risk Management Process Often, the risk management plan is communicated to clients as part of a comprehensive financial plan. However, if you are solely developing a risk management plan, you would communicate your recommendations once the plan is developed.

With respect to the Risk Management Process, discuss "Monitor the Recommendations for Needed Changes"

Step 7 of the Risk Management Process Recommendations need to be monitored for two reasons. 1) Things change over time (both the client's situation and available coverage options). 2) To catch new or missed risk exposures, obtain missing information, and correct previous mistakes.

With respect to an insurance companies attempts to limit liability, discuss subrogation.

Subrogation is the right of an insurance company that has paid for a loss to recover its payments if it is determined that a different insurance company or person is responsible for the loss and is required to pay for it. This prevents the insured from collecting twice for the same loss.

Discuss Risk Reduction

Taking steps to reduce the risk. Examples: 1) If the same business wants windows but is still concerned about vandals, it may choose to have windows made of a material that is very difficult to break. 2) If the individual wants to play the sport, but wants to limit potential damage, she can wear protecve gear.

Discuss Risk Avoidance

Taking steps, or not taking steps, to completely avoid a risk. Examples: 1) If a business wants to ensure that it will not have windows broken by vandals, it can avoid the risk by not having windows. 2) An individual who does not want to get hurt playing a particular sport can avoid playing that sport.

What is the Risk Management Matrix?

The Risk management matrix helps one determine which risk management strategy should be employed

Discuss step 6 of the Risk Management Process

The client must ultimately decide whether she will do anything at all to implement the financial plan, you can provide better client service by helping to implement the plan.

Discuss Risk Retention

The individual or business retains the risk. If a loss occurs, the individual or business pays the cost. This strategy is used when: 1) The potential loss is small and the business or individual believes any losses that occur can be covered out of pocket. 2) The cost of transferring the risk is high, so there may be no reasonable alternative.

What are the basic facets of underwriting

The insurance company: • determines if the exposure meets the requirements of an insurable risk, • decides whether it is practical for the insurer to provide insurance against this particular risk, and • establishes how the insurance should be priced.

At what level is the insurance industry regulated?

The insurance industry is regulated at the state level

With respect to an insurance companies attempts to limit liability, discuss Policy limits or face value

The policy limit or face value of a policy is the maximum amount that will be paid when the insured loss occurs. With most forms of insurance, the policy will pay for losses up to the amount of coverage. With life insurance, it is the amount that is paid when the death occurs. Some policies have more than one face amount or limit (ex: in automobile physical damage coverage, no face amount is stated; recovery is limited to the automobile's ACV). The majority of homeowners policies have face amount limits and include several internal limits applying to certain types of property, losses, locations, perils, or hazards.

Discuss the basic methods for handling risk

There are 4 basic methods, grouped into two groups: Risk Control Avoidance Reduction Risk Financing Retention Transfer

With respect to the Risk Management Process, discuss "Implement the Recommendations"

This is Step 6 of the process The client must ultimately decide whether she will do anything at all to implement the financial plan, you can provide better client service by helping to implement the plan.

With Respect to the Risk Management process, discuss "Develop a Risk Management Plan"

This is step 4 of the Risk Management Process Consider alternative risk treatment approaches for each risk exposure and select the most appropriate option. In this step, it is very important to involve your client in developing a risk management plan to ensure a seamless implementation. Consider the options discussed in the upcoming section of this module titled Risk Management Strategies. Future modules covering life insurance, disability, long-term care, health, and property and liability will address analysis and selection in more detail.

Discuss risk reduction and avoidance

This requires planning such as: - not participating in dangerous sports/activities (avoidance) - installing a security system (reduction) Advantages: savings in premium costs and potentially fewer liability claims. Disadvantages: Not always possible or reasonable (ex: eliminating risk posed by driving could impose undue burden)

Why are there dollar limits on insurance policies?

To avoid catastrophic losses on the part of the insurance company in the event of a single, large peril effecting many people

What is the main process associated with evaluating risk exposure?

Underwriting

With Respect to the Risk Management Process, discuss the second step of Step 1.

What general and specific risks does the client face? Clients who own boats, motorcycles, airplanes, and jet skis face different risks than those who stay at home and aren't active. Those who aren't active face health risks. Those who own motorized "toys" have accident and liability risks. People who serve on boards, own businesses, own farms, have children in sports, clean their own gutters, own dogs or horses, or drive for carpools all have risks. Think through each of these activities and identify the financial risk that could result from the activity. Most clients will want to maintain their lifestyles and keep their possessions. This will guide your identification of the general and specific risks your clients face. You will need general knowledge of risk management techniques and the ability to evaluate which risk management techniques apply to your clients' circumstances.

With respect to an insurance companies attempts to limit liability, discuss "other insurance"

When a loss occurs, and there is more than one insurance policy covering the same loss, the insured will not profit from the loss. Either one policy is considered primary with the other paying for any uncovered loss, or the policies pay prorated shares of the loss.

In the insurance world, what is a 'producer'?

a producer is a person or entity that distributes insurance products and services on behalf of insurance companies

What is a dynamic risk? Give examples

a risk that results from changes in the economy, such as changes in the business cycle or inflation. Insurance does not typically cover dynamic risks. Examples: inflation

What is a static risk? Give examples

a risk that results from factors *other than* changes in the economy. They tend to occur with regularity and can be insured. Examples: earthquakes, floods

From the point of view of the legal system, the insurance producers fall into the legal categories of ___________________________.

agent or broker

Risk management includes ...

all of the actions one can take to minimize risk

Planned loss generally involves

criminal act

For a risk to be insurable, losses must be _____________________

fortuitous (aka accidental)

With respect to an insurance companies attempts to limit liability losses, discuss Insurable Interest.

insurable interest exists when the interested party will suffer a financial loss if the insured loss occurs. AKA the policyholder must demonstrate that some sort of reasonable relationship exists with the insured and that they will experience financial or emotional suffering if the insured dies. A person has an unlimited insurable interest in their own life, but other forms of insurable interest can include blood relation or marriage, financial relationship (e.g., business partners or key-life), domestic partnerships, charitable organizations, or funeral homes. For property and casualty insurance (e.g., home and auto), insurable interest must exist both at the time the policy was issued and at the time of the loss. For life insurance, insurable interest must be present at the time the policy was issued, and does not need to be present at the time of a claim.

The concept of insurance requires application of the ________________________. Simply stated,

law of large numbers there must be a large number of similar potential losses so that the insurer can reasonably apportion the expected financial loss. The insured people or property must also be widely disbursed geographically to avoid catastrophic loss on the insurance companies part due to a single peril.

An insurer is also known as a

producer

Insurance companies use various distribution channels to provide their products and services. These individuals are generally referred to as _____________________.

producers

What is a 'hazard'?

something that increases the potential for loss

The insurance industry is regulated at the _________ level

state

What is a 'peril'?

the cause of a loss

What is a 'risk'?

— the possibility of a loss, or —a negative deviation from a desired outcome

Describe the relationship between the principal and agents.

• A principal (an insurer) gives an agent the authority to solicit and bind insurance contracts, subject to the limitations of the agency agreement between the two, as modified by the law of the jurisdiction. • The agent is the representative of the insurer.

In the insurance world, what is a Broker? Name 5 points about brokers.

• Brokers are individuals who are licensed with and represent many insurers. • A broker is the agent of an insurance buyer. • Companies that do not maintain extensive field forces of their own may sell their products using agents of other companies through what are called "brokerage contracts." This may be their primary or even sole distribution system. • Many companies that do maintain their own field forces look at brokerage business as a way to increase the amount of insurance they sell without having to increase their overhead for training and provide support services to additional agents. • Clients benefit from this practice because brokers have the products of a large number of companies available to them instead of the products of a single company

In the insurance world, what is a Surplus-Line, Excess-Line Brokers or Excess-Line Agents?

• Handle any type of insurance that cannot be purchased using normal distribution channels within a given state. • A surplus-line agent has the authority to go outside the state and place the business with a surplus-line (nonadmitted) insurer if the necessary coverage cannot be obtained from an insurer admitted in the state. • These are found almost exclusively in the property and casualty field.

Name the seven types of insurance that are discussed in this course.

• Property insurance • Liability insurance • Life insurance • Annuies (oen considered longevity insurance) • Health insurance • Disability insurance • Long-term care insurance