CFP: Insurance Planning and Risk Management

Two levels to consider in Risk Management:

1. risk control (avoidance/ reduction)-and 2. risk financing-(retention and transfer). Risk management is more than just insurance management. Insurance management takes place as a step in the risk management process. After one decides what to avoid, what to reduce, and what to retain, then insurance is considered. Insurance is the last risk financing step after all other alternative methods have been explored.

Which of the following are hallmarks of an insurance transaction?

A. Certainty of financial payment from a pool. B. Proper redistribution of losses. C. Accurate predictability of losses.

Absolute liability

Absolute liability, also called strict liability, is imposed on individuals whose specific actions, or failures to act, result in third-party losses, such as bodily injury or property damage. Even if no harm has been intended or when the defendant cannot be accused of lack of care for the others, they can be held liable for committing an absolute liability tort in certain situations involving extremely hazardous activities.

Actual Cash Value

Actual Cash Value (ACV) means replacement cost at the time of loss, less depreciation. Actual Cash Value is one of the strategies used to implement the principle of indemnity. The insured can only recover the amount of the loss, even if the face value of the policy was higher because the property was over-insured.

Ownership rights evidenced by something tangible or intangible is called chose. There are two types of choses:

Choses in possession ownership rights by tangible objects, such as jewels. For example, Susans diamond necklace and her Ford Mustang would legally be choses in possession. Choses in action: Ownership rights by something tangible but not having a value of itself like an insurance policy. An insurance policy is a chose in action. The contract in an insurance policy itself has no value. It evidences an intangible of value. To recover value from a chose in action, legal action may be necessary. For example, Susans stocks and her life insurance policy would legally come under the choses in action category. In themselves, they have no value because they are just paper documents. However, Susan has the right to claim the value of her stocks and policy by taking some form of action.

Completed Operations Insurance

Completed operations insurance policies cover claims from injuries arising after a service is rendered and the propertys control is returned to the owner. This coverage would help a plumber whose negligence caused a water heater to explode.

Financial Risk Management

Financial risk management is the approach whereby a company optimizes the procedure in which it takes risks. It is based on recognition of the fact that all companies accumulate resources. These resources are invested in business activities that are uncertain. Successful organizations take risks that are necessary for their goals and avoid other risks.

Appleton Rule

In this framework of insurance regulation by the states, the extra-territorial rule of New York State is given special consideration. In 1939, New York made the Appleton Rule part of its insurance code. Put simply, the rule states that insurance companies doing any business in New York State must be in substantial compliance with all of New York's rules in whatever state they do business. Because most of the largest life and non-life insurers transact business in New York, the New York insurance code has an impact well beyond the state borders. Thus, consumers who are not New York residents still get the benefit of New York legislation if they deal with an insurer doing business in New York.

Indemnity

Indemnity means the insured should be restored to the same financial position occupied before the insureds loss.

Group Life Insurance

Insurers call life insurance purchased by business firms and other organizations as an employee benefit group life insurance. Many employers, including the federal government, provide group life insurance as a benefit. The purpose of this life insurance is to help attract, motivate and retain employees.

Specific-perils contract

Insurers call policies that specifically identify a list of covered perils specified-perils contracts.

Presumptive Disability

It is common to include a definition of presumptive disability in policies that provide benefits for total disability. Under the presumptive disability clause, an insured is always considered totally disabled, even if he is at work, if sickness or injury results in the loss of the sight of both eyes, the hearing of both ears, the ability to speak, or the use of any two limbs. Usually, the insurer begins benefits immediately upon the date of loss and waives the medical care requirement. The insured can work in any occupation and full benefits will be paid to the end of the policys benefit period, while the loss continues.

Errors and Omissions Insurance

Many professionals, such as real estate agents, insurance agents, accountants and architects, need this type of liability protection to cover clients claims alleging professional negligence.

PRACTICE STANDARD 500-2

PRACTICE STANDARD 500-2 Selecting Products and Services for Implementation The financial planning practitioner shall select appropriate products and services that are consistent with the client's goals, needs and priorities.

Daily Benefits of LTC

The buyer is usually offered a choice from a schedule of maximum daily benefits and length of benefit periods. A typical LTC policy might offer the buyer a daily benefit schedule of: $140 per day increasing in $10 increments to a maximum of $400 per day

Limit of Liability - Single Limit

The declarations page may provide a single limit of liability, such as $500,000, which sets the limit for all types of damage an insured may cause in one occurrence equal to this stated amount. If judgments exceed this limit, the insured, not the insurer, is responsible for the excess. The single limit policy may provide more compensation to a single victim of the insured than the other type of liability coverage, known as split limits liability.

McCarran-Ferguson Act

The governing federal insurance law is the McCarran-Ferguson Act (Public Law 15). In a most unusual outcome for a federal law, the McCarran-Ferguson Act turns over the regulation of the insurance industry to the states. Each of the 50 states, plus Washington D.C., Puerto Rico, American Samoa, Guam, and the U.S. Virgin Islands, has its own insurance code. An official, usually known as the insurance commissioner, whose job is to apply state insurance laws to specific cases, conducts the administration of a state's insurance laws. The Act was adopted in 1945. 1. It explicitly empowers the state to regulate and tax insurance. 2. It allows insurers to share related information that lowers their cost of doing business. 3. It provides insurers with a limited and narrow exemption from federal anti-trust laws as long as states monitor that kind of activity.

There is a distinction in PAP between collision and comprehensive

There is a distinction in PAP between collision and comprehensive (non-collision) damage to a vehicle. Collision coverage provides protection against damage to the vehicle if it collides with or is struck by another object while in use. Those situations considered non-collision losses include: Breakage of glass, loss caused by missile, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, or colliding with a bird or animal. These losses would fall under the comprehensive (non-collision) coverage. The insured has a choice to purchase one, both, or neither of these forms of coverage. If purchased, a deductible (the insureds portion of risk retention) must be selected. Typical deductible options are $100, $250, $500, or $1,000 per accident. The insured does not have to purchase either coverage. However, if they have a car loan the lender will require both coverages within certain deductible limits until the loan is paid. This protects the collateral for the loan, which is the vehicle itself.

Tort Actions

Tort actions, like other civil actions, begin when a person injured by another's act or omission files a complaint in court, alleging that the defendant has committed a tort, and requesting damages. Three categories of tort liability: 1. Intentional torts: Defendants actions are calculated to cause injury to another. 2. Negligent torts: Defendant unintentionally acts or fails to act in a prudent manner. 3. Strict liability torts: Damages result from dangerous activities. Tort law recognizes certain defenses that extinguish or reduce the defendant's liability. For example, even if a plaintiff establishes all the elements of a tort, a defendant who proves facts constituting a legitimate defense may prevent or limit the plaintiff's recovery.

Maximum Possible Loss

Total loss a peril could cause under worst case circumstances.

Any Gainful Occupation

Under the any gainful occupation clause, insureds are considered totally disabled when they cannot perform the major duties of any gainful occupation for which they are reasonably suited because of education, training or experience. Because the insured may be able to work at any of several suitable occupations, even though he or she is incapable of working at his regular job, this clause is a more restrictive definition of disability than the own occupation definition. It can limit recovery of benefits under the policy.

Cause of Loss

When providing physical damage coverage, insurers make an important distinction based on the cause of the loss. A loss is caused by collision or it is not, thus, the definition of collision in automobile insurance takes on similar importance to the definition of fire in the property insurance policy. To get a complete program of automobile property insurance, a business must purchase collision coverage, in which the insurer agrees to pay "for loss caused by collision," and a second part, sometimes referred to as comprehensive coverage, in which the insurer agrees to pay "for loss caused other than by collision." Each of these coverages may be purchased separately, but in so doing a consumer may unknowingly create a serious gap in automobile property insurance protection. It should be noted that the above distinction also applies to the Personal Auto Policy.

Residual Loss of Income Formula

(Loss of Income / Prior Income) * Monthly Indemnity Benefit = Residual Benefit

According to the legal definition of terminally ill, an individual must be medically certified as having an illness that could result in death within how many months?

24 months

Condition Subsequent

A condition subsequent ends an existing duty of immediate performance. For example, an insured must initiate a lawsuit toward the insurer for denial of claim within 12 months or the insurer is relieved of all obligation.

Contract

A contract is a legally binding agreement creating rights and duties for those who are parties to it. If one party to the contract fails to perform its duties without a legal excuse, the contract is breached. If a contract is breached or if disputes arise between the parties about the interpretation of the contract, the issues may be settled by a court. Courts can enforce their judgments and settle contractual disputes using a variety of remedies.

Negligence Suit Defense

A defendant has two main lines of defense against a charge of negligence: 1. Contributory negligence 2. Assumption of the risk

A peril

A peril is defined as the cause of the loss. For example, fires, tornadoes, heart attacks, and criminal acts constitute perils.

What will insurance companies pay if no rebuilding is done?

Actual cash value of the loss. Many insurance companies will insure replacement values but pay only depreciated value until the property is replaced. Insurers impose this strict condition to prevent firms from receiving the replacement value in cash and then not replacing the property.

Open-perils contract

An insurance contract that covers all losses except those specifically excluded.

Best Insurance Reports

Best's reports contain considerable information about insurers including the names of their officers, their home office address, company history and composition of assets, balance sheets and significant operating ratios. A consumer considering dealing with an unfamiliar insurer, or even a familiar one whose condition is in doubt, would find relevant information about the company in Best's.

Income Objective =

Capital Liquidation + Capital Retention

Fitch Ratings

Fitch Ratings Insurance Group provides ratings and research on insurance and insurance-related companies worldwide.

Bodily injury

For example, wages lost while the plaintiff was recovering from an injury.

Categories of Risk

For property insurers, as well as for life and health insurers, the amount of capital required is a function of the following categories: Asset Risk - the potential for default or decline in the market value of investments. Credit Risk - the potential that premiums or reinsurance will not be collected. Underwriting Risk - the potential that rates will be inadequate to cover future losses. Catastrophe Risk - the potential for a catastrophe to reduce profitability or capital. The NAIC model law applying to the risk-based capital ratio specifically prohibits the public use of this ratio as a ranking or rating tool. Nevertheless, this information is likely to be known by the public, and thus many insurance companies will likely work to improve their results.

Renter's insurance provides what coverage?

If you are a tenant, it is important to purchase Renter's Insurance, a very inexpensive form of homeowner's coverage. In addition to covering your clothes and furniture, Renter's Insurance also provides liability protection.

Medicaid Option

In the United States, Medicaid is the "provider of last resort" for the poor. Medicaid is a joint federal and state entitlement program that pays for medical expenses for qualified recipients. Eligibility for Medicaid long-term care services is based on each state's income and resource standards. Individuals cannot have more than $2,000 in countable assets to apply, and some assets are not counted, such as household goods, personal possessions, clothing, furniture, jewelry, a car, and up to $500,000 or $750,000 of home equity, depending on the state. Assets that are considered countable include savings, CDs, money market accounts, real estate, stocks, bonds and other investments. Until recently, many financially well-off families, facing the need to provide long-term care for an aged parent, would arrange for the transfer of the parent's assets either to children or to a trust, to voluntarily "impoverish" the parent who would then be eligible for Medicaid. In response, Congress imposed strict limitations on the transfer of assets when it passed the Deficit Reduction Act of 2005. Now certain transfers for less than fair market value made within the "look back" period will incur a penalty period of ineligibility. Medicaid payments would be withheld for a calculated period of time once the nursing home resident depletes his assets to the state's qualifying levels. The penalty period begins on the later of the date of the asset transfer, or the date a person entering a nursing home is eligible for Medicaid coverage, if it weren't for the imposition of the transfer penalty. The following provisions are applicable to all potential Medicaid recipients; they are intended to minimize financial manipulation: Property transferred to individuals, charities or a trust within 60 months of application for Medicaid is considered as owned by the applicant and must be disclosed. Applicants must provide five years worth of financial records to satisfy the "look back" period, regardless of whether transfers were made to a trust or to others. State Medicaid programs are required to attempt to recover any Medicaid payments from the estates of recipients. PRACTITIONER ADVICE Though Medicaid continues to provide some financial security to the truly needy, it will no longer be subject to the same types of manipulation as before. The message is clear: If there is any way for people to cover their own LTC expenses, they should try to do it. Many states now have long-term care "partnership" programs which allow buyers to qualify for Medicaid after the policy's benefit period ends, and protects some assets from spend-down requirements. For example, if a policy is purchased with $100,000 in benefits, the buyer can keep that amount of assets and still qualify for Medicaid. Ownership of LTC insurance may also exempt the nursing home resident's estate from payment recovery. See your specific state for details.

INSURANCE PLANNING MODULE

Insurance Planning Module

LIFE INSURANCE MODULE

Life Insurance Module

Moody's Investor's Services

Moody's Investors services provide credit ratings for roughly 700 insurance companies worldwide. It also rates major re-insurers and financial guarantors. The firm also provides performance ratings and supporting research on the Lloyd's syndicates through the Lloyd's Market Service.

Viatical settlement income tax free

Recent federal legislation makes all proceeds of a viatical settlement income tax free. This is of great benefit to the terminally ill viator in dire need of the money. However, the viator must meet the legal definition of being terminally ill. This denotes that the proceeds from a viatical settlement are tax-exempt only if the life expectancy of the viator is two years or less.

Living insurance takes one of three forms:

Terminal illness Catastrophic illness Dread disease coverage.

Collateral source rule

The collateral source rule, or collateral source doctrine, is an American case law evidentiary rule that prohibits the admission of evidence that the plaintiff or victim has received compensation from some source other than the damages sought against the defendant.

Gift Tax Exclusion

The federal gift tax law is not aimed at the usual exchange of gifts associated with birthdays, holidays and similar occasions. The law permits the donor to make this type of gift without tax by excluding the first $14,000 of outright gifts in any one specific year to any one recipient. This annual $14,000 exclusion applies to gifts made to each recipient, irrespective of the number. Moreover, it is available year after year. An individual could give $14,000 to each of a large number of recipients each year, without incurring any gift tax liability. The exclusion is indexed for inflation with respect to gifts made after 1998. The IRC provides that the indexed exclusion is rounded to the next lowest multiple of $1,000. As the inflation adjustment occurs in multiples of $1,000, it can be several years between adjustments. The donor's exclusion is applied to each recipient individually, and if a recipient receives less than $14,000, the exclusion is limited to the actual amount of the gift.

Consumer Choices

The insurance consumer must make five separate choices. These include: company, agent, policy, amount, and price. The Internet is a big help, allowing for comparison-shopping and practical advice on how to purchase insurance.

Exposure To Loss

The insureds possibility of loss is called his exposure to loss. If the insured purchases an insurance policy, he transfers the exposure to loss to the insurer.

Commercial Perils Covered

The property component requires a causes-of-loss form to complete the contract. There are three main alternatives: 1. The Basic Form 2. The Broad Form 3. The Special Form The basic form covers the following perils: Fire Lightning Explosion Windstorm or hail Smoke Aircraft or vehicles (striking the property) Riot or civil commotion Vandalism Sprinkler leakage Sinkhole collapse (this happens in Florida and elsewhere) Volcanic action The broad form extends the coverage by adding more perils, including falling objects and water damage. The special form provides open-perils coverage. With this form, the insured is covered unless the peril causing the loss is specifically excluded. With the open-perils coverage, the legal burden is on the insurer to show that exclusion applies. With the specified-perils form, the insured has the burden of showing the proximate cause of the loss was covered.

Proximate cause of a loss

The proximate cause of a loss is the first peril in a chain of events resulting in a loss. Without proximate cause, the loss would not have occurred. The general rule in property insurance is that, for the insured to collect, the proximate cause must be a covered peril. Moreover, if the proximate cause is excluded from coverage, the insurer generally will not pay for the loss.

Risk Management Process

The risk management process involves the identification, measurement, and treatment of property, liability and personal loss exposures. (EGADIM) 1. Establish risk management objectives 2. Gather information 3. Analyze information 4. Develop the risk management plan 5. Implement the risk management plan 6. Monitor and revise the risk management plan.

Comprehensive General Liability (CGL)

This coverage insures a business against accidents and injury that might happen on its premises, as well as exposures related to its products. It is your last line of defense against claims for things over which you may have little or no control. Categories of Liability Insurance include general liability, specialized liability and workers compensation.

Business firms often purchase life insurance for the following reasons:

To provide benefits for employees. To protect the firm against the financial problems caused by the loss of a key person. To aid in transferring business ownership.

When does a gift of endowment insurance proceeds occur?

Upon maturity of the endowment policy. The proceeds are paid to a revocable beneficiary of the policy who is not the owner.

Participation Provision

With a major medical policy, the insurer agrees to pay only a percentage of the insureds bills. The insured must pay the difference. This sharing of costs is called the participation provision. Typically, the insurer pays 75 to 80 percent of the bills after the deductible requirement is met. The insured pays the remaining 20 to 25 percent. As with deductibles, the amount of coinsurance that the insured shares beyond the deductible is another form of risk retention. The more the insured shares, the lower the premium; the less shared, the higher the premium.

HOMEOWNERS INSURANCE SECTION

Homeowners Section

Special Forms of Life Insurance

Insurance companies have always been willing to design new products that are especially suited to unique situations: Survivorship Whole Life or Universal Life Also called "second-to-die" policy, this product insures two people and costs much less than two separate policies. Some insurance companies will accept an uninsurable spouse so people with medical issues may be able to get coverage. The policy insures two lives and pays the death benefit only at the second death, so the survivor needs to plan on still paying premiums. The original use for this policy was to cover estate taxes payable at the death of a surviving spouse. It can also be a more economical way to cover two parents for minor children, for charitable planning or wealth transfer. Also, it has been used in business situations if the cash would be needed at the second death. Single Premium Life Assume a policyholder purchases a Whole Life policy in a single premium payment. This creates an immediate cash value that is sufficient to fund the cost of death benefits over the life of the policy. Earnings accumulate tax-free until the policy is cashed in, or the policy owner can borrow cash up to the cost basis. Tax rules passed in 1988 eliminated the tax advantages of these policies. Endowment Life Insurance Endowment policies promise to pay the policy face amount on the death of the insured during a fixed term such as 20 or 30 years, as well as the full face amount at the end of the term if the insured survives the term. This is in contrast to term policies, which provide for the payment of the full policy amount only if the insured dies during the policy term. Though these policies have a maturity date set before expected mortality and thus appear to be a form of temporary coverage, they are actually considered a form of permanent insurance. Policies payable only in the event of death are purchased chiefly for the benefit of others. On the other hand, endowment policies, although affording protection to others against the death of the insured during the fixed term, pay to the insured if he or she survives the endowment period to maturity. PRACTITIONER ADVICE Endowment policies are no longer sold in the U.S. In 1984, Congress passed legislation that included definitions of life insurance. Because Endowment policies have premiums that are much higher than required for the death benefit, these policies no longer qualify as life insurance, and as a result, lose the benefit of tax sheltered growth of the cash value. Single Premium Life Another example of a product variation designed to meet a market need, but then eliminated by tax law changes. Insureds buy a Whole Life policy and then pay a large Single premium which creates an immediate cash value that is sufficient to fund the cost of death benefits over the life of the policy. Earnings accumulate tax-free until the policy is cashed in, or the policy owner can borrow cash up to the cost basis. New tax rules passed in 1988 eliminated the tax advantages of these policies. Modified Endowment Contracts Modified Endowment Contracts (referred to as MECs) are life insurance policies with a high amount of cash value buildup. Single Premium Life became popular in late 1980's after other tax shelters were eliminated by the Tax Reform Act 1986. In 1988 Congress passed TAMRA to close loopholes in their definition of insurance. The new rules said: If a policy's premiums equal or exceeds a 7-pay premium, the policy is a MEC. The 7-pay premium is the aggregate amount of premiums required to be paid during the first 7 years of the policy on a level-annual premium basis. A MEC means: Any funds withdrawn are subject to "last-in, first-out" taxation so investment income is withdrawn first a 10% penalty applies to cash withdrawal or loan before age 59 ½. Adjustable Life Insurance Introduced in 1971, as a way to allow the insured to adjust the amount of the death benefit and premium over time. The relationship between the premium and the amount of protection determined the cash value. When premiums paid exceeded the cost of protection, the cash value increased. This seemed like a concept that would work, but it never got popular and was not marketed by the major insurers. Joint Mortgage Redemption Policy A Decreasing Term policy, written on two lives, pays the death benefit at the first death. It is designed to cover the mortgage obligation of a two-income couple in the event one dies. The premium is slightly less that separate individual mortgage protection policies on each partner.

The three exceptions to the rule that insurance contracts are contracts of indemnity are:

1. Life insurance, 2. Replacement-cost insurance, and 3. Valued insurance.

AUTO INSURANCE SECTION

Auto section

BUSINESS LIABILITY SECTION

Business Liability Section

Financial objectives =

Cash Objectives + Income Objectives

COMMERCIAL PROPERTY SECTION

Commercial Property Section

The forms of life insurance used by business firms are usually:

Group life insurance, Key employee life insurance, and Split-dollar life insurance.

Long-Tail Claims

Insurers call claims filed many years after the alleged injury long-tail claims. For example, if a manufacturer made a product in 1940 that injures a person in 2006, a long-tail claim may be encountered. Unfortunately for the insurers, premiums collected in the 1940s often are not adequate to cover the claims made in the current decade. Two examples of long-tail claims taking years before they become known to the insured and the insurer or product liability and medical malpractice.

All valid contracts must have the following four elements:

Offer and acceptance Consideration Capacity Legal purpose

Doctors Liability Policy

Physicians, surgeons and dentists are included under this liability policy. These policies are often written with a $1 million limit per incident, and a $3 million limit for the policy period. Policy costs are a function of the city and state of the physicians practice, and medical specialty with surgeons and obstetricians among the most expensive classes. Insurance rates generally are not a function of the practitioners history, but a poor claims history can lead to non-renewal or denial of coverage.

Chance of loss

The chance of loss is the probability of loss. The concept of chance of loss refers to a fraction. The numerator is either the actual or the expected number of losses. The denominator represents the number exposed to loss. The chance of loss in a given case may or may not be known accurately before a loss occurs. If we are referring to the predicted chance of loss, we divide the expected number of losses by the number of exposed units. This fraction is called a priori chance of loss. If we are looking back in time, we can divide the actual number of losses by the total number of exposures. This fraction is called the actual or ex post chance of loss.

Conditions of Commercial Coverage

The common conditions cover policy cancellation, assignment of the policy, and other legal rights and duties. In addition to the common declarations and conditions, each component part has its own specific declarations page and conditions.

Why, then, would a consumer want to reinstate a policy rather than purchase a new one? The reasons are as follows:

The consumer avoids being charged for the large initial expenses of a new policy for the second time by reinstating a lapsed policy. The cash value is restored immediately after a policy has been reinstated. The premium will be lower on the reinstated policy because it was issued at an earlier age. There may be a change in policy terms from one series of policies to the next, with the original policy having more favorable terms. For example, the maximum interest charge on loans may be 5 percent versus 8 percent in a new policy. The suicide clause time period does not restart. Only statements made for the purpose of reinstatement are contestable until a new time period expires.

Comparative Negligence

The contributory negligence rule is harsh. Even slight negligence on a plaintiff's part can relieve a grossly negligent defendant of responsibility for an accident. Today, most states apply a modification of the contributory negligence rule called the doctrine of comparative negligence. The comparative negligence doctrine allows plaintiffs some recovery despite contributing to their own injuries.

Types of Annuities

There are many different types of annuities which are based on how they are purchased, the types of benefits received, when benefits begin, and the number of annuitants in the contract. The method of payment can determine the type of annuity purchased. One method is to purchase annuities through serial payments. A level-premium deferred annuity is a series of fixed payments that will be made for a period of time before annuity payments actually begin. A flexible-premium deferred annuity is purchased by unequal payments over a fixed period of time, before annuity payments begin. This method of payment allows for smaller payments to be made by the annuitant, which are within minimum contribution limits set by the insurer. The annuitant often pays an expense charge for the administrative costs associated with this contract, which is a front-end load charge. There are also single premium annuities that are paid in full by one payment. An example is a single-premium immediate annuity, whereby a person will pay for the annuity with one payment at the time they want annuity payments to begin. Another example is a single-premium deferred annuity, which means that one payment is made before annuity payments are scheduled to begin. With a single-premium deferred annuity the deposit earns interest at a minimum guaranteed rate determined annually, which grows tax-deferred in the account. If the account has generated interest that exceeds the minimum guaranteed rate, the excess interest is credited to the account. This excess earnings provision applies to flexible-premium deferred annuities as well. Annuities can be purchased based on the minimum payments an annuitant wishes to receive. An annuity, five years certain guarantees that the annuity will be paid out for five years. If the annuitant dies before the five year period, their successor beneficiary will continue to receive the remaining payments. A period-certain life-income annuity is generally limited to a 20 year payout period, and payments are reduced for longer contract periods. With a cash refund annuity if the annuitant dies before receiving payments equal to the amount of premiums paid, the difference is paid as a refund to the beneficiary. An installment-refund annuity is similar to a cash refund annuity, but payments are made to the beneficiary over time equal to the amount of premiums the annuitant contributed. There are three types of annuities that provide different benefits. These types of annuities allow cash to be invested in various fashions: 1. Fixed Annuity: This contract provides a guaranteed rate of interest to the assets. The rate can be flexible or can be locked in for certain periods of time. 2. Variable Annuity: This contract provides a variety of separate accounts which allow assets to be invested in securities such as stocks, bonds, money market accounts, etc. The account owner can transfer assets between accounts. Variable annuities usually contain a fixed account which provides a guaranteed interest rate account. Variable annuities usually provide a death benefit. If death occurs during the accumulation period, the beneficiary may be guaranteed to receive the greater of the account value or the amount invested. 3. Index Annuity: This contract provides a return on the assets invested that is tied to a market index, typically the S&P 500 Index. There is often a participation rate and cap on these contracts. For example, the contract will pay interest equal to 65% of whatever the S&P 500 Index achieves over a certain time frame. However, the S&P 500 Index return may be capped at, say, 10%. Also, there may be a feature that has a floor. For example, if the S&P Index is less than 2% in a given year, the annuity will pay 2%. When a cap and floor is added to the contract, a collar is created. With the facts present above, a range of 2% - 10% is achieved regardless of how high or low the S&P Index performs for the year.

Vicarious Liability

Vicarious Liability is also called indirect liability, most often arises when a firm hires an independent subcontractor. If the independent subcontractor injures a third party, the firm hiring the contractor may find itself named in the lawsuit along with the independent contractor. The plaintiff would claim the firm was negligent in hiring, informing, or supervising the contractor.

Exclusions

limit insurance coverage by identifying the types of losses that are not covered by the policy. Exclusions can apply to perils, hazards, people, property, locations or time periods that the insured does not wish to cover.

Declarations

name the insured and the property covered under the contract, and present facts about coverage, premiums, and the insurer's limits of liability.

Insurance is regulated at the

state level.

Personal risks

those that directly impact one's person (death, disability, health)

Personal property can be defined as both ...

... "real" property interests such as land, buildings and other structures, and personal property interests such as homes, boats, cars, jewelry, furnishings, clothing etc. Personal property insurance is purchased to protect real and personal property interests and provide liability coverage for bodily injury or property damage.

The question of whether or not an individual has acted reasonable is a question of ...

... fact. When a case goes to court, often the purpose is to determine the facts. After reviewing the evidence, judges or juries determine the facts. Once a judge or jury determines the facts, the judge applies the appropriate legal remedy. Two different juries may view the same evidence and reach different conclusions about the facts. Actions that are reasonable in rural North Carolina may be unreasonable in New York City. The point is, however, that the outcome of a legal contest cannot be determined until a jury settles the questions of fact. The facts are what a jury says they are.

Negligence ...

... involves doing something a reasonable person would not do, or not doing something a reasonable person would do, which results directly in some injury to another person.

There are other provisions only found in some life insurance contracts, for example, options for what to do with the cash value:

1. Dividend options 2. Non-forfeiture options 3. Policyholder loans 4. Settlement options

What are the most frequently purchased professional liability policies?

1. Doctors Liability Policy 2. Druggist Liability Policy 3. Hospital Liability Policy 4. Directors and Officers Liability Insurance 5. Errors and Omissions Insurance 6. Completed Operations Insurance 7. Medical Liability

What provisions appear in all life insurance policies?

1. Entire-contract provision 2. Grace period 3. Incontestable clause 4. Annual apportionment of surplus 5. Misstatement-of-age provision

What are the 3 steps in estimating income loss?

1. Expected and post-loss income. 2. Potential income loss. 3. Estimated income loss. The process begins with a forecast of expected income under normal circumstances. A second estimate of post-loss income follows. The difference is the potential income loss following a direct loss. The risk manager should ask informed people how long it would take to resume physical operations if a total or partial loss occurs. The accountant should estimate how much income would be lost in addition to how much fixed and continuing expenses would occur before normal operations resume.

There are two approaches to insuring personal property in homeowners policies, known as

1. Named-peril coverage: lists the specific perils covered in the homeowners policy. 2. Open-peril coverage: the insurer pays for damages by any peril, except for those excluded in the policy.

People face three basic categories of losses:

1. Property losses (both direct and indirect), 2. Liability losses, and 3. Income losses related to human life contingencies.

The current living standard may translate into a survivor income need of at least _____% of the pre-death family income.

60%

In what period of time does the government normally expect payment of estate taxes?

9 months.

Dividends

A dividend is an amount paid on participating insurance policies. The dividends received from a mutual life insurance company are not subject to federal income tax. The IRS views these dividends as a return of part of the premium and not as earned income. But, if dividends are paid to owners of stock, such dividends are a taxable return on their investment.

Gift of Life Insurance and Annuities

A life insurance policy is especially well suited as a gift. Gifts are also made of annuities. Gifts of life insurance and annuities include gifts of the contract itself, gifts of premium payments and gifts of policy proceeds. Each of these is dealt with separately for valuation.

Gift Tax Law

A lifetime gift to an individual incurs a federal gift tax generally at the same rate as the federal estate tax. For 2015, the maximum amount of lifetime gifting is reunified with the estate tax at $5,430,000. . Taxable gifts are amounts that exceed $14,000, the annual exclusion amount. A person could gift more than $5,430,000 in his or her lifetime without incurring a gift tax by gifting in increments of $14,000, since annual exclusion amounts are not taxed.

Insurable Loss

A typical insurable loss is an undesired, unplanned reduction of economic value arising from chance. We call losses not resulting from chance depreciation expenses. Therefore, depreciation cannot be insured against, as such loss is guaranteed to occur, rather than being left to chance.

Void contract

A void contract is a contract that a court will not enforce because from its beginning it lacked one or more features of a valid contract. Likewise, if an incompetent person (such as a person declared legally insane) were to enter into an insurance contract, this contract would be considered, "void ab initio," or void from the very beginning. In legal terms, the court is saying that a contract never existed.

A.M. Best Company

Alfred M. Best founded the A.M. Best Company in 1899. It is a ratings firm with the longest history of evaluating insurance companies. The ratings are published as Bests Insurance Reports. The ratings published in these reports are a standard measure of the financial performance of the insurance companies. Best's rates a large percentage of insurance companies and also uses a series of "not rated" classes for companies that are too small, too new, etc.

LTC Coverage Limitations

All LTC policies contain some exclusions and limitations of coverage. Common exclusions include war, self-inflicted injuries and chemical or alcohol dependency. Policies may also exclude coverage for mental illness that is not organically based. In the past, policies did not cover senile dementia, Alzheimer's disease or Parkinson's disease. Virtually all LTC policies now cover these conditions and all other mental illnesses that can be demonstrated as organically based. PRACTITIONER ADVICE In the past, most policies had pre-existing condition limitations, meaning that illnesses already being treated would not be covered for long-term care services. Now, good quality policies will cover previous conditions if the person is accepted as insurable.

Homeowners insurance has three levels of coverage that correspond to the three types of homeowner policy forms:

Basic or standard coverage: Provides a minimum level of protection restricted to perils of fire, theft, vandalism and extended coverage. Broad form coverage: Includes basic coverage plus 16 perils. Special coverage: Provides coverage on an open-peril basis which also includes coverage for theft. There are six standard homeowner policy forms and coverage is typically written on a broad named-peril basis or a special open-peril basis.

Life insurance exception to the rule of indemnity

Because the economic value of a human life cannot be measured precisely before death, life insurance cannot be a contract of indemnity. One could not be put in exactly the same financial position occupied before a loss because that position cannot be foretold.

Insurance Regulation Information System (IRIS)

Besides on-site inspection and audit, insurer solvency is monitored annually by the NAIC Insurance Regulatory Information System (IRIS), a computer-based testing system designed to spot solvency problems before they result in losses to insureds. Using IRIS, the NAIC calculates many ratios based on data submitted by each insurer to be audited. A list of companies not submitting to this audit is also sent to each state licensing such a company.

Cash Objectives

Cash objectives require a single-sum cash amount to fulfill. They are the easiest to estimate. These objectives arise from the need or desire to pay outstanding liabilities such as auto and personal loans, credit card balances, payment of an outstanding mortgage loan balance and incurred income tax liabilities. Cash needs also might arise from a desire to establish or augment an educational fund. Final and medical expenses also fall into this category. Cash Needs at Death include: 1. Final Expenses 2. Outstanding Debt 3. Housing 4. Education Fund 5. Emergency Fund PRACTITIONER ADVICE It is important for clients to understand that cash need figures are being allocated for those specific needs. Thus, any resources earmarked to cover those specific funding needs will not be available for future income needs. Often clients will attempt to include these cash amounts when determining available resources for on-going income needs. For example, $250,000 of life insurance proceeds designated to fund a surviving child's education should not be viewed as available funds to replace daily income needs.

Catastrophic Illness Coverage

Catastrophic illness coverage provides for accelerated death benefit payments on approximately the same terms and conditions as terminal illness coverage. The difference is the insured must have been diagnosed as having one of several listed catastrophic illnesses.

Collision

Collision means collision (violent striking) of an automobile with another object (a car, a tree, or even standing water). The word "object" is quite broad and includes almost anything that can be seen or felt. However, the collision must occur while the car is being operated. Losses clearly not caused by collision include theft, vandalism, fire and windstorm. For example, an unoccupied car sitting in a driveway that has a tree fall on top of it is not involved in a collision. As might be expected, gray areas exist. Automobile policies providing collision and non-collision coverage deal with these questions by including wording such as the following: For the purpose of this coverage breakage of glass and loss caused by missile, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, or colliding with a bird or animal shall not be deemed to be loss caused by collision. It makes a difference if a loss is a collision or not. Frequently, different loss settlement provisions, such as the dollar amount deducted from the loss before the insurer must pay, make this distinction important. The distinction would also be important if one or the other but not both of the coverages were purchased. While discussing the difference between collision and non-collision (comprehensive) coverage, a popular personal auto policy subject comes to mind. Do I really need to purchase insurance when I rent a car? The answer depends on the definition in your auto policy. For example, most auto policies extend collision coverage to a rental car. The reasoning is you can only be driving one car at a time, so while driving the rental, they aren't covering your car against collision. However, as for comprehensive (theft or damage caused by everything but a collision) coverage, the rental car may only be covered if the insureds vehicle is parked at the normal place of garaging. To the insurer, leaving your car at the airport parking lot while on you are on vacation creates an unfair situation. The insurer is still protecting your car from a comprehensive loss when you also seek the same coverage on the rental. The insurer doesn't want to be covering two cars for the price of one at the same time. So, when deciding whether or not to purchase coverage for a rental car, know your policys definitions.

Comprehensive Coverage

Comprehensive medical insurance plans provide broad coverage and significant protection from large, unpredictable medical care expenses. Most such plans usually cover a wide range of medical care charges with few internal limits and a high overall maximum benefit. Comprehensive medical insurance covers a wide range of health care benefits. It includes in-patient and out-patient hospital services, physician and diagnostic services, specialty services such as physical therapy and radiology, and prescription drugs. Individuals choose from multiple cost-sharing arrangements. In the individual market, deductibles of between $250 and $2,500 are common, whereas limits on total out-of-pocket expenses begin at $1,200 and may reach or exceed $6,000 annually.

General Liability Insurance forms include

Comprehensive policy - Businesses purchase this insurance to insure their liability exposures. Commercial Policy - Includes occurrence-based liability policy, and claims-made forms. Long-Tail Claims - Insurers call claims filed many years after the alleged injury "long-tail claims". Tail Coverage - Is also called the extended reporting period.

Contractual Liability

Contractual liability occurs if a firm accepts by contract a liability it otherwise would not have. For example, to get the Rockenroll railroad to build a track to its warehouse, the Big Tree Lumber Mill agrees to sign a hold-harmless agreement. The contract relieves Rockenroll of liability arising out of the use of the tracks on Big Trees property and places the liability for accidents on the tracks with Big Tree. In this example, Big Tree needs liability insurance for the exposure it assumed from Rockenroll. If a Rockenroll train engineer negligently destroys a truck or injures somebody on Big Trees property, then the injured party may sue either Big Tree or the Rockenroll railroad, but in either case Big Trees insurer will satisfy the legal judgment.

Vicarious liability

Courts can also impose liability for the negligent acts of other parties. For example, assume Michael Anthony loans his car to Julien Alexander, who causes an accident. Michael might be held liable if it can be shown he was negligent in lending his car to someone he knew or should have known was a poor driver. Likewise, vicarious liability can arise for people or organizations, when parties they hire as contractors (or subcontractors) injure others.

There are three categories of liability insurance:

General liability Specialized liability Workers compensation

Health Maintenance Organization (HMO's)

Health maintenance organizations (HMOs) operate in limited geographic areas, providing members with broad health care coverage in exchange for a set fee called a capitation payment. The employer pays a fixed periodic premium in advance to cover medical care services for each participant in the HMO plan. HMOs typically cover physicians charges, hospital costs, surgery, X-ray films, and emergency care. The capitation payment does not change with usage, but often the HMO applies a small fee to each physician visit or prescription to discourage over-utilization. Because it receives a set fee, the HMO has a profit incentive to keep members healthy. Therefore, HMOs provide regular physical examinations. Private insurers or Blue Cross and Blue Shield plans generally do not cover preventive physical examinations.

Judgment

If each of the three elements of a negligent act is established to the satisfaction of the judge and jury, the plaintiff is entitled to a favorable judgment, usually a specific sum of money. A judgment is the official decision of the court as to the rights of the parties to a suit. It is enforceable by officers of the court. Thus, if the court finds the defendant must pay the plaintiff $300,000, the plaintiff can expect the court to enforce this decision. The plaintiff need not try to collect. On the other hand, if the plaintiff fails to establish any one of the elements of negligence, or if the defendant establishes a successful defense, the court will not award the plaintiff a favorable judgment.

Insurable Interest

If individuals could insure property or a life in which they had no financial interest, insurance would become gambling. A policyholder would not be indemnified but enriched by a loss. Such contracts of insurance were written for a time in England. The fraud and murder associated with them caused laws to be passed in the eighteenth century prohibiting the issuing of insurance policies in which the policyholder lacked interest in the loss.

Performance

In the normal course of events, insurance contracts end by performance; that is, each party does what it has agreed to do. The insurer renders payment if a loss occurs or stands ready to do so if none occurs. In most cases, no loss occurs. The insurer still performed as required by standing ready to pay legitimate claims. Insureds discharge their duties by paying premiums and abiding by the conditions of the contract.

Industrial insurance

Industrial insurance includes life and health insurance policies issued to individuals. Individuals purchase industrial insurance in small amounts, usually less than $2,000. Usually the premiums are collected at the insureds home on a regular basis, generally weekly or monthly.

Claims-Based Liability

It obligates the insurer to pay only for the claims first made against the insured during the policy period and arising from incidents occurring after the retroactive date stated on the policy.

LONG TERM CARE MODULE

Long Term Care Module

Convertibility

Most term insurance policies include a convertible feature. This feature is a call option that permits the policy owner to exchange the term policy for a cash-value insurance contract, without evidence of insurability. Often the period during which conversion is allowed is shorter than the maximum duration of the policy. The conversion privilege increases the flexibility of term life insurance. For example, at the time a term policy was purchased, a policy owner may not have selected the type of policy best adapted to his or her needs. He or she may have preferred another type but, because of budget considerations, decided on low-premium term coverage. Following the issuance of the term policy, circumstances may have changed so as to enable the policy owner to purchase an adequate amount of other insurance. Alternatively, he or she may desire to use insurance to accumulate funds rather than entirely for the purpose of protection against death. If an individual concludes that term insurance does not meet present and future needs, this conclusion could be implemented by exchanging the term contract for a type of insurance that conforms better to his or her needs. A significant percentage of insureds become uninsurable or insurable at higher than standard rates as their health changes with age. Under such circumstances, a term policy that cannot be renewed beyond a certain point may fail to protect the insured in the desired manner. If the policy contains a conversion privilege, and if the time limit for making an exchange of the policy has not yet expired, the exercise of this privilege can be to the insured's advantage, thus protecting against the possibility that insurance may expire before death occurs. If the insured is insurable at standard rates, there may be little or no financial advantage to exercising the conversion privilege compared to reentering the marketplace and shopping carefully. An exception to this statement can exist if the insurer provides a conversion credit against the new policy's premiums. Such credits may include a stated dollar amount, such as $2 per $1,000 of insurance, an amount equal to the previous year's term premium paid, or a fixed percentage of the new policy's premium. The credit may apply only if the conversion takes place within a specified period from issue. REAL-LIFE EXAMPLE: A husband, age 30, and wife, age 32, had just purchased their first home. Since both of their incomes (his $35,000; hers $40,000) were vital to paying the new mortgage, they wanted "mortgage" life insurance coverage. As the mortgage was a new expense, they wanted to keep the premiums on this coverage to a minimum. They realized that as they started a family and acquired more assets, their need for life insurance would probably increase for a period of time, even though the mortgage would decrease. They also felt they would eventually want some portion of their life insurance to be permanent to cover their final expenses at life expectancy. With a tight budget, they knew such permanent coverage would have to wait. There also was a history of high blood pressure and heart disease in the husband's family, making future insurability a real concern. Based on these factors, the solution was for each to purchase a $150,000 20-year renewable term policy, convertible within the first ten years. This provided them with: enough coverage to protect the current mortgage; the ability to keep the full amount so that as the mortgage decreased, there would be additional coverage for future needs; provided some guaranteed future insurability via the renewal; allowed for guaranteed conversion to some permanent coverage later; and fit their current budget constraints.

Environmental Impairment Liability

Over the years, as different liability claims have been brought against businesses, some types of exposures have caused specific types of liability policies to be created. A list of such coverage includes: Environmental impairment liability (EIL) describes a class of legal claims against individuals and organizations whose actions damage the environment.

Contracts can be discharged on the grounds of the following conditions:

Performance Condition precedent Condition subsequent Rescission Reformed

Nursing Home Care

Policies often provide for three levels of nursing home care. They include skilled nursing care, intermediate nursing care and custodial care. Formerly, most LTC policies required a hospital stay before admission to a nursing home. Also, the stay must have been certified "medically necessary." This is no longer the case.

What will insurance companies pay for rebuilding at the same site?

Replacement cost with no reduction for depreciation expenses.

Risk Avoidance

Risk avoidance means avoiding the risk altogether. By not purchasing a car for a college student, one avoids the liability and other exposures of auto ownership.

Business loss control activities are designed to reduce costs associated with loss and include the following risk management tools:

Risk avoidance, Loss prevention, and Loss reduction.

Functional Replacement

Sometimes insurers do not use an actual cash value provision in their policies. In cases where the replacement cost of a building is greater than its market value, as is often the case with older, inner-city structures, insurers provide coverage based on replacement cost with modern construction techniques. Insurers call this provision functional replacement.

Personal injury

Suffered when a person is deprived of their rights.

Tail Coverage

Tail coverage would be useful, if a contractor ceased operations but wanted liability insurance for a few years in case some lawsuits were filed over previously completed work. The tail period, which insurers also call the extended reporting period, extends the time during which a claim may be filed for a loss occurring during the policy period. Supplemental tail coverage sometimes called extended reporting period coverage can be purchased for an additional premium to provide protection for claims made during a limited period after the policy year expires.

HIPAA

The Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) and the Health Insurance Portability and Accountability Act of 1996 (HIPAA) were two attempts by the federal government to increase access to health care. COBRA required that employees and certain beneficiaries be allowed to continue their group health insurance coverage if coverage was lost for certain reasons. COBRA applies to employers with group plans covering 20 or more employees. HIPAA was significant because minimum federal standards were imposed for all plans nationally, including self insured plans. Two important aspects of HIPAA include limited exclusion for pre-existing condition(s) for no more than 12 months. A pre-existing condition is one that manifested itself within six months prior to enrollment in a group plan. Also, in the individual market it made policies guaranteed renewable.

Do I really need to purchase insurance when I rent a car?

The answer depends on the definition in your auto policy. For example, most auto policies extend collision coverage to a rental car. The reasoning is you can only be driving one car at a time, so while driving the rental, they aren't covering your car against collision. However, as for comprehensive (theft or damage caused by everything but a collision) coverage, the rental car may only be covered if the insureds vehicle is parked at the normal place of garaging. To the insurer, leaving your car at the airport parking lot while on you are on vacation creates an unfair situation. The insurer is still protecting your car from a comprehensive loss when you also seek the same coverage on the rental. The insurer doesnt want to be covering two cars for the price of one at the same time. So, when deciding whether or not to purchase coverage for a rental car, know your policys definitions.

Asset Valuation Reserve

The asset valuation reserve (AVR) is supposed to act as a buffer, allowing insurers to absorb losses arising from sales of assets for less than their cost (capital losses). These losses arise from what financiers call "business risk." For example, the maximum guideline for the safest bonds is one percent of value, while for the lowest safety category the formula calls for 20 percent of face value. For mortgages, the percentage required in the AVR varies from 3.5 percent to 10.5 percent depending on the delinquency rate of the mortgage class. The AVR requires the insurer to consider the risk of its holdings in the following categories: 1. corporate and municipal bonds 2. common and preferred stocks 3. mortgages and real estate 4. joint ventures

Automatic Premium Loans

The automatic premium loan provision, which is typically found in policies having a cash surrender value, requires the insurer to advance a loan to the insured for the purpose of premium payment. Thus, if an insured does not pay the premium when due and the grace period expires, the insurer makes an automatic loan to pay the overdue premium, if the policy has sufficient cash value. This provision is included in most cash value policies at no cost.

Benefit Arrangements

The basic benefit arrangement of disability income policies consists of the benefit for total disability and a benefit for waiver of premium. These two components are common to all insurers, regardless of any additional coverage that may be included directly in the policy form. When the person is totally disabled, the insurer usually pays monthly indemnity as follows: One must become totally disabled while the policy is in force. One must remain so until the end of the elimination period. No indemnity is payable during that period. After that, monthly indemnity will be payable at the end of each month while you are totally disabled. Monthly indemnity will stop at the end of the benefit period or, if earlier, on the date you are no longer totally disabled.

Beneficiary

The beneficiary is the party receiving the funds at the insureds death. It is the beneficiary who must demonstrate the insurable interest at the time of application. The insurer needs to know that the person who will be receiving the death benefit has an adequate relationship to the person being insured. PRACTITIONER ADVICE Most often, the primary beneficiary is the spouse. Some divorce agreements now require that life insurance be maintained to provide for the children, naming the ex-spouse as beneficiary for the benefit of the children. To minimize estate taxes, the insured's estate should not be named as beneficiary

Benefit Coverage of LTC

The benefit provisions in LTC policies set forth what will be payable by the insurer if an insured event occurs. These relate to the types and levels of care for which benefits will be provided, any prerequisites for benefit eligibility, and the actual level of benefits payable. No policy covers all LTC expenses. The policies offered by many companies provide: A choice of elimination (waiting) periods (0 to 365 days) before benefits. A schedule of maximum daily benefits and length of benefit periods. The schedule of the benefit periods offered might range from two to five years. Very few insurers offer a lifetime benefit period, which is an expensive option. A maximum lifetime approach to defined benefit payments. Thus, if the benefit amount is $250 per day and the benefit period four years, the maximum lifetime payout would be $250 times 365 days times 4 years, for a total of $365,000. This $365,000 pool of money can be used for covered services in whatever way desired, subject to the daily maximum. Some companies pay a set amount monthly, as with disability income insurance. Thus, the policy may agree to pay $5,000 per month or a per day amount such as $265 regardless of actual charges. Community-based care can be less expensive than nursing home care (if they need less than 24-hour care). The maximum daily benefit is often 50 percent of the maximum daily benefit for nursing home care. The length of the benefit period is often the same for both coverages, but some policies require a different waiting period. PRACTITIONER ADVICE Policies can now be designed with 100% of the daily benefit for community-based care. This is more appealing to clients, and easier for them to understand and remember (e.g. $200 a day, no matter where the care is given).

Cross-Purchase Plan and Entity Plan

The buy-and-sell plans can be arranged in either of two ways: 1. The cross-purchase plan is where each partner or shareholder can purchase life insurance on every other partner or shareholder. 2. The entity plan is where the partnership or corporation can purchase the insurance on each partner or shareholder. With a cross-purchase plan, the number of policies needed is equal to: n x (n 1), where n equals the number of partners or shareholders. With an entity plan, the number of policies is equal to the number of partners or shareholders. For example, assume a partnership has eight employees. In a cross-purchase plan, each partner would have to purchase seven policies for a total of 56 policies [(8 x (8 1)]. Under the entity plan, only eight policies would be needed. Tax consequences, however, may favor the cross-purchase arrangement in some cases. The second alternative involves a much smaller number of policies. Take, for example, a partnership firm with eight employees. In a cross-purchase plan, each partner would have to purchase seven policies, and a total of 56 policies would be purchased. Under the entity plan only eight policies would be needed. Tax consequences, however, may favor the cross-purchase arrangement in some cases.

Capital Liquidation Approach

The capital liquidation approach assumes that both principal (capital) and interest are liquidated over the relevant time period to provide the desired income. This approach requires a smaller capital sum to provide a given income level than the retention approach. When the need for income is for the entire life of the survivor(s), the capital liquidation method can be approached in one of two ways: The future desired lifetime income could be funded through the purchase of a life annuity. The capital liquidation method could provide for the complete liquidation of principal and interest between the present and the maximum age to which the income recipient is likely to live. The critical decision variable in the second approach is the maximum age. If the life expectancy age is set too low, the income recipient may outlive the income. The higher the age, the higher the principal sum required to fund the income. The life annuity will generate a higher income than the other liquidation approach (assuming a long life expectancy), all other things being the same. Moreover, with the life annuity, the income recipient cannot outlive the income. Using the time value of money keys as demonstrated previously, we can apply this concept. Assume upon death of the breadwinner that the family will need $4,000 per month for the next 15 years until the children are out of school and the surviving spouse has retired. What amount of death benefit is needed today, assuming a 4.25% rate of return and that the monthly payment occurs at the beginning of each period? The answer is $533,601, calculated as: Keystrokes f REG f FIN g BEG 4000 PMT 15 g 12× 4.25 g 12÷ PV The calculator returns: (533,601.21) Note: The "g" key envokes the blue registers, referenced on the bottom of the keys. PRACTITIONER ADVICE: The life annuity concept demonstrates why annuities should be considered as part of every person's retirement plan. Bank accounts, CDs, and mutual funds that are being tapped for income do not provide a guaranteed life income. As a hedge against superannuation (outliving one's money), an annuity can be a safe complement to a retirement portfolio.

Capital Retention Approach

The capital retention approach assumes that the desired income is provided from investment earnings on the principal, and no part of the desired income is from the capital. In other words, the capital is retained undiminished, even after death. This approach permits a capital sum to be passed on to the family's next generation (or to whomever is designated). It is considered more conservative, because in an emergency, the principal itself can be accessed. The decision to follow the capital retention or one of the capital liquidation methods is not an all-or-nothing proposition. As each option does not have to pay out all capital or retain all capital, there is a continuum between the two extremes. Using the time value of money keys as demonstrated previously, we can apply this concept. Assume that upon death of her of husband, Joan receives a $750,000 death benefit. Joan will need $2,500 at the beginning of each month for the next 12 years until her expected death. Upon her death, she wants to pass to her children the $750,000 of death benefit proceeds. What yearly investment return is needed so that she does not utilize any of the principal? The answer is 4.0134%, calculated as: Keystrokes f REG f FIN g BEG 2500 PMT 12 g 12× 750000 CHS PV 750000 FV i The calculator returns: .3344 g 12× The calculator returns: 4.0134 Note: The "g" key envokes the blue registers, referenced on the bottom of the keys. PRACTITIONER ADVICE The retention approach is both more conservative and more flexible. Having the principal available (rather than being distributed) means keeping more resources on hand for increasing inflation, unexpected medical costs or declining rates of return on investments. Using the time value of money keys as demonstrated previously, we can apply this concept, which allows for less than the full death proceeds. Assume that upon death of her of husband, Joan receives a $750,000 death benefit. Joan will need $3,250 at the beginning of each month for the next 12 years until her expected death. She can invest this principal in a safe 3% investment. What amount of these death benefit proceeds could the children expect to receive? The answer is $510,616.67, calculated as: Keystrokes f REG f FIN g BEG 3250 PMT 12 g 12× 3 g 12÷ 750000 CHS PV FV The calculator returns: 510,616.67 Note: The "g" key envokes the blue registers, referenced on the bottom of the keys.

Consideration of Income

The current and future income of the individual or family is an important factor in estimating future resources and needs. Information on income is compiled during the information-gathering process. The importance and security of future income varies depending on the individual's family status: Single-parent family: Income is derived primarily or solely from the single-parent's salary. As this is the most important income source, the parent's death or incapacity could have a financially devastating impact on the dependents. Two-parent, single-income family: Income is from only one parent. The dependents are vulnerable to income loss because of death or incapacity of the wage earner. Two-parent, dual-income family: The family is affected by the death or incapacity of either wage earner; however, the family is at less risk than the family dependent on a single income, as the death or incapacity of one wage earner does not leave the family without any income no matter how reduced it may be. If the dual-income family is financially dependent on both incomes, consideration must be given to the impact on the family of the loss of income from one or both wage earners. Both life and disability insurance and possibly long-term care insurance often will prove a necessity on both lives. Single individual: Single-person households are becoming more common. Such persons often must rely exclusively on their own incomes. The greatest personal risk revolves around loss of health and incapacity. In the event of their death, no one is financially dependent upon them so life insurance is not as important as health, disability or long-term care insurance.

Consideration of Savings Programs

The death or incapacity of a parent or spouse causes a disruption in savings. A soundly conceived plan to accumulate funds to finance education can be completely disrupted by the death or incapacitation of a parent. As a result, most parents consider the disruption of planned savings and investment programs as falling properly in the loss exposure category. The same is true for retirement savings, especially for individuals who are dependent on their ability to earn income. Plans for dealing with an incapacitation must consider replacement of savings to continue funding retirement.

Elimination Period

The elimination period, sometimes called the waiting period, refers to the number of days at the start of disability during which no benefits are paid. It is a limitation on benefits that is somewhat like a deductible in medical expense and property insurance policies. It is meant to exclude the inconsequential illness or injury that disables the insured for only a few days and that is more economically met from personal funds. PRACTITIONER ADVICE: Remember, deductibles and elimination periods are forms of risk retention on the part of the insured. The more risk retained by the insured helps to reduce the premium charged. When a need exists and affordability is important, choosing a less than optimal elimination period, monthly benefit amount, or benefit period can be a good decision. In general, insurers make available elimination periods ranging from 30 days to one year, with three months being common. Because indemnities of the policy are paid at the end of each month of continuing disability, a three-month elimination period usually means that a disabled insured will not receive benefits for at least 120 days from the time sickness began or injury occurred. Premiums are lower for policies with longer elimination periods. Most insurers require that the elimination period be the same for sickness and injury. The following figure shows how one insurer's premiums vary with different elimination periods. The major insurers allow for a temporary break in the elimination period so that the insured will not be penalized for any brief attempt to return to work before the elimination period has expired at the start of disability. The brief recovery is generally limited to six months or, if less, to the length of the elimination period. If the insured is then again disabled because of the same or a different cause after the interruption, the insurer combines the two periods of disability to satisfy the elimination period.

Rule #1: Insure First Exposures to Loss

The first rule in choosing the proper amount of insurance is to insure first those exposures to loss most likely to cause the greatest amount of damage. For example, Tom and Gloria Simmons are in the process of planning their insurance needs. They own a house, a small construction business, two cars and a pickup truck. Recently, Gloria also inherited some family heirlooms such as jewelry and antique furniture. Tom runs the business, while Gloria cares for their two young children. Applying the insure first exposure to loss rule, Tom and Gloria decide that Toms life should be insured, because if he dies, Gloria would not be able to care for the business, resulting in loss of income. They also plan to insure their pickup truck because its damage or loss could cripple the business. Thus, in their first step of insurance planning, they opt to insure that which is likely to cause the most damage.

Taxation of Living Benefits Withdrawals

The general rule under the clause of living benefits is, if the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis, (premiums paid less dividends received), the excess is subject to federal income tax in the year of the withdrawal. For example, Bill Shakespeare purchased a whole life insurance policy 35 years ago when he was 25 years old. He decides to retire at age 60 and he withdraws the cash value of his life insurance to buy a recreational motor home. Assume Bill's total premiums ($50,000) less dividends he received ($21,000) equal $29,000. If Bill withdraws $35,000 in cash value, $6,000 ($35,000 - $29,000) is subject to tax. For the past 35 years, Bill has not had to report the interest income on the savings value of the policy. When the withdrawal is made, however, the excess of the cash value over his adjusted basis is subject to the income tax at ordinary rates.

Deductions

The gift tax marital deduction permits tax-free transfers between spouses. This deduction is available without limit for most types of property transferred to spouses. A married individual can make present interest gifts of $28,000 (indexed) per year to each beneficiary without incurring any gift tax liability, if the spouse consents to splitting the gift. Gifts of a present interest mean the recipient or donee has an immediate right to use the gift without restriction. The IRC permits a full gift tax deduction for gifts to qualified charities. An individual can donate a life insurance policy to a qualified charity without incurring any gift tax, and will receive a charitable income tax deduction as well. Gifts to private individuals can never qualify for the charitable deduction, no matter how needy or deserving the donees may be.

Homeowners Divided Coverage

The homeowners package provides divided coverage. Each coverage (A through F) is treated separately. Dollars may not be transferred among the various coverages. The maximum amount the insured could collect is the sum of all the coverages. That is, if a property loss is total, an insured theoretically could collect the total amount of Section 1, Coverages A through D. If a liability loss occurred in addition to a property loss, the Section 2 coverages, E and F, would add to the amount the insured could collect under the policy. PRACTITIONER ADVICE: When considering the need for homeowners insurance, a few things come into play. If there is a mortgage, the lender will require a guarantee that there is enough coverage to protect the amount of the loan. Beyond that, the homeowner should consider: Fire exposure Safety of neighborhood Exposure to liability to others (do many people come on the property; are there any unique risks such a pool, animals, guns, etc.) What are the habits of the inhabitants? (Smoking, carelessness, children's behavior, etc.) A key rule to remember is "Don't risk a lot for a little." In other words, don't purchase "cheap" coverage and expose yourself to a large loss just to save a little bit on the premium payments.

Interest Maintenance Reserve

The interest maintenance reserve (IMR) is designed to allow insurers to absorb losses caused by changes (increases) in interest rates on government securities. If an insurer's investment results are poor in a particular year, the AVR will increase, but if previous years' results were good, the balance in the AVR may be sufficient to absorb actual realized losses. In fact, one purpose of the IMR is to act as a buffer, so investment declines in a particular year can be dampened. As history has shown, investment reserve requirements or any other type of reserve requirement cannot provide an absolute guarantee of insurer solvency. Reserve requirements, however, should allow an insurer to be rehabilitated or liquidated with much less injury to its insureds than otherwise would be the case.

Life-Income Option

The life-income option guarantees, for a lifetime, a series of regular payments to the beneficiary. This is the annuity option. The insurer only makes payments under this option if the beneficiary is alive. Assume that Mrs. Johann S. Bach receives the proceeds of a $400,000 policy under the life-income option. Assume she lives only three years beyond Johann. She received only $75,000 of benefits. The remainder of the money she did not receive is pooled to pay benefits to other annuitants. Despite the potential for losing some of the death proceeds, the life-income settlement option is often quite practical. A beneficiary's need for income ceases when the beneficiary dies. In some cases, there may be no dependent beneficiaries other than a surviving spouse. The life-income option can provide a sure source of income because the payments are guaranteed for life. As the payments include a portion of principal, they will significantly exceed interest-only payments at later ages. The payments will be partly income taxable, with the return of principal portion being excluded form income. This settlement option makes good sense if the surviving spouse is inexperienced in investing money. It is also useful if the surviving spouse has an unscrupulous relative or friend who may talk the beneficiary out of the money if a large lump sum of cash were paid. PRACTITIONER ADVICE There are also Refund Options available. The client will receive lower monthly payments, but any remainder will be paid to a named beneficiary, instead of being kept by the insurance company.

Loss Reserve

The loss reserve is set up to account for unpaid losses. The loss reserve is especially important for insurers writing liability insurance, but it applies to other lines of insurance as well. The claims covered by this reserve account may be losses not yet reported to the insurer or losses that have been reported but for which claims have not yet been paid. Unpaid claims may be the result of an unsettled lawsuit, or a fire insurance claim on which the insurer and insured cannot agree. For both unreported and reported but unsettled losses, the insurer makes actuarial estimates of the expected loss payments. The loss reserve represents the total of these expected payments. By observing years of data, actuaries are able to estimate what percentage of the losses from a given year has been settled and what percentage remains to be settled. For example, perhaps after one year 80 percent of a given year's automobile physical damage claims have been settled, leaving 20 percent of the claims unsettled and requiring a reserve. After two years, perhaps the percentages are 90/10 percent, respectively. By the third year, all the automobile physical damage claims are settled. In comparison, after one year perhaps only 60 percent of automobile liability claims are settled, with a reserve needed for 40 percent not yet settled. Perhaps after three years, because of litigation or other problems, 20 percent of the automobile liability claims remain outstanding and still require an estimate of their final outcome to be held in a reserve. In liability insurance, many years may pass between the time an insurer is notified an insured is being sued and the time the case is closed. In some lines of liability insurance written on an occurrence basis, it is possible for 20 or more years to elapse between the time an incident occurs and the time a lawsuit is brought. Another ten or more years might pass before such a claim results in a payment from the insurer to an injured victim. Because the losses they represent can be unresolved for such long periods and may involve large amounts of money, loss reserves are essential to fairly presenting the accounting statements of liability insurers.

The Essential Elements of LTC are:

The need for medical, personal or social services, The need results from an accident, illness or frailty, Services are provided by other persons, either paid or unpaid, at home or in a nursing home, and Services are to assist the individual in performing the essential activities of daily living (ADLs).

Non-Disabling Injury Benefit

The non-disabling injury benefit pays up to a specific sum, usually one-quarter of the monthly indemnity, to reimburse the insured for medical expenses incurred for treatment of an injury that did not result in total disability.

Underinsurance

The other extreme that the decision of a risk manager may reach is underinsurance. It is defined as the point where: A firm could not afford to pay for retentions and deductibles from "normal" cash flow, or A probable loss could result in the firm's insolvency, that is, its inability to pay currently due sums, or bankruptcy where the firm's debts exceed its available assets.

Insurer

The party agreeing to pay for the losses.

Insured

The party whose loss causes the insurer to make a claims payment.

Patient's Share

The patient's share of Medicare cost is subject to change each year. To illustrate just one gap in Medicare coverage, consider inpatient hospital care. In 2012, the patient is responsible for a one-time deductible of $1,156 for hospital stays of 60 days or less. For longer hospital stays, the patient's co-payment increases to $289 each day for stays between 61 and 90 days. Finally, Medicare charges a co-payment of $578 each day for additional days taken from the 60-day reserve that a patient can only use once in his or her lifetime. Moreover, other co-payments apply to such things as short-term stays in nursing homes and to certain charges by physicians and other service providers. Therefore, the great majority of Medicare beneficiaries have also purchased Medigap coverage. In a recent year more than 70 percent of the people enrolled under Medicare purchased some form of Medicare gap-filling coverage. Just 25 insurers earned almost 70 percent of the Medigap premiums. PRACTITIONER ADVICE: Remember to use deductibles and coinsurance as a way to keep premiums affordable. Such risk retention options should be based upon the client's loss exposure and ability to pay the premium versus the retained limits.

Premium

The payment received by the insurer.

Use of Annuities

The primary purpose of annuities is to convert assets into a stream of income that cannot be outlived. They provide tax-sheltered accumulation of assets which can help reduce income taxes during the accumulation period. Additionally, the tax sheltering of assets helps the owner avoid reaching certain income limits, which could trigger adverse conditions, such as taxation of Social Security benefits and phase-out of tax credits and/or deductions. PRACTITIONER ADVICE: Imagine a retiree collecting Social Security. They have assets invested in Certificates of Deposit. The interest from the CD's is simply re-invested rather than spent. That interest is factored into income to determine if the retiree will pay income taxes on their Social Security benefit. By transferring assets from CD's to a fixed annuity, the re-invested income becomes tax sheltered and no longer counts towards income for that purpose. This could possibly save Social Security benefits from being taxed.

Principal Sum Benefit

The principal sum benefit is a lump-sum amount payable if the insured dies accidentally. This provision requires that death be caused directly and independently by injury and that it occur within a specified number of days, usually 90 or 180, following the date of the accident. The principal sum amount benefit also pays a single sum, usually 12 times the sum of the monthly indemnity and any supplemental indemnities, if sickness or injury results in dismemberment or loss of sight and the insured survives the loss for 30 days. The lump sum is in addition to any other indemnity payable under the policy, and it is payable for two such losses in the insureds lifetime. The principal sum benefit usually is limited to the irrecoverable loss of the sight of one eye or the complete loss of a hand or foot through severance above the wrist or ankle.

Uninsured Motorist Coverage

The purpose of uninsured motorist (UM) coverage is to protect people from financially irresponsible drivers; those who neither purchased liability insurance nor have adequate financial resources to compensate people they injure through the negligent use of their automobiles. UM coverage also applies to those people who have purchased adequate insurance but their insurer has since been declared insolvent. It is important to realize that UM coverage is fault-based. Insureds must show they are legally entitled to recover damages for bodily injury, not for property damage, from a negligent uninsured motorist to receive UM benefits. The insuring agreement for Part C creates a legal right for insureds to collect compensatory (but not punitive) damages from their own insurer if an uninsured motorist injures the insured. The intention of the insurer not to pay punitive or exemplary damages is repeated in the exclusions section of this coverage. In general, suing uninsured motorists, especially hit-and-run drivers, is not a promising source of recovery. Because UM coverage is fault-based, insureds must convince their own insurer that the driver of the uninsured automobile caused the accident. Only when the other driver is negligent is the insured legally entitled to recovery. If the insured cannot establish the uninsured driver's negligence or if the extent of the damages is subject to dispute, then an awkward situation is created under this coverage. The insured must confront his or her own insurer to resolve the dispute. In such circumstances, the policy provides for an arbitration process to determine if the insured is actually entitled to recover damages, and, if so, in what amount. The limit of liability for this coverage is found on the policy's declarations page, subject to reduction for any recovery from the negligent driver or from a workers' compensation claim.

Rehabilitation Benefit

The rehabilitation benefit generally allows a specific sum, often 12 times the sum of the monthly indemnity and any supplemental indemnities, to cover costs not paid by other insurance or public funding when the insured enrolls in a formal retraining program that will help him or her return to work. PRACTITIONER ADVICE Some disability plans will cover the cost of the retraining program, and some group disability plans will even pay for daycare so the parent can go to training.

Partial Disability Benefit

The residual concept generally has replaced the partial disability benefit for most professional occupations. Many insurers, however, provide a partial disability provision as an optional benefit for their less-favorable occupational risks. The typical partial disability benefit is 50 percent of the monthly indemnity for total disability and is payable for up to six months or, if less, for the remainder of the policy benefit period when the insured has returned to work on a limited basis after a period of compensable total disability. Partial disability customarily is defined in occupational terms with reference to time and duties.

Special Limits of Liability

The special limits of liability section of an insurance policy establishes the maximum dollar amounts that an insured can recover when the specifically identified property is damaged or stolen. In addition, some types of property, such as jewelry (limited to $1500 on homeowners), can be covered on a Scheduled Personal Property Endorsement. Its purpose is to provide open-perils coverage for specific items at higher amounts of coverage. For example, boats and their trailers are only protected up to $1500, so boats of higher value need to be insured separately. Silverware and gun collections are each limited to $2500, and the coverage is only for theft, not for loss. PRACTITIONER ADVICE Valuable possessions like jewelry, fur, etc. that are worth more than the policy limit should be listed on a separate Scheduled Personal Property Endorsement. Other personal items such as cameras, musical instruments, fine arts and antiques, and stamp and coin collections can be covered as well, with the exception of fishing and hunting equipment. With a Scheduled Personal Property Endorsement not only can the amount of coverage be increased, but also the items are covered if they are misplaced or if the diamond falls out of a ring and is lost. There is an additional premium for this protection, and it typically requires having the items professionally appraised.

Rule #3: Never Risk Great Loss

The third rule in choosing the proper amount of insurance is to never risk a great loss, that is, a high percentage of your assets, in exchange for a small gain, that is, saving the insurance premium. For example, Tom and Gloria also decide to purchase disability insurance for Tom, with a benefit equal to 60% of his income of $3,000 per month. Though their annual premium payments would be $1,300, they realize that maintaining this insurance is necessary, because the expenses of raising two young children and maintaining their lifestyle in the event of disability have to be met. REAL-LIFE EXAMPLE John was very concerned about the cost of his auto insurance. He had a poor driving record and drove an expensive car. These two facts, coupled with having very sound coverage, put John's annual premium at nearly $2,000. As a very successful executive earning a six-figure income, John could certainly afford this cost. However, for him it was more of a "principle"—he wasn't going to get "gouged" by an insurance company. So John cancelled his Collision, Comprehensive, and Bodily Injury to Others coverage to the compulsory limits. He saved $800. Late one night about six months later, John was returning home after a long business meeting. He did not see the deer until the last minute or the other car until he swerved into its path. His $36,000 car was totaled, a college student was in critical condition, and John was now experiencing the regrets of "risking a lot for a little."

Benefit Provision Components

The three basic components that establish the premium and define the payment of benefits under disability income policies are: The elimination period, The benefit period, and The amount of monthly indemnity. All other parts of the policy relate to these common elements and are used to limit or expand their value in meeting the specific needs of the insured at the time of loss. The strength of a particular disability income plan lies in how liberally the insurance company permits these elements to operate within the policy provisions and through its own administrative practices.

Transplant Benefit

The transplant benefit provides that, if the insured is totally disabled because of the transplant of an organ from his or her body to the body of another individual, the insurer will deem him or her to be disabled as a result of sickness. This provision also includes cosmetic surgery performed to correct appearance or disfigurement. REAL-LIFE EXAMPLE: John's brother Ron was in need of a kidney transplant. Identified as an ideal donor, John decided to give his brother one of his kidneys. As such surgery is commonly more invasive to the donor and requires weeks of recovery, John contacted his disability insurer to see if he would be able to collect. His policy contained a transplant benefit and had a 30-day elimination period. Therefore, he was able to collect benefits for the time he was unable to work beyond the first 30 days.

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Insuring Arrangements

There is an array of insuring arrangements that offers comprehensive medical insurance plans. Blue Cross/Blue Shield is an important source of individual medical expense insurance in many areas of the United States. Blue Cross insurers offer relatively comprehensive individual coverage. What distinguishes the Blues and traditional life insurers is that traditional life insurers rely largely on indemnity-type reimbursement plans, whereas the Blues negotiate and pay hospital and health care provider fees directly, sometimes at a lower rate than that applicable to reimbursement plans. Health maintenance organizations (HMOs) are sources of comprehensive medical insurance coverage, especially in the United States. They combine the provision of health care and its financing into a single organization.

Maximum Probable Loss

Total loss a peril could cause under average case circumstances.

Defining Disability

Traditionally, individual disability income policies have been called loss-of-time insurance because of the occupational definitions used to qualify the insured as disabled. A disabled person under these types of policies is presumed to have suffered a loss of income because he or she cannot work. The definitions of total disability and partial disability are linked to the inability of the insured to perform certain occupational tasks. In recent years, the concept of residual disability has largely replaced the partial disability provision as a means of paying proportionate benefits to an insured that is able to work, but at reduced earnings as a result of sickness or injury.

Umbrella Policies

Umbrellas provide coverage if underlying (homeowners and automobile) policies are exhausted. A $1 million personal liability umbrella usually is moderately priced, costing about $175 per year.

Gift of Insurance Proceeds

Under ordinary circumstances, life insurance death proceeds are not gifts. In some extraordinary instances, there may be a taxable gift, such as when one person owns a policy, a second is the insured, and a third is the beneficiary. A gift can be considered as occurring from the policyowner to the beneficiary at the insured's death. The amount of the gift equals the full amount of the insurance proceeds. For example, Jan owns a insurance on her husband's life, with their children named as revocable beneficiaries. Jan will be deemed to have made a gift to the children in the full amount of the proceeds when they are paid at her husband's death. It is assumed that there is no intent to make a gift in the literal sense, but a taxable gift has been made nevertheless. A gift of endowment insurance proceeds likewise occurs when, upon the maturity of an endowment policy, the proceeds are paid to a revocable beneficiary of the policy who is not the owner.

Interest-Only Option

Under the interest-only option, the proceeds are left with the insurance company. The insurer pays the first beneficiary, such as a widow, regular payments composed entirely of interest earnings. The beneficiary can request the full payment of principal at any time. It can be set up so that at the first beneficiary's death, the insurer pays the death proceeds to a second beneficiary, such as a child. The interest-only arrangement can be useful, for example, if the beneficiary has substantial investment, wage or social security income. PRACTITIONER ADVICE The money received in this option is fully income taxable, as it is considered interest only, not a return of principal.

Social and Ethical Concerns

Uninsured losses can have significant non-financial effects. In the absence of adequate funding, uninsured losses could bankrupt organizations and produce socially or ethically undesirable consequences including undercompensated, dead or injured employees, a polluted environment, or unemployed workers. These considerations cannot be factored into the deductible and policy limit decisions. For many business people, social and ethical concerns will be the deciding factors in solving all business decisions including those we have been describing. For example, let us consider the insurance purchasing and risk management practices of British Petroleum (BP). BP now insures against smaller losses while self-insuring against the larger ones. Smaller losses were less than $10 million. Larger losses were greater than $10 million. What BP discovered was that over a ten-year period when it self-insured relatively small losses and bought catastrophe coverage for large losses, it paid $1.15 billion in premiums and recovered $250 million in claims. Moreover, when BP did have one very large loss, its insurer resisted the claim. After spending $1 million on legal fees to fight its insurer, BP recovered only 70 percent of its loss. After reviewing its loss data, estimating future loss probabilities and considering past experience with its insurance program, BP decided to insure its smaller losses with either a BP captive or from a commercial insurer if it received a lower competitive bid, and assume its larger exposures. The insurance market for the smaller losses was more competitive than the market for very large exposures, so the insurers' profits were smaller. For the large exposures, only a few underwriters at Lloyd's of London could provide the needed coverage, and they were able to extract considerable profits. Also, its evaluation of the insurance market led BP to believe its financial capacity to absorb losses was equal to or greater than the insurance underwriters. One additional calculation also made the self-insurance of large exposures appear desirable to BP. BP's marginal tax rate on income from oil produced in the North Sea was 87 percent. Thus, a $2 billion loss would only lower firm value by $260 million after tax deductions for the loss. Economists generally focus attention on the demand for insurance coverage, while BP's risk management decisions were driven in large part by supply considerations.

Policy Pricing

Useful hints for consumers will help them to pay the right price, but few absolute rules exist. PRACTITIONER ADVICE: When selecting the right policy at the right price one must consider the financial strength of the insurer to back up its promise to pay in the event of a loss. What good is a policy that costs less when the insurer is very slow or disagreeable in paying claims? When choosing policies, be sure to narrow the field to only those insurers you have determined to be worthy of your business. "You get what you pay for" is a popular saying for a good reason. The right price is the one providing the consumer with the greatest amount of insurance after giving consideration to the other criteria just described. That is, the right price for insurance is not necessarily the lowest price. The lowest price may come from a company that has other drawbacks, such as: A company whose financial strength is questionable A company that too frequently resists or denies its insureds' legitimate claims An insurer whose agents are not trained adequately, and A company whose policies do not offer coverage as valuable as that offered by other companies. For these and other reasons, the consumer should first consider all the other criteria and then search for the right price. One rule in finding the right price is to engage in comparison-shopping. Researchers have found considerable price variation for comparable insurance policies offered by similar insurers. The need for shopping is true in both life and property insurance. A consumer should consider shopping from both mutual and stock insurers, and from both independent agents and direct writers. Changing insurers to save a small amount of money, especially if a consumer's current insurer gives discounts for insureds of long standing, may not be an efficient strategy. PRACTITIONER ADVICE: Life insurance regulations require all policy illustrations (detailed numeric and narrative representations of what the policy will do over time) to be presented in a similar format to make comparisons easier. Also, policy illustrations must use standard indexes to provide a numeric per unit cost for comparison. All else being equal, the policy with the lower index number is the most cost-effective choice.

Policy

What the insurance contract is known as.

PRACTITIONER ADVICE about comparing insurance companies

While it can be confusing to compare an insurance company's ratings from the different agencies, there are a few guidelines to follow. Get the ratings for a number of years, (not just the last 2) and watch out for a downward trend. Look for excellent ratings for more than 5 years. Look for very high ratings from at least 2 of the 5 ratings services.

Endorsements

and riders change standard insurance contracts by adding or eliminating coverage to meet the insured's specific insurance needs.

Legal liability insurance is categorized as ...

automobile liability, business general liability and commercial general liability.

The Consumer Products Safety Act of 1972 requires ...

notification of the Consumer Product Safety Commission (CPSC) by manufacturers and retailers of any product hazard of which they become aware.

DISABILITY INSURANCE MODULE

Disability Insurance Module

Property damage

Destruction or loss of use of tangible personal property.

PRACTICE STANDARD 400-3

PRACTICE STANDARD 400-3 Presenting the Financial Planning Recommendation(s) The financial planning practitioner shall communicate the recommendation(s) in a manner and to an extent reasonably necessary to assist the client in making an informed decision.

Fixed-Period Option

The fixed-period option is similar to the fixed-amount option. With the fixed-amount option, the choice of the amount of each payment determines how long the payments will last. With the fixed-period option, the choice of the length of the period determines the size of each payment. This option might be used to fund a fixed number of years of a college education.

How HO policy forms are there and what is the typical basis of coverage?

There are six standard homeowner policy forms and coverage is typically written on a broad named-peril basis or a special open-peril basis.

What are 4 considerations for defining residual disability?

When due to injury or illness you: 1. are not able to do your important daily business duties. 2. are not able to do your daily business duties in the usual amount of time. 3. lose at least 25% of your prior monthly income. 4. are under the care and attendance of a physician.

A Problem faced by the aviation insurance industry ...

... is the small number of exposure units weakens the application of the law of large numbers, while any single exposure unit is capable of causing a catastrophic loss. The nature of the aviation insurance market results in a small number of insurers, each using considerable judgment in their rate-making and underwriting decisions, and no standard aviation insurance policy.

Accelerated death benefit provisions are also referred to as ...

... living insurance, because the insured person is entitled to receive benefits while he or she is still living, in contrast to general life insurance that usually pays benefits upon the death of the insured.

What are some potential advantages of owning an insurance policy?

1. Assists with savings. 2. Furnishes a safe and profitable investment. 3. Encourages thrift. 4. Minimizes worry. 5. Provides an assured income in the case of annuities. 6. Helps preserve an estate.

Three criteria should be considered when choosing an insurance company:

1. Financial strength (this is first and foremost). 2. Fairness and promptness in processing claims. 3. The ability and willingness to provide service before and after a loss.

Financial Transactions related to Risk Management

1. Forward Contracts: contracts similar to futures contracts but not traded on organized exchanges. 2. Futures Contracts: orders placed in advance to buy/sell a commodity or financial asset at a specified price. Traded in organized commodities or securities markets. 3. Swaps: agreements between two companies to exchange or lend securities. There are two types of swaps: currency and interest rate swaps. 4. Traded Options: a legal right to buy or sell a commodity or financial asset at an agreed upon price for a specific time period. (I'm guessing this has to be a major focus of a CFA program.)

Exposures

1. Intentional 2. Unintentional Exposure to liability claims may result from either the actions we choose to take, or those we choose not to take. Sometimes our intentional acts such as speeding or selling a dangerous product can make us liable to others. Other times, when we fail to take action that is considered prudent or fail to exercise proper care, we may be held liable. For instance, a childcare center may be held liable for injuries caused by a worker who had a criminal record for child abuse, because they chose not to conduct a background check during the hiring process.

Risk managers must be familiar with these requirements and all other relevant federal and state environmental legislation for two reasons.

1. Many corporations accept the responsibility of good corporate citizenship, including the responsibility of protecting the environment. 2. Many of these laws provide for significant fines and penalties.

What are the two requirements of a good insurance policy?

1. Provides for the needs of the client. 2. Policy amount is no more than needed.

What are the 5 types of responses to risk?

1. Risk Avoidance 2. Risk Reduction 3. Risk Transfer 4. Risk Retention 5. Risk Diversification

What are the various federal environmental control acts?

1. Superfund 2. Superfund (Amendment of 1986) 3. Clean Air Act (Amendment of 1990) 4. Water Pollution Control Act 5. Environmental Protection Act (EPA)

Typically, living insurance takes one of two forms:

1. Terminal Illness Coverage 2. Catastrophic Illness Coverage and Dread Disease Coverage

Business liability losses arise from three sources:

1. The cost of a legal defense. A defense can be expensive even in cases where a court finds that claims made by the victim are groundless, false, and/or fraudulent. In some cases, the legal defense costs more than the damages awarded to parties claiming injury. 2. Legal damages awarded by a court to an injured party. 3. The cost of loss prevention arising from potential legal liability.

There are three basic components that establish the premium and define the payment of benefits under disability income policies:

1. The elimination period 2. The benefit period 3. The monthly indemnity amount

When a life insurance policy is purchased, three distinct classifications of interest are created:

1. The insured is the person whose death causes the insurer to pay the claim. 2. The owner is the person who may exercise the rights created by the contract. 3. The beneficiary is the person receiving the proceeds when the insured dies.

A person cannot legally enter a contract if:

1. They are a minor 2. They are intoxicated 3. They are legally incompetent

4 other Disability Insurance Benefits:

1. Transplant benefit 2. Rehabilitation benefit 3. Non-disabling injury benefit 4. Principal sum benefit

General liability insurance forms include:

A Comprehensive policy is purchased by businesses to insure their liability exposures using the comprehensive general liability policy. A Commercial Policy includes an occurrence-based liability and claims-made form obligates the insurer to pay only for claims first made against the insured. Worker's Compensation Insurance provides benefits to workers and their dependents when a worker suffers an occupational injury or disease. Long-Tail Claims Insurance claims filed many years after an injury takes place. Tail Coverage is useful, if a contractor ceased operations but wanted liability insurance for a few years in case some lawsuits were filed over previously completed work. It is also called the extended reporting period, and extends the time during which a claim may be filed for a loss occurring during the policy period.

Business Insurance Package

A General liability and property package policy includes General liability insurance to cover your commercial liability and property insurance for physical assets, such as office contents or inventory that are leased or owned. The package insurance policy may also cover loss of business income and extra expense resulting from an insured peril. A business insurance package policy generally insures lost or damaged property for replacement value, which means you'll receive a settlement amount sufficient to replace the property without deducting for depreciation. The property insurance portion of a general liability and property package policy also covers other peoples personal property to the extent that the business owner is legally liable for the damage.

Binder

A binder is a temporary contract in property insurance, and is often used before the issuance of the formal insurance policy. The binder must meet all the requirements for a legal contract. It is distinguished by its temporary nature (often 30 days or less). The purpose of the binder is to provide coverage during the time it takes to process an application. A binder may be oral or written. An oral binder, such as one an agent may give over the telephone, should be followed by a written document to reduce the likelihood of disputes and to protect the positions of both parties. Normally, written binders will specify the amount of insurance, the period during which the binder is effective, and the parties to the binder.

Collateral Assignment

A collateral assignment is a temporary transfer of only some policy ownership rights to another person. Collateral assignments are ordinarily used, in connection with loans from banks or other lending institutions and persons. They are partial, meaning only some policy rights are transferred, in contrast to absolute assignments where all policy rights are transferred. They are temporary, in that the transferred partial rights revert to the policyowner upon debt repayment. The vast majority of life insurance policy collateral assignments in the United States use the insurance company's specific form or American Bankers Association (ABA) Collateral Assignment Form No. 10.The form attempts to provide adequate protection to the lender and, at the same time, permits the policyowner to retain certain rights under the policy. Thus, the assignee, for example, the lending institution, obtains the right to: Collect the proceeds at maturity/death Surrender the policy pursuant to its terms Obtain policy loans Receive dividends, and Exercise and receive benefits of nonforfeiture rights. On the other hand, the policyowner retains the right to: Collect any disability benefits Change the beneficiary, subject to the assignment, and Elect optional modes of settlement, subject to the assignment. Under the form, the assignee agrees: To pay to the beneficiary any proceeds in excess of the policyowner's debt Not to surrender or obtain a loan from the insurance company, except for paying premiums, unless there is default on the debt or premium payments, and then not until 20 days after notification to the policyowner, and To forward the policy to the insurer for endorsement of any change of beneficiary or election of settlement option.

Excess Liability Insurance

A commercial umbrella policy can be purchased to provide coverage after underlying liability policies have been exhausted. In this case, the umbrella policy is called excess liability insurance because the umbrella policy pays only for losses in excess of the underlying limits. Typically, the insureds' retention limits must be at least $10,000 and often a larger amount for cases where the commercial umbrella policy is providing the initial coverage rather than an underlying liability insurance policy. In all cases, umbrella policies require the insured to maintain minimum amounts of underlying liability insurance coverage. Typically, those limits are $250,000/$500,000 for bodily injury, $100,000 for property damage, $100,000 for automobile liability coverage, and $100,000 to $500,000 for employer's liability coverage. Naturally, the insurer providing the umbrella coverage realizes its loss potential less often if the insured has more underlying liability coverage.

Condition Precedent

A condition precedent is something that must be done by one party to activate the other party's duty to perform. For example, policyholders must continue to pay premiums in order to keep the policy in force. The insured must satisfy both conditions precedent before the insurer is obligated to pay the claim.

Conditional receipt

A conditional receipt can provide temporary coverage, contingent on an applicants ability to present evidence of insurability. Life insurance agents give applicants a conditional receipt when the applicants submit a premium payment with the application. With one common type of conditional receipt, if evidence of insurability exists, coverage begins from the date of the receipt. Evidence of insurability always includes, but is not limited to, good health. Occupation would be another factor. The conditional receipt affords the life insurance applicant temporary coverage during the underwriting process. Agents should always encourage an applicant to submit an initial premium payment with the application in order to receive such a receipt. If the agent does not educate the applicant of this when a conditional receipt is available, and the applicant dies in an accident after all medical testing had been completed, the agent could be sued by the deceased applicants heirs for failure to provide advice that is expected of a licensed professional. Such mistakes of agents are why errors & omissions insurance exists and should be maintained.

Legal Purpose

A contract must have a legal purpose, an end or intention permitted by law. Contracts having an antisocial purpose are legally unenforceable. No court will aid the parties to such a contract. An insurance policy purchased as a gamble on a famous persons life or on any life in which the contract owner has no legal interest is an example of an unenforceable contract. If a beneficiary attempted to collect proceeds from contracts where an insurable interest was lacking, a court would hold the contract void. REAL-LIFE EXAMPLE: Mr. Smith fraudulently purchased a life insurance policy on the life of his girlfriends child without her knowledge, claiming he was the childs father. When the young boy died under suspicious circumstances, Mr. Smith submitted a claim. It was determined that he had lied about his relationship to the child and had no legal right to apply for the policy. The insurer denied the claim as the contract was not a contract for a legal purpose. Mr. Smith did not have an insurable interest (legally recognizable economic relationship) in the child at the time he applied for the policy.

Defining A Good Policy

A good insurance policy is defined as one that meets the consumers needs without providing more insurance than is required. In choosing a good property insurance policy, the consumers selections are standardized. The two largest non-life exposures are the home and automobile. The consumers role is easier today, when one or two packaged plans of insurance can cover most property needs. Before 1950, it was necessary to buy several different policies and riders, and even then the consumer could not always be sure that there were no gaps or overlaps in the property insurance coverage. Even today, insureds with money-making hobbies or unusual property such as expensive artwork, extensive gun or coin collections, or a large greenhouse may need to amend the standard policy to tailor the coverage to their needs. Choosing a good life insurance policy is more difficult than choosing a good non-life insurance policy because life insurance policies are not standardized. Some policies combine savings with protection, while other policies are purely protection. Generic policies, such as whole life or term insurance are often given fancy names such as Extraordinary Estate Builder or Junior Executive Heritage Protector or Super-Duper Money Maker by insurers. One companys universal policy may be different from another companys universal policy. Some companies policies are combined with desirable riders, while others are combined with less desirable ones. Some companies provide for a substantial surrender charge, while others do not.

Coverage A or B

A homeowners policy will typically include a replacement cost provision which acts as an inflation rider. Homeowners can purchase full replacement cost coverage to insure against losses to buildings and homes. The alternative is to have damages and losses paid out on an actual cash basis. Actual cash value is calculated as the replacement cost minus the buildings depreciation. Buildings under Coverage A or B are settled at replacement cost without deduction for depreciation, subject to the following: If, at the time of loss, the amount of insurance on the damaged building is 80% or more of the full replacement cost of the building immediately before the loss, then the ISO will pay the cost to repair or replace the damaged building. The ISO will apply the policys deductible before paying the insured the lesser of the following amounts: the limit of liability under the policy that applies to the building the replacement cost of that part of the building damaged for like construction and use on the same premises, or the necessary amount actually spent to repair or replace the damaged building. For example, the replacement cost of a home is $800,000 (which is not the homes fair market value) and the owner buys insurance to cover 80% of the replacement cost value, which is $640,000 of coverage. If a fire destroys the kitchen resulting in $200,000 worth of damages, then the insurance company will pay the full $200,000 of replacement cost coverage minus the policys deductible. In this case, the amount of insurance purchased ($640,000) divided by 80% of the replacement cost of the home ($640,000) equals 1. Therefore, the insurance company will pay the full replacement cost of the loss minus the deductible. In the previous example, if the entire house had burnt down, the owner would only collect $640,000, which is less than the $800,000 loss. HO-03 also covers debris removal, and if the cost of replacement equals or exceeds the face amount of coverage, the insurer provides an additional 5% of the limit of liability for the debris removal expense. For example, a homeowner has an HO-03 policy with $300,000 of coverage equal to the homes current replacement cost. Assume the home had a total loss by a covered peril and the cost to rebuild the home was $300,000. If a contractor charges an additional $4,000 to remove the structure, the insurer would pay $304,000 minus any deductible. The loss settlement provision of homeowners insurance form H0-02 includes a penalty if the homeowner purchases coverage that is less than 80% of the replacement cost value. If, at the time of loss, the amount of insurance in the policy on the damaged building is less than 80% of the full replacement cost of the building immediately before the loss, the ISO will pay the greater of the following amounts, but not more than the limit of liability under the policy that applies to the building: the actual cash value of that part of the building damaged, or the proportion of the replacement cost of the loss that the amount of insurance bears to 80% of the replacement cost value of the building.

Lapsed Policy

A lapsed policy means the insured voluntarily has given up the life insurance contract by not paying the premium within the grace period. Letting a life insurance policy lapse is usually expensive to the insured and to the insurer. Most of the expenses of acquiring the life insurance policy and putting it in force occur in the first year of the policy. These expenses must be recovered in the early years of the contract or the insurer loses money. These acquisition costs include: Salespersons commission, Cost of medical examination, and Home-office administration. When an insured lets a policy lapse, it means he or she has become displeased with a purchase decision, decides the coverage is no longer needed, or perhaps cannot afford to pay the premiums. Perhaps the insured purchased the wrong type of policy or found a better offer from another insurer. Whatever the reason, a lapsed life insurance policy may represent a mistake, often a very expensive one. First, consider any sales charges. Second, determine tax issues such as a realized loss or gain. Realized losses are not tax-deductible and realized gains are subject to ordinary income tax rates. Therefore, after considering the above issues, the insured who allows a policy with an accumulated cash value to lapse will have several choices with respect to having the reserves or cash value returned.

Buy-and-Sell Agreements

A legal agreement for the purchase between the buyer and seller, called a buy-and-sell agreement, must also be arranged before a purchase plan becomes effective. Thus, people need the services of both a lawyer and a life insurance agent to arrange and fund the business continuation plan, which is a buy-and-sell agreement properly funded by life insurance. Calculating the appropriate value of the business interest is an important part of the process. The IRS requires the value determined in the buy-and-sell agreement to be a fair price because the purchase price ordinarily will be a part of the decedents estate and be subject to the estate tax. This also sets the purchasers cost basis in the business. As a business grows and prospers, the amount of life insurance needed for purchasing the owners interest increases. Thus, buy-and-sell life insurance plans must be flexible and be reevaluated regularly. Partnerships and closely held corporations also present the need for business continuation life insurance. Often the surviving partners or shareholders want to purchase the interest of the member who dies. Life insurance policies can be used to fund the purchase.

Life Annuity

A life annuity is a contract made with an insurance company. The conditions of the contract are as follows: The insurance company promises to pay the owner a certain guaranteed minimum income every year for as long as the individual lives. Payment ceases on death, unless a refund feature had been selected. The life insurance company is able to liquidate both the capital sum and the interest in making these payments. The insurer can also further discount the cost of providing an annuity, that is, guarantee a larger income payment. At the same time, the insurer can guarantee that the annuity recipient will not outlive the payments. The insurer does this by applying the law of large numbers to the probabilities of survival, in contrast to probabilities of death as in the case of life insurance. If income is needed for the lives of two people then a joint and last survivor annuity should be considered. The annuity payments continue in whole or in part until both individuals die. Generally, once the annuity payments have begun the owner of the contract will not be able to cancel the contract.

Products Liability Insurance

A manufacturer of a product has a legal liability to design and produce a product that will not injure people in normal use. Product liability arises when a manufactured item injures a consumer. Products liability insurance traditionally has been provided to manufacturers as part of the comprehensive general liability policy. One problem with this policy is that it does not make clear which insurer is liable for the loss. In addition, products must be packaged carefully and accompanied by adequate instructions and warnings so consumers may use them properly and avoid injury. If any of these duties are not fulfilled and the result is an injured user, potential for a product liability lawsuit exists. Moreover, not only must the manufacturer or processor be named as defendants in a product liability lawsuit, but the vendor of a product, such as a drugstore or automobile dealer also may be named. A key question in product liability cases is whether the plaintiff has the burden of establishing the defendants negligence or whether the defendant has the burden of proving a lack of negligence on its part. We will analyze the liability problem of a particular product. The liability arising out of the use of asbestos and other dangerous substances now has a long and complex legal history. Asbestosis and other diseases caused by exposure to hazardous substances may be recognized only decades after the initial exposure. A worker may have been exposed to some disease-causing chemical from 1975 until 1995, but the first symptoms of disease may not have appeared until 2005. Death may not have occurred until 2010, when the worker was 70 years old. During this period, the employer, its suppliers and its customers may have had a dozen different insurers providing product liability insurance. Moreover, the injured employee may have had several different employers during his career and may have smoked two packs of cigarettes a day for many years.

Gift Marital Deductions

A married individual can make gifts of $28,000 (indexed) per year to each beneficiary without incurring any gift tax liability, if the spouse consents to splitting the gift.

Rating Bureau

A particular concern about federal regulation if the McCarran-Ferguson Act were repealed would be the applicability of the federal antitrust statutes to insurance company rate making. In many different lines of insurance, such as automobile liability and fire insurance, companies pool their data using an intermediary called a rating bureau. Rating bureaus develop advisory rates for use by members or provide raw data. This practice clearly involves collusion leading up to setting a price and thus would be illegal under federal antitrust law. If federal regulation, including the antitrust laws, were imposed, it would have the effect of causing every company to duplicate the ratemaking and data collection efforts of the others. Federal regulation also would give large companies, with larger databases, a competitive advantage over smaller companies. Thus, federal regulation, without an antitrust exemption, has the potential for rearranging the competitive structure of the industry. As the matter now stands, the largest property insurance rating bureau, the Insurance Services Office, supplies its members and regulatory agencies with loss data, but not actual rates. Each company is free to use this loss data combined with its own expense structure in developing its rates.

Coordination of Benefits

A policy with a coordination of benefits provision is one that may not pay or will pay only a portion of its benefits, if another policy is available to cover the loss. The clause prevents an insured from collecting more than needed to provide indemnity. This clause also determines the order in which insurers are responsible for payment in cases involving multiple policies. Because it is possible for the same period of hospitalization to be covered by automobile medical insurance, group medical insurance, workers compensation and individually purchased coverage, the coordination-of-benefits clause provides for each insurer to pay a portion of the total expenses. Some coordination-of-benefits clauses determine whether the policy provides primary or excess coverage.

Assumption of Risk

A second line of defense involves establishing that the plaintiff knowingly assumed the risk of injury. If the defendant establishes assumption of the risk, the plaintiff will not be awarded a judgment. For example, if the plaintiff challenged the defendant to a wrestling match, the plaintiff may not collect damages when his arm is broken during the contest. As we shall see shortly, the risks one assumes, either expressly or by implication, can be a question of fact. To illustrate the issue, consider a hockey player. He assumes the risk of being struck by a puck or being checked forcefully by opponents. But does engaging in this sport also imply that he assumes the risk that an irate opponent will use his stick to split open his skull? If the injured player takes the aggressor to court, can the aggressor legitimately raise the assumption of risk defense? The question is for a judge and jury to decide.

Torts

A tort is a private or civil wrong or injury, other than breach of contract, for which the court will provide a remedy in the form of an action for damages. While contract law is designed to compensate one person for injuries caused by anothers failure to perform under a contract, tort law provides compensation for legal wrongs committed against a person or his or her property arising independently of any contract between the parties. A person who commits a tort is known as a tortfeasor, and acts or omissions constituting torts are said to be tortious. Torts are subject to state laws and civil actions. The plaintiff seeks compensation from the defendant for the injury caused by the defendants conduct, usually due to negligence, or perhaps a deliberate act. The plaintiff may sue for monetary damages for loss of earning power, reasonable medical expenses, and pain and suffering. A crime is an intentional violation of anothers rights. It is an offense or wrong for which the public vindicates its rights through a criminal prosecution. A criminal prosecution is maintained by the state or federal government and punishes the defendants conduct by imposing a fine, prison term, or both. Criminal law is not generally designed to compensate individuals injured by criminal conduct. For example, assume Andrew punches Billy, breaking his nose. In this case, the state may take criminal action under its criminal code against Andrew for assault and battery, leading to a fine or prison sentence. In addition, Billy may file a tort action against Andrew using common law tort principles to recover damages in compensation for his injuries. Although the same conduct may be both a crime and a tort, most torts are not crimes. Torts are simply those wrongs other than a breach of contract for which the law provides compensation through a civil action.

Valued Insurance Policies exception to the rule of indemnity

A valued insurance policy is an exception to the rule of indemnity. Valued policies pay the limit of liability whenever an insured total loss occurs. The value of the insured property is agreed to before the policy is written. If a total loss occurs, it may cause more or less damage than the stated amount. Nevertheless, the stated amount will be paid. The use of valued policies generally is limited to objects for which market value may fluctuate or be difficult to determine accurately after a loss, such as art objects and other collectors items. Underwriters do honor the principle of indemnity when writing valued policies and generally require insureds to get appraisals of their property to establish its insurable value.

Viatical Settlement Firm

A viatical settlement firm is a specialized company, or group of investors, that purchases life insurance policies from terminally ill individuals for lump sum cash payment. It is a private enterprise and not considered an insurance company. Individuals, agents and financial planners typically bring potential sellers to the viatical settlement firm. In a viatical settlement transaction, people with terminal illnesses assign their life insurance policies to viatical settlement companies in exchange for a percentage of the policy's face value. The viatical settlement firm, in turn, may sell the policy to a third-party investor. The viatical settlement firm or the investor becomes the beneficiary to the policy. They pay the premiums and collect the face value of the policy after the original policyholder dies.

Voidable contract

A voidable contract allows one party the option of breaking the agreement because of an act or omission of an act (a breach) by the other party. The party with the right to void the contract may instead choose to have the contract enforced. A good insurance example of a voidable contract is one in which the insured has attempted to defraud the insurer. After the insurer establishes the insureds fraud, it will be released from its contractual obligations. At the insurers option, the contract can be set aside or voided.

Contribution Principle

A widely accepted equitable concept is known as the contribution principle. It holds that insurers selling participating policies must distribute surplus accumulated on behalf of a block of policies in the same proportions as the policies are considered to have contributed to the surplus. Dividends actually paid usually will exceed illustrated dividends in periods when investment returns are generally higher during the period after policy issuance than they were during the period before. Of course, the opposite also applies. For example, during the high-yielding 1980s in the United States, high dividends were illustrated. The dividends actually paid, however, were less than illustrated, giving rise to disappointment and even lawsuits. PRACTITIONER ADVICE The dividend received by the policyholder is actually a credit for an overpaid premium and is considered by the IRS to be a "return of premium." The dividend received is not taxable income to the insured unless it exceeds the cost basis. For example, if the policyholder's cost basis is $1,000, any amount received of $1,000 or less is a return of basis and there are no tax consequences. However, if the dividend is $1,025, $1,000 is return of premium/basis and $25 is taxed as ordinary income.

How do states regulate to help maintain insurer solvency?

A. By setting conditions for minimum reserve requirements for insurers. B. By maintaining minimum reserves on the liability side of the balance sheets of insurers. C. By setting conditions for surplus requirements. D. By setting investment requirements for reserve and surplus accounts.

Reinstatement Provisions

After a policy lapses, the insured has an opportunity to reinstate it if specified conditions are met. The opportunity to renew a lapsed policy is called the reinstatement provision. New York has a limit of three years from the date of default in which the owner may reinstate the policy. Furthermore, the insured must not have withdrawn the cash surrender value, but must have chosen a non-forfeiture option that allows the policy to continue. PRACTITIONER ADVICE: As previously noted, some states have different regulations that can impact the insured's rights. For example, the Commonwealth of Massachusetts does not allow for the reinstatement of term life insurance policies. The state has decided that, since term insurance is akin to renting coverage, it doesn't make sense to pay "back rent" when you know you didn't use it. Unfortunately, by taking away the consumer's right to make that decision, the state has created a situation where some people who have become uninsurable cannot buy a new policy. For this reason, it is important that policy owners and professional advisors fully understand existing policy features and options before making any changes.

Coverage Limitations of LTC

All LTC policies contain some exclusions and limitations of coverage. Common exclusions include war, self-inflicted injuries, and chemical or alcohol dependency. Policies also exclude coverage for mental illness not organically based. Virtually all LTC policies now cover conditions like senile dementia, Alzheimer's disease, Parkinson's disease, and all other mental illnesses that can be demonstrated to be as organically based. Most LTC policies restrict coverage of preexisting conditions - sicknesses that started, or injuries that occurred, prior to the issuance of the policy. The most common pre-existing condition restriction is for six months (some policies use 12 or 24 months), although a few policies have no preexisting condition exclusions.

Exclusions and Limitations

All insurance contracts have a list of losses not covered and losses with limited coverage. This is referred to as Exclusions and Limitations. Exclusions: No benefits will be paid for disability as a result of: War or act of war Self-inflicted injury or sickness Pregnancy (in some states, e.g. Massachusetts, state law requires that pregnancy be treated as any other illness, and therefore it is covered) Aviation - serving as pilot or crew member of an airplane Narcotics - use of llegal drugs or taking those not prescribed by your physician Incarceration or loss of professional license Illegal occupation Committing or attempting to commit a felony Limitations: Benefits for disabilities related to mental/emotional disorders are paid only for two years. Alcohol and drug abuse can have the same two-year limitation on benefits. Pre-existing conditions can be handled in different ways by different insurance companies. Sometimes they are completely excluded, usually done by an "exclusion rider" with very specific language. For example, an applicant who has received treatment from a chiropractor will typically see the following: "no coverage for disability from injury to or disorder of the cervical spine, its muscles, ligaments, discs or nerve roots." Other carriers may use the following limitation: "Disabilities due to conditions not disclosed on the application, for which medical advice, treatment or medication was received, are not covered for the first 2 years that this policy is in force." PRACTITIONER ADVICE Group LTD has more liberal underwriting and may cover pre-existing conditions as long as disclosed on the application and not excluded. Other insurers use a waiting period such as 3/12 - any condition treated in the prior 3 months is not covered for the first 12 months.

Recurrent Periods of Disability

All insurers include a provision that is related to the benefit period and that deals with consecutive or recurrent episodes of disability and identifies whether the company is dealing with a new or continuing claim. The typical provision states that the company will consider recurrent periods of disability from the same cause to be one continuous period of disability, unless each period is separated by a recovery of six months or more. Among the major insurers, use of a 12-month recurrent provision is common in policies with benefit periods to age 65 or longer. The provision is to an insureds advantage in the following ways: A new elimination period will not be required for disability that recurs within six months, This, in turn, protects the insured from multiple elimination periods, The benefits for recurring loss becomes payable immediately for the unused portion of the original benefit period, and The provision allows for a new benefit period, and a new elimination period, if loss results from a different cause at any time after an earlier disability, or if loss recurs due to the same cause more than six months after recovery.

Guaranty Funds

All states have solvency laws and guaranty funds to protect insureds from losses caused by insolvent insurers. State regulators are likely to intervene in an insurer's independent operations when the company's surplus accounts reach an unacceptably low level, or if the company's conduct appears to be jeopardizing the policy owner's interests. Regulators call the first phase of intervention conservatorship, rehabilitation or receivership. If this phase fails to correct the problems, regulators can order the next level of intervention: liquidation. In the case of small insurers, the state may try to rehabilitate the company, find a solvent insurer to assume the business, or liquidate the company using the guaranty fund. The failure of both large and small insurers can require policy owners to give up some contractual rights including access to their funds for stated periods. In some cases involving life insurance companies, policy owners received lower investment returns than called for in contracts issued by failed insurers. The money to finance the state guaranty funds comes from assessments on all insurers doing business in a particular state. Thus, there is a transfer of funds from solvent insurers to support the insureds of insolvent insurers. The fairness and logic of such a transfer are subject to criticism, since the most likely transfer is from insureds purchasing coverage from insurers charging adequate (higher) premiums to insureds of companies charging inadequate (lower) premiums The 1989 NAIC Guaranty Fund Model Act provides some national uniformity among the various state regulations. Critics note that insureds having already paid a higher price now must pay more to support those insureds who, voluntarily, chose to purchase insurance at a lower price. State regulators are likely to intervene in an insurer's independent operations when the company's surplus accounts reach an unacceptably low level, or if the company's conduct appears to be jeopardizing the policy owner's interests. PRACTITIONER ADVICE States prohibit insurers or agents from implying that Guaranty Funds make financial strength of the carrier a non-issue. Discussion of these Funds should be avoided and only when the consumer specifically mentions them. To remain compliant and to avoid any chance of misunderstanding, an agent should stress the importance of insurer stability and direct consumer Guaranty Fund questions to the State's insurance department.

Whole Life Cash Values

All whole life policies involve some prefunding of future mortality costs. The degree of prefunding is a function of the premium payment pattern and period. Because of this prefunding, all whole life policies sold in the United States and some other markets are required to have cash values, which must build to the policy face amount, usually by age 100. PRACTITIONER ADVICE One of the major advantages of any cash value type of life insurance contract is that the cash value grows on a tax deferred basis. The funds in the savings part of the contract grow every year, and there is no income tax due unless the owner takes out more money than has been paid in. Whole life cash values are available to the policy owner at any time by the policy owner's surrendering, or canceling, the policy. Alternatively, cash values can be used in other ways, providing flexibility to the policy owner. Whole life policies usually contain cash-value schedules that show for selected time periods the guaranteed minimum amounts that the policy owner could receive from the company on surrender of the policy. Owners of whole life insurance policies do not have to surrender their policies to have access to funds. Under participating whole life policies in which dividends have purchased paid-up additional insurance, such additions may be surrendered for their attained cash-value with no impact on the policy. Also, policy owners normally can obtain a loan from the insurer for amounts up to that of the policy's cash value. Of course, interest is charged for this loan, and the loan is deducted from the gross cash value if the policy is surrendered, or from the face amount if the insured dies and a death claim is payable. Policy loans may, but need not, be repaid at any time and are a source of policy flexibility. PRACTITIONER ADVICE: Many consumers misunderstand the concept of cash value. It is important to remember that this is not equal to the amount paid into the policy by the insured. Thus, cash values are typically non-existent in the first year of a policy and grow slowly over time to equal the face amount of the policy by age 100. Remember, premiums are not deposits; insurance is not an investment.

Adjusted Gross Estate

Allowable deductions are subtracted from the gross estate, which results in the adjusted gross estate. Allowable deductions include funeral and administration expenses, debts of the decedent, certain taxes, and casualty or theft losses. The taxable estate is calculated by subtracting allowable deductions from the adjusted gross estate. These deductions include bequests to the surviving spouse, which qualify for the marital deduction, and bequests to qualified charities, which receive a charitable deduction. Another deduction is taken for state death taxes paid. A decedent who is the owner/insured of a life insurance policy will have the death benefit proceeds included in his or her gross estate at death. If the spouse is named the beneficiary of the policy, the decedent's marital deduction would offset the death benefit amounts, and the proceeds would avoid inclusion in the decedent's taxable estate in 2015. If a charity is named the beneficiary of the policy, the decedent's charitable deduction would offset the death benefit amounts, and the proceeds would not be included in the decedent's taxable estate. Both the surviving spouse and the charity would receive the death benefit proceeds income tax-free.

Assignment Provision

Although insurance policies possess some unique characteristics, they are property and, therefore, subject to the law on property. Treating life insurance policies like other types of property, the assignment provision allows ownership rights in life insurance policies to be transferred by the current owner to another person.

Absolute Assignment

An absolute assignment is the complete transfer, by the existing policy owner of all of his or her rights in the policy to another person. In other words, it is a change of ownership. In the case of a gift, the assignment is a voluntary property transfer involving no monetary consideration. Gifts of life insurance policies are frequently made among family members, for both personal and tax reasons. Sometimes a life insurance policy is sold for a valuable consideration. This is known as a transfer for value. A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. Under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer for value rule cannot be avoided by cancelling the transaction at a later time.

Insurance Planning Module Summary

An insurance policy provides protection from the financial consequences of the ever-increasing perils that humans face today, be it loss of property or personal losses. The key concepts to remember are: Insurance Planning Process - The risk management process involves establishing objectives, identifying loss exposure, and measuring loss exposure. This process helps analyze the financial consequences of loss of health and of premature death. Insurance Coverage - Health insurance includes numerous plans of coverage to protect against specific financial losses from injury, illness, or incapacity. It can be classified into three categories: medical expense insurance, long-term care insurance and disability income insurance. Property Coverage - Homeowners insurance, commercial insurance and liability coverage encompass property insurance. The commercial package policy provides insurance coverage to a broad range of organizations, including manufacturing firms, schools and retailers. It does not apply to private homeowners.

Legal Reserves and Surplus

An insurer must at all times comply with the reserve and surplus requirements of the state in which it is domiciled. The law requires an insurer to maintain minimum reserves on the liability side of its balance sheet. To help satisfy these reserves, the insurance company invests its excess premiums collected over expenses paid in various investment assets. The difference between the investible assets and the liabilities is called the reserve and/or surplus. This difference is a cushion beyond current operating income available to meet an insurer's financial obligations. The reserve and the investment requirements are important tools in promoting insurer solvency. Before an insurer is granted a license to operate in a state, it must establish that it has satisfied the state's minimum capital and surplus requirements. These requirements vary from state to state. If an insurer fails to maintain the minimum amount of specified capital, it is placed under the commissioner's supervision until it can be determined whether rehabilitation or liquidation best serves the public interest. If an insurer's capital and surplus fall below the minimum standard, it is considered to be impaired. If an insurer's liabilities exceed the value of its assets, it is insolvent. It is probable that every insurer will experience less than desirable underwriting or investment results at some time, and an adequate surplus will allow an insurer to survive such a period without injury to its insureds.

Own Occupation Clause

An own occupation clause deems the insured to be totally disabled when they cannot perform the major duties of their regular occupations. This is considered the most liberal definition of disability available, and thus the best to have. A regular occupation is the one in which the insured was engaged at the time the disability began. Under this definition, the insured can be at work in some other capacity and still be entitled to policy benefits if they cannot perform the important tasks of their own occupations in the usual way. The most common variation of the own occupation definition is the one that deems the insured to be totally disabled as long as they: Cannot perform the major duties of their regular occupation, and Are not at work in any other occupation. If the insured is disabled from their regular job, the insurance company can terminate disability benefits only if the insured has voluntarily chosen to work at some other job. REAL LIFE EXAMPLE Doctor Smith was a 45-year-old neurosurgeon with a successful practice. Due to a car accident, he lost the use of his right hand, thereby ending his ability to perform surgery. After a long rehabilitation period, he was offered a teaching position at a prominent medical school. He had purchased an "Own Occ" disability policy when he was 30 and had selected a benefit period that would last until age 65. Due to this "Own Occ" definition, he not only collected benefits while totally unable to work, but even after he started his teaching position. PRACTITIONER ADVICE This level of protection is essential for any specialist, e.g. a trial attorney, a commercial architect. Policies with "own occ" definitions are harder to find than previously, and there is an increased premium for this protection, but it is definitely worth it.

Description of Annuities

Annuities are contracts issued by life insurance companies. They can be used to accumulate funds to a future point in time when the assets can be converted to a lifetime stream of income. Essentially, annuities can provide an income that cannot be outlived. There are three components to an annuity: 1. The Owner 2. The Annuitant 3. The Beneficiary Annuities have two phases: 1) the accumulation phase, and 2) the distribution phase. During the accumulation phase, deposits may be made either as a single payment or as a series of payments over time. During the accumulation period, assets may be withdrawn but may be subject to a surrender penalty imposed by the insurer. The accumulation phase can be as brief as thirty days or may be indefinite in length. Regardless of its length, the accumulation phase ends when the distribution phase begins. Typically, when an annuitant who purchased a deferred annuity dies during the accumulation period, their beneficiary receives a return of the premiums, often with interest. The distribution phase may be based on the life expectancy of the annuitant who may or may not be the owner. The beneficiary would receive the value of the annuity if the owner dies during the accumulation period. Some insurance companies use the annuitant rather the owner to trigger payment to the beneficiary. There are two general categories of annuities: 1. Deferred annuities, have an indefinite accumulation period. Essentially, it lasts until death of the owner, the contract is surrendered or the distribution period begins, and 2. Immediate annuities begin the distribution phase immediately, using no longer than thirty days after the contract is funded.

Guaranteed Insurability Option

Another approach to increasing disability coverage is to purchase the Guaranteed Insurability Option (GIO) rider. This allows for a larger monthly benefit increase, (e.g. $500 a month). This benefit is especially important for people who are starting careers with the expectation of higher incomes, such as doctors, dentists, or new business owners. The GIO allows the individual to purchase more protection without having to provide evidence of health. However, the insured must prove they financially qualify. This type of coverage is typically offered at a specific age, after a specified number of policy years, or a specific life event (e.g. marriage). There are maximum limits on the amount purchased and the age of the insured, for example some companies stop offering at age 40. The increased premium is calculated at the insured's "attained age," that is, their current age.

Modified Endowment Contracts (MECs)

Any life insurance contract sold after June 21, 1988, that fails to pass the test instituted by the Technical and Miscellaneous Revenue Act of 1988 (TAMARA) will be classified as a Modified Endowment Contract (MEC). The test is called the Seven-Pay Test and was created by Congress to discourage using life insurance with high premiums as an investment. The test compares the premiums paid for the policy during the first seven years with seven annual net level premiums for a seven-pay policy. Basically, people were contributing excess premiums to build up the cash value quickly and then using it as a source of tax-free loans. Currently, people who decide to use their life insurance as a place to accumulate and then withdraw funds risk having it treated as a MEC and incurring negative income tax ramifications such as funds being subject to last in/first out treatment and a 10% penalty that applies on any taxable gains withdrawn before age 59 ½. However, the death benefit from a MEC will remain income tax-free to the beneficiary.

Primary coverage

As a general rule, coverage on the auto involved in the accident is considered primary coverage. Primary coverage pays first.

Extended Term Option

As a second option, Johann may choose to convert to a term insurance policy providing the same $400,000 face amount as his whole life policy. The insurer will determine how long the $400,000 of term insurance will continue if a $166,800 premium were paid. Assume the answer is 14 years and 4 months. Thus, without paying another premium, Johann could continue with $400,000 of life insurance protection. However, at age 74 and 4 months, the insurance protection and the cash value would be gone, and the term insurance has no cash value. This option is called the extended-term option. A policy lapsed under this option may be reinstated under the reinstatement provision.

Reduced Paid-Up Option

As a third non-forfeiture option, Johann may choose a reduced amount of paid-up life insurance. That is, he currently has a $400,000 whole life policy with $166,800 cash value. If he stops paying premiums, he may choose a fully paid-up policy of $212,500 face amount. This option is called the reduced paid-up insurance option. A policy lapsed under this option also is subject to the reinstatement provisions.

Disability Income Benefit Taxation

As is the case with all kinds of health insurance benefits, premiums (or other employer contributions) paid by an employer for disability income insurance for employees are generally tax deductible by the employer and are not taxable income to the employee. Employee contributions, on the other hand, are not tax deductible by the employee. Consistent with these two rules, the payment of benefits under an insured plan or a non-insured salary continuation plan result in taxable income to the employee, to the extent that benefits received are attributable to employer contributions. Thus, under a non-contributory plan, the benefits are included in an employee's gross income. Under a partially contributory plan, benefits attributable to employee contributions are received free of federal income taxation and benefits attributable to employer contributions are included in gross income and employees are eligible for a tax credit. The income tax treatment of amounts paid under individual health policies is reasonably straightforward. Generally, amounts received under such policies are amounts received for personal injuries and sickness and are treated as reimbursements for expenses incurred. You will learn in a subsequent module that a tax credit for the elderly and disabled is available to persons who are totally and permanently disabled. This credit is taken on the employees federal income tax return. For example, assume that John works for ABC Incorporated, that the yearly premium for disability coverage is $2,000, and that John receives $15,000 of disability benefits for the year. What portion of the premium is deductible and what portion of the benefit received is taxable? Scenario 1 - If ABC Incorporated pays 100% of the $2,000 premium, John does not report this $2,000 as income and the company is able to deduct this amount as an expense. Because John did not pay any of the premiums, the entire $15,000 of benefit received is taxable to him as ordinary income. Scenario 2 - If ABC Incorporated pays 0% of the $2,000 premium, John does not report this $2,000 as an expense against his taxes. Because John paid the entire premium, the $15,000 of benefit received is tax-free. Scenario 3 - If ABC Incorporated pays 80% of the $2,000 premium and John pays 20%, John does not report $1,600 of the premium paid as income or report the $400 paid as an expense against his taxes and the company is able to deduct the $1,600 amount as an expense. Because the company paid 80% of the premium, John will report $12,000 of benefit received (calculated as $15,000 x 80%) as ordinary income. Because John paid the 20% of the premium, $3,000 of the benefit received (calculated as $15,000 x 20%) is tax-free.

Misstatement of Age Provision

As the applicant's age is a key factor in underwriting and pricing the insurance, a misstatement of age, either intentionally or by mistake, causes rating errors. The misstatement-of-age provision causes the insurer to adjust the face amount of insurance to reflect the insured's true age, rather than allowing the insurer to void a policy if a misstatement is discovered. There is no time limit on this provision - typically the mistake is not discovered until a death claim is being processed. For example, if the insured, Amy Grafton, reported her age to be three years less than it actually was, the benefits, $100,000, would have to be reduced to $92,000, or whatever amount of insurance the premiums would purchase at the insured's true age. REAL LIFE EXAMPLE Upon her death, Mrs. Smith's son was reviewing her life insurance policies so that he could submit the claim. While reading one policy, he noticed that the photocopy of the original application indicated his mother had been born in 1905 instead of 1908. For all the years since the policy was purchased, his mother had been paying more than she should have for the policy. She obviously had not reviewed the policy information all these years. Fortunately, upon making his claim and pointing out the error, Mr. Smith received a larger death benefit payment based on the amount his mother had paid and her correct age.

LTC Regulations

As the long-term-care market developed, the NAIC (National Association of Insurance Commissioners) wrote model legislation that has been adopted in many states. The LTC Insurance Model Act specifies minimum standards that products must meet to be considered LTC insurance. However, as with all insurance products, they are regulated at the state level and the financial planner will need to read specific provisions relating to where the client is located.

Business Umbrella Policies

As the risk manager contemplates worst-case possibilities, surely the possibility of being sued successfully for an amount in excess of available policy (CGL) limits must be considered. To deal with this possibility, a commercial umbrella policy can be purchased which provides for coverage in the following ways: 1. Excess coverage over underlying liability coverage is available when those policy limits are not sufficient to pay for judgments against the insured. 2. More comprehensive coverage is available for losses and exposures left uncovered by underlying policies. 3. Drop-down coverage is available meaning the umbrella becomes the underlying coverage after underlying liability policies have been exhausted, if the insured absorbs the first dollars of the loss. There is no standard form of commercial umbrella liability insurance and many policies have substantial differences. However, most policies provide coverage for personal injury liability, property damage liability and advertising liability. Some examples of personal injury liability include coverage for bodily injury, mental injury and anguish, sickness, disease, disability, and also libel, slander and defamation of character. Coverage is generally comprehensive but is not all-risk since many contracts contain common exclusions for liabilities arising from workers compensation, unemployment compensation, disability benefits law and others.

Taxation of Benefits

As with group health insurance, premiums paid by an employer for disability income insurance for employees are generally tax deductible by the employer as a business expense, and are not considered taxable income to the employee. Employee contributions, on the other hand, are not tax deductible by the employee. Consistent with these two rules, the payment of benefits under an insured plan or a non-insured salary continuation plan result in taxable income to the employee to the extent that benefits received are attributable to employer contributions. Thus, under a non-contributory plan, the benefits are included in an employees gross income. Under a partially contributory plan, benefits attributable to employee contributions are received free of federal income taxation and benefits attributable to employer contributions are included in gross income (employees are eligible for a tax credit, however). A tax credit is available to persons who are totally and permanently disabled. This credit is taken on the employees federal income tax return. The maximum credit is $750 for a single person and $1,125 for a married person filing jointly. The benefits received from a disability income policy purchased individually are not subject to federal income tax and the premiums paid for the policy are not tax deductible.

Consideration of Assets in Needs Analysis

Assets normally are considered either liquid or illiquid. Liquid assets are those assets available to be liquidated with reasonable price certainty. These would be available to meet income or other monetary needs on an individual's death, loss of health or incapacity. They include stocks, bonds, money market and savings accounts, mutual funds and amounts available in pension, profit sharing or individual retirement accounts. Illiquid assets are those assets not available to meet income or other monetary needs because they are not easily liquidated. They include the family's house, automobiles, and personal possessions such as clothing, jewelry and household goods. These assets are usually passed intact to heirs or kept for personal use. PRACTITIONER ADVICE Traditional pensions, funded solely by the employer's money, may not be accessible until retirement. PRACTITIONER ADVICE Using a more conservative approach, you would not count Retirement Plan funds as usable assets, but rather leave them in place for the surviving spouse. This is less of a consideration if the surviving spouse is close to retirement age.

Cash Surrender Value

Assume 60-year-old Johann S. Bach has a continuous-premium whole life insurance policy on which he has paid premiums for 20 years. The contract requires payments until age 100. Johann decides to stop premium payments. The face amount of his insurance is $400,000 and the cash value is $166,800. When he stops his premium payments, Johann may ask for the $166,800 in a lump sum from the insurer. This is the first option, taking the cash surrender value. If the cash is withdrawn in this manner, the policy may not be reinstated.

Contributory Negligence

Assuming the plaintiff establishes the defendant's negligence, the defendant may counter with a defense of contributory negligence. If it can be shown the plaintiff's own negligence contributed to or led to the injury sustained, the court will not allow recovery of damages from the defendant under the contributory negligence rule. This is not to say the existence of some measure of negligence on the plaintiff's part relieves defendants of their duties. It means that because both parties are at fault, neither will be allowed recovery from the other. For example, assume the plaintiff fails to signal a turn and the plaintiff's car is hit in the side by an oncoming car that was speeding. Assume the defendant, driver of the speeding car, establishes the plaintiff's, negligent failure to signal caused, or at least contributed to, the loss. In this circumstance, neither plaintiff nor defendant could recover from each other under the contributory negligence rule.

Additional Inland Marine Coverages includes:

Bailees' Customers' Policies Annual Transit Policies Instrumentalities Of Transportation Policies Floater Policies

Insurers sell the following five types of health insurance policies:

Basic medical expense insurance Major medical insurance Disability income insurance Medicare supplement insurance Long-term care insurance

Basic Medical Expense Insurance

Basic medical expense insurance generally provides the first-dollar coverage with no deductible provision for expenses of hospitalization and doctor's service. Insurance companies other than Blue Cross typically provide "reasonable and customary" payments for the care provided. However, dollar limitations may apply. Some contracts provide benefits paying a specific dollar amount (for example, $150 per day) that can be substantially less than the amount the hospital charges. If an insured wants a contract specifying larger payments, the premium is increased. Contracts can provide various benefit periods, including 60-day, 90-day, and 120-day periods with premiums increasing accordingly. In purchasing this coverage, a consumer should consider the trade-off between the larger daily coverage limit and the longer length of coverage.

First-Dollar Coverage

Basic medical insurance policies often have no deductible provision and salespeople often call this insurance first-dollar coverage because the insurer pays covered losses from the first dollar onward.

Umbrella Liability

Because of the increasing size of settlements and jury awards in lawsuits, insurance companies developed an additional level of liability protection. Typically referred to as Umbrella Liability policy because it "sits on top of" underlying policies, the limit can range from $1 million to $10 million. Whether the claim is from general liability or auto-related, the Umbrella policy steps in when the basic policy has reached its maximum claim limits. In addition to providing excess coverage for claims, the umbrella policy offers broader coverage, for example, driving anywhere in the world is covered, rather than restricted to the U.S. and Canada. An Umbrella Liability policy will also provide coverage for some exposures that are not covered by the insured's basic coverage. A deductible or self insured retention is typically applied when the loss is covered by the umbrella coverage but is not covered by the basic contract or contracts. While high net worth clients need Umbrella policies due to their higher risk of being sued, many other clients could benefit from this inexpensive protection. Anyone with young drivers in the household, people who travel and drive internationally and those with higher risks like swimming pools and trampolines should learn more about the costs and benefits of this policy.

Benefit Provisions

Benefit provisions usually describe the circumstances of loss, the way in which the company will pay benefits, and at what point benefits may end. The following is typical of the benefit provisions for total disability. When you are totally disabled, you will receive the monthly indemnity as follows: You must become totally disabled while this policy is in force. You must remain disabled until the end of the elimination period. No indemnity is payable during that period. After that, monthly indemnity will be payable at the end of each month while you are totally disabled. Monthly indemnity will stop at the end of the benefit period or, if earlier, on the date you are no longer totally disabled.

Additional Coverage

Both Sections I and II of the Homeowners policy contain extra protections listed under Additional Coverages. In Section I, these provisions help offset the costs associated with a loss, for example, debris removal. There is some limited coverage for the replacement of trees and bushes damaged by fire or theft, since trees are covered up to 5% of the limit for Coverage A, but not more than $500 for any one tree. Also, there is a payment of up to $1000 for Loss Assessment coverage for obligations from the condominium or property owners association. With HO-03 coverage, charges incurred from the unauthorized use of credit cards is covered up to $500 and deductibles do not reduce this amount. Ho-03 provides this coverage regardless of the contract the insured has with the credit card issuer. In Section II, there are more coverages available including a similar Loss Assessment provision. Expenses of the insured in providing first aid to an injured person can be reimbursed under the First Aid Expenses. The Claim Expense provision pays for costs associated with a lawsuit. In addition to the cost of the attorneys, there are payments for the interest due on a judgment, as well as lost wages for the insured during the trial.

Commercial Insurance

Business firms and homeowners need property insurance. When businesses purchase insurance, it is called commercial insurance. Historically, businesses had to purchase several different insurance policies to weave together a complete insurance program. Specialized firms such as building contractors, jewelry firms, and firms operating aircraft needed even more policies. Since 1987, a package or combination of policies has allowed many firms to make one insurance purchase providing all needed coverages. The Insurance Services Office (ISO) designed the commercial package policy (CPP) to provide insurance coverage to a broad range of profit and nonprofit organizations, including manufacturing firms, schools, retailers and apartment building owners. In fact, most property owners (excluding private homeowners) can use this policy.

The PAP provides coverage for four categories of insureds that have potential liability arising from the use of an auto.

Category 1: The named insured and resident family members are covered for the ownership, maintenance, or use of any auto, whether it is owned or borrowed, unless an exclusion applies. In some states, such as Massachusetts, all licensed family members living in the same home as the insured must be identified and listed on the policy, whether or not they have their own policy. If a loss occurs due to a licensed family members driving and the family member was not listed on the policy and does not have their own policy, the claim will be denied. This is to combat fraud, where a risky family member is unknown to the insurer, thus the premiums charged are less than what should have been assessed for the risk. Of course, if the household member is covered by another policy, merely listing them as a licensed household driver will not impact the insureds premiums. It is only when such a household driver does not have other coverage that their driving record will impact the insureds premiums. Category 2: Covers any person using the named insured's covered auto. That is, the car owner's insurance, not the driver's insurance, would pay a claim if the owner let somebody borrow his or her auto. Categories 3 and 4: In some situations, people or organizations other than a driver can be sued due to a driver's negligence. In some of these instances, the PAP will cover the liability of these people. For example, assume that the Alpha Beta Gamma Omega fraternity sends a brother, Bozo, to get some refreshments for a "party." Assume that Bozo uses his own auto. If an accident results during the shopping trip, the PAP would cover the fraternity's liability in this suit. The fraternity's liability arises because Bozo was technically an agent of the fraternity while on this mission. The difference between Categories 3 and 4 is between the insured driving an owned or a nonowned vehicle.

Financial Rating Firms

Consumers can get a professional opinion of the financial strength of many insurance companies by reviewing the ratings provided by an independent financial ratings firm. The following five firms provide financial ratings of insurance companies: A. M. Best Company, Standard & Poors, Moody's Investor's Services, Duff & Phelps and Weiss Research. Some of the material provided by these firms is available on the Internet, and some is available in public and university libraries. The following points list some concerns of critics about relying too heavily on an insurer's financial rating when making a purchasing decision: The ratings firms often do not agree among themselves on a specific insurance company's merits. All ratings firms can make and have made mistakes. One letter grade cannot accurately sum up an insurance company's operations. Slight differences in letter grades probably do not make for a sound basis for choosing one insurer over another. Companies with high ratings can sell policies that are not the most efficient choices. Ratings are evaluations of past behavior, and are no guarantee of future results. One rule of thumb is that unranked companies, or those ranked lower than the highest three ratings categories by the majority of the ratings firms, should be avoided unless the consumer has good reason to deal with an unrated or low-rated insurer. But the problem with following this advice is that in most cases, new insurance companies fall into the lower or unranked categories. These new insurance companies may offer innovative products, have lower prices, or offer some other competitive advantage that the consumer will lose out on, if they avoid low-rated companies. Another important point to remember is that different companies use different rating scales. For example, an A- rating from A.M. Best may not mean the same thing as an AA- rating from Duff & Phelps.

Compensatory Damages

Courts award compensatory damages to put the victim in the same financial condition after an injury as he or she was in before the occurrence. Insurance policies may cover the following three categories of loss: 1. Bodily injury, 2. Personal injury, and 3. Property damage. Special damages are designed to compensate for measurable losses, such as medical expenses and loss of income caused by the injury. The collateral source rule allows that damages for bodily injury can be assessed against the negligent party even when the injured person recovers the amount of his or her loss from other sources. For example, an injured party who was fully compensated by an insurance company can still sue the negligent party for the amount of medical expenses and lost income incurred due to his or her injuries. General damages compensate the injured party for intangible losses, such as pain and suffering, disfigurement, mental anguish, and loss of consortium.

Property Coverage consists of four types of coverage:

Coverage A: Dwelling Coverage B: Other Structures Coverage C: Personal Property Coverage D: Loss of Use

Section One of the HO consists of the following five parts:

Coverage A: Dwelling Coverage B: Other Structures Coverage C: Personal Property Coverage D: Loss of Use Additional Coverages

Other Structures

Coverage B applies to other structures on the residence premises separated from the home by a clear space. An unattached garage, fences, patios, swimming pool or tool shed are examples of property covered in this section. However, if the garage or tool shed is attached to the house, it is covered under Coverage A. The policy makes clear that a claim for loss under Coverage B of the HO-02, 03, 05 and 08 homeowners forms does not reduce the amount available for losses to the dwelling under Coverage A. This coverage is in addition to that on the home dwelling itself. Once the insured chooses an amount for Coverage A, Coverage B automatically equals ten percent of that amount.

Section Two of the HO consists of the following three parts:

Coverage E: Personal Liability Coverage F: Medical Payments to others Additional Coverages

Medical Payments to Others

Coverage F, Medical Payments to Others is coverage used to pay the medical expenses of someone injured on your property, or someone injured off your property by you or a family member. For example, if you accidentally hit someone with a golf ball while at the golf course you are covered. This protection pays the cost of medical care to an injured party regardless of whether the policyholder is liable. This coverage does not apply to you or regular residents of your household except "residence employees" like nannies. The basic limit is $1000, which can be increased to $5000. In the example above, if the injured golfers medical expenses totaled $1,200, the medical payments coverage under the policy would pay up to the limit of $1,000 and the remaining balance of $200 would be covered under the personal liability section of the policy.

Credit Insurance

Credit Life insurance is a special type of life insurance. Lending institutions, such as banks and credit unions, or retail stores selling merchandise on credit, offer credit insurance to their customers to cover debtors' obligations if they die or become disabled. For example, Herb buys a $20,000 car, taking out a $15,000 loan for 4 years. The dealer offers credit life protection so that if he dies during the loan period, his family doesn't have to pay the declining loan balance due. The policy is available for a one-time cost of $500, which can easily be financed into his loan. Is this a good deal? Assuming Herb is 35 years old and in good health, for $125 per year over a 4-year period, Herb could purchase a traditional level term life policy for at least $100,000 coverage. Dollar for dollar, the credit life insurance is much more expensive. PRACTITIONER ADVICE: Most experts agree that, dollar for dollar, credit life insurance is much more expensive than traditional life insurance. Unfortunately, credit life is packaged and sold at a time when consumers are making expensive purchases and may feel obligated. Companies selling credit life insurance know this, and are offering a limited product at high cost. Generally, it is best to avoid credit life insurance, and build the amount of protection into your overall life insurance need.

Current Income defined for Residual Benefit

Current income means the insureds earned income in each month while he or she is residually disabled. Insurers differ in their treatment of current income, but they calculate it either on the basis of cash actually received or on an accrual method to exclude income that was earned but not collected before disability began.

Offer and Acceptance

Deals begin when one person makes a proposal to exchange something of value with another person. The proposal to make an exchange is called the offer. The offer must be reasonably definite and communicated clearly. If the second person agrees to the exchange, this is called acceptance. The acceptance must be unconditional, unequivocal, and communicated clearly. The offer and acceptance may be oral or in writing. The law recognizes both forms. In property insurance, most states allow oral insurance binders and contracts, but they are usually put in writing as soon as possible to provide protection for the insured and insurer.

Consideration of Final Expenses

Death in itself creates expenses and taxes called final or postmortem expenses. For example, probate costs will be incurred. Probate is the process of filing, validating and executing a will by a court. These costs vary significantly by jurisdiction and as a function of the estates size. Such costs commonly range from 2 to 5 percent of the gross estate and can be higher. Executor fees may also be incurred in final expenses. Postmortem expenses include estimated final illness expenses. A well-designed and implemented financial plan should provide for health insurance or other means for meeting these expenses. Funeral expenses, which today average around $8,000 in the United States, should also be recognized in the financial plan. Death-related federal and state taxes could constitute a major final expense for those with significant net worth. These taxes should be estimated and included as a postmortem expense to be paid on death.

Death Proceeds

Death proceeds are the policy face amount and any additional insurance amounts paid by reason of the insured's death, less any loans taken against the policy and past due premiums during the grace period. When the beneficiary receives the death proceeds of a life insurance policy, generally no federal income tax applies to this amount. This is reasonable because premium payments for individually purchased life insurance are not deductible from a person's federal income tax. Generally the only time a death benefit may be taxed deals with business life insurance. Often when a business owns a policy on the life of an employee, it will deduct the premiums paid as a cost of business. Since a tax advantage is taken up-front, the death benefit becomes taxable to the beneficiary upon receipt. If the beneficiary does not take the proceeds as a lump sum of cash, and instead takes a series of payments that includes interest earnings, there is federal income tax on the interest portion. PRACTITIONER ADVICE Why does Life insurance receive special tax treatment? Most clients do not know how or why this occurs. The federal government uses tax laws and regulations not only to influence the economy, but also to encourage certain behavior that is good for society. If families provide for themselves, less people will end up being dependent on social welfare programs. This alleviates pressures on the government. So, by providing tax incentives, the government hopes people will buy life insurance to support their survivors.

Depreciation

Depreciation is calculated as a percentage. The numerator is the number of years the structure was in use. The denominator is an estimate of the useful life of the structure. For example, a building used for 15 years having an expected useful life of 60 years would be one-quarter depreciated (15/60) and three-quarters undepreciated (45/60). This depreciation calculation is not the equivalent of the accounting concept because the accounting concept is based on purchase price, while depreciation for ACV calculations is based on replacement cost and an estimate of the assets useful life.

Purchase Selection Rules

Despite the difficulty in choosing the proper amount of insurance, some commonsense rules apply: 1. Insure first exposures to loss 2. Never over expose 3. Never risk great loss REAL-LIFE EXAMPLE I met with a couple to assess their Life Insurance needs. Based on our discussion, they needed $500,000 for him and she needed $300,000 of coverage. They felt their budget could afford $50 a month to accomplish this. Based on these constraints, the proper solution was Term insurance for both. However, the husband had heard about Whole Life insurance and really felt the cash build-up and tax benefits were better than Term. After much discussion, I was able to convince them to move ahead with my recommendation as going with Whole Life would mean retaining most of the risk they sought to transfer. This was an example of the mistakes consumers make when not following the proper steps in policy selection. Discussion of policy types should be avoided until after both need and budget are known. Limiting policy types to only those that fit both constraints will ensure only suitable solutions are pursued.

Determine Amount of Assets

Determining the amount of available assets to meet one's needs is the next step in selecting the proper amount of life or disability insurance. For example, when reviewing life insurance needs, available assets include existing life insurance policies, individual savings, social security benefits and group life insurance provided by employers. If a gap exists between financial needs and available assets, this gap is the appropriate amount of insurance to purchase. Making an informed purchase of the proper amount of life insurance often is a complicated procedure. However, there are certain principles that help make an informed decision.

Consumers' Financial Goals

Determining the consumer's financial goals is the starting point when choosing the proper amount of life or disability insurance. How much money is needed to solve financial problems if death or disability were to occur immediately? Choosing the proper amount of insurance, like choosing the proper policy, begins with knowledge of the need for insurance. The need for insurance is related to the severity and the probability of a potential loss. In property insurance, the need for protection usually is based on either the acquisition cost or the replacement value of a physical asset. This need can be readily calculated. In cases of business income insurance or liability claims, estimates of potential losses are needed. Trends suggest that people tend to buy too much insurance for low severity, high-frequency losses, and purchase inadequate coverage for high severity, low frequency exposures. An example of such a mistake would be to purchase a service contract on a new car extending the warranty several years, while simultaneously driving with the minimum amount of liability coverage. The most one could lose in terms of a car repair bill is far less than the most one could lose in a liability suit. PRACTITIONER ADVICE It is important to review all of the client's insurance coverages to see if their money is being well spent. For example, could the deductibles on the Homeowners and Auto policies be increased so that the premium savings could be used to buy Life Insurance?

We can categorize business general liability exposures as follows:

Direct Liability Vicarious Liability Contractual Liability

Direct Liability

Direct liability arises out of the firms own actions. Most of these exposures, except damage done by vehicles, fall into the following three subcategories. 1. Premises and Operations 2. Work Liability 3. Product Liability

Direct losses

Direct losses are the immediate, or first, result of an insured peril. For example, if a fire destroys a home, the loss of the home is the direct loss.

Direct and Indirect Personal Property Losses

Direct property losses are frequently caused by perils including fire, theft and windstorm damage. Indirect property losses include temporary housing expenditures during a period when a home is rebuilt after a fire and car rental expenses after a vehicle has been wrecked or stolen. Most property, real and personal, is insured, with a homeowners insurance policy. This type of policy also provides some income reimbursement and liability coverage, and can be quite flexible when endorsements for special situations are attached to the basic policy.

Directors and Officers Liability Insurance

Director and Officers liability insurance (D&O) covers Directors of corporations and other organizations. It is valuable in attracting people to serve on boards of directors. In the absence of this coverage, board members might find their personal assets subject to liability claims, or might find they had to finance a legal defense of their alleged malfeasance from their own resources.

Total Disability

Disability contracts typically define disability in one of 3 ways: 1. Own occupation definition, which is usually referred to as "own occ." 2. Modified own occupation, with a time limit (e.g. 2 years) on "own occ" protection. 3. Any gainful occupation definition, which is popularly, if somewhat inaccurately, called "any occ." For example, the Total Disability clause may read: "Total Disability" means, that for the first 2 years, you are disabled if, due to injury or illness: 1. You are unable to perform the duties of your occupation, and 2. You are under the care and attendance of a physician." PRACTITIONER ADVICE After ensuring that the insurer being selected is strong and reputable, the most important factor in selecting a policy is its definition of disability. What good is a "cheap" premium if the insured will never be able to collect benefits due to restrictive definitions?

PRACTITIONER ADVICE for Disability Insurance:

Disability protection is perhaps the most overlooked of all needs. Most people assume they have some form of coverage through their employer or the government. Unfortunately, the qualification requirements for Social Security benefits for disability are very strict, with approximately 70% of all first-time applicants being denied. Additionally, only about 30% of the workforce is covered by some form of sick pay / salary-continuation program. The vast majority of this coverage is short-term (less than a year of coverage). Ignorance of what coverage really exists as well as denial that a disability may happen to them (it impacts approximately 1 in 3 people during their working years), causes most people to avoid doing a true assessment of this need.

Dividends Actually Paid

Dividends actually paid are, as the name implies, amounts actually paid as dividends. Dividends are not guaranteed, and, therefore, may not equal the dividend illustration. Dividends actually paid equal those illustrated only if their experience basis is the same as that implicit in the illustration. Future experience rarely tracks past experience exactly and never over an extended period. On the other hand, some insurers have "frozen" their dividend scales. They have paid dividends almost exactly as illustrated regardless of the developing experience. PRACTITIONER ADVICE Having a loan against your cash value life insurance policy will probably have an impact on the dividends you receive. Most insurers that pay dividends use a direct recognition scale so that those with loans get lower dividends than those who have no loans from their cash value.

Viatical Settlement Model Act

Due to concerns over possible abuse of viatical settlement transactions, the National Association of Insurance Commissioners (NAIC) promulgated the Viatical Settlements Model Act and a companion regulation to guide the viatical settlement business. The Viatical Settlements Model Act requires that certain disclosures be made to the viator. These disclosures include: The impact of the transaction on eligibility for government benefits, Possible tax implications, Rescission rights, and Alternatives to viatical settlements. The Act also covers the licensing of viatical firms and brokers, as well as offer guidelines that establish minimum prices as a percentage of the policy death benefit.

Variable Life Insurance

During the 1980s, some universal life policies added separate investment accounts from which insureds could choose in addition to the fixed interest rate. This increased the opportunity for the fund to grow, but with greater risk to the insured. The death benefits may vary directly with the insured's investment results. While these new variable universal life policies provide more options, they still operate similarly to the basic universal policy.

Taxation of Annuities

During the accumulation phase, the assets invested in an annuity contract grow tax-deferred. When distributions are withdrawn, and if they do not represent a contract that has been annuitized, the date of the insurance contract will determine whether first-in-first-out (FIFO) or last-in-last-out(LIFO) tax treatment will be utilized: 1. FIFO Method- Pre August 14, 1982, for distributions. 2. LIFO Method - Post August 13, 1982, for distributions. When the contract owner receives a distribution, the date that the original annuity was purchased will determine the appropriate accounting treatment used to calculate ordinary income, if any. Then, unless the owner of the contract is older than 59-1/2, has suffered a disability, or has died, the taxable portion will be subject to a 10% penalty. For example, assume a contract was purchased on 1/15/79 for $5,000 and the account is currently worth $75,000. If a 55-year-old takes a $3,000 distribution, the amount is a tax-free return of basis and not subject to a 10% penalty since it is a pre August 14, 1982, annuity and FIFO accounting is used. The remaining basis is now $2,000 ($5,000 original purchase price - $3,000 distribution). Now assume the same facts except the contract purchase date is 1/15/89. The $3,000 is now taxed as ordinary income and a 10% penalty applies because the owner is age 55 and the disability exception is not applicable. The basis is still $5,000, as LIFO tax treatment was used. Understanding the tax basis of distribution is extremely important when a policyholder wants to annuitize an annuity contract. The net tax basis before the contract is annuitized is used to determine the amount of each annuity payment that is a tax-free return of basis calculated in the exclusion ratio. This net tax basis is the numerator of the formula given below. Continuing with our example, if the FIFO contract is annuitized, the numerator in the exclusion ratio is $2,000; otherwise, it is $5,000, based on the LIFO contract. The exclusion ratio is: Payment Received x (Basis in Contract / Expected Number of Payments to be Received) = Return of Basis. (Note: If the contract is a deferred annuity with no post-tax basis (e.g., tax-deductible IRA contributions), then the exclusion ratio is zero, because all distributions are taxed as ordinary income.) Continuing with the previous example, assume the $72,000 is used to purchase a yearly straight annuity of $10,000 with 9 years of actuarial number of payments. If the FIFO annuity was used, the exclusion ratio for each payment is $222.22 [($2,000 / ($10,000 x 9 years)] x $10,000, and $9,777.78 ($10,000 payment - $222.22 return of basis) is taxed as ordinary income. The exclusion ratio under the LIFO method is $555.56 calculated as: [($5,000 / ($10,000 x 9 years)] x $10,000 and $9,444.44 ($10,000 payment - $555.56 return of basis), and is taxed as ordinary income. What happens if, after only one payment, you die? With a straight life annuity, the payments stop at death. However, the remaining basis is an itemized deduction NOT subject to 2% of adjusted gross income (AGI). The basis after one payment in the above example under the FIFO contract is $1,777.78 ($2,000 - $222.22) and $4,444.44 ($5,000 - $555.56) under LIFO.

Exclusions in Section 1 in HO-2

Eight exclusions apply to the section 1 coverage in HO-2. Exclusions specify losses not covered by the policy. Each of the eight exclusions eliminates the insurers liability for the insured loss. The ISO form does not insure for loss caused directly or indirectly by any of the exclusions listed below. Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to be loss. 1. Ordinance of Law - The ordinance or law exclusion eliminates coverage for additional expenses if current zoning laws or building codes prevent rebuilding a structure comparable to the damaged home. For an additional payment, this exclusion can be removed by endorsement. 2. Earth movement 3. Water damage 4. Power failure 5. Neglect 6. War 7. Nuclear hazard 8. Intentional loss

Emergency Planning

Emergency planning is an integral part of a thorough risk management program. Some disasters require quick action. Plans should be in place in advance to deal with such things as extortion plots, kidnapping of executives, explosions, natural disasters, chemical leaks, or any disaster where the amount of damage can be reduced by the action of an emergency response team. Firms with international operations should have personnel available to travel to any location where disaster threatens or has occurred. All organizations incur costs because they are exposed to unexpected losses. Paying insurance premiums, paying for uninsured losses, paying for driver training programs, or paying for installing a fire sprinkler system represents a cost of being exposed to loss. A risk manager has some ability to control the amount and timing of these costs. Successful loss control efforts reduce the amount of loss costs. Given that some losses occur even when loss control efforts are effective, an efficient risk-financing program minimizes the impact of these losses on profits.

A personal risk management plan involves the following steps:

Establish Objectives Identify potential loss exposure Measure potential loss exposure Develop a risk management plan Implement a risk management plan Regularly review the plan

Personal Liability Losses

Estimating potential liability loss is nearly as difficult for individuals as it is for business firms. Million-dollar claims for injury are almost commonplace. For this reason, many people add an excess personal liability policy to extend and increase the liability coverage on their other insurance policies. Since these excess policies provide wider coverage than the base policies they cover, they are referred to as umbrella policies. These umbrellas provide coverage if underlying (homeowners and automobile) policies are exhausted. A $1 million personal liability umbrella usually is moderately priced, costing about $175 per year.

Audits and Solvency Testing

Every insurance company is required to file an annual statement with the insurance department in each state in which it transacts business and with the NAIC. The various state insurance departments verify these reports by an audit. The audit is conducted by the state insurance department of the state in which the insurer is domiciled, joined by representatives of insurance departments of other states. The NAIC audit procedure divides the country into four zones, with one representative from each zone participating in each audit.

1035 Exchanges of Insurance

Existing life insurance policies and annuity contracts can be exchanged for new policies and contracts with different insurance companies as a tax-free exchange. This is permitted by IRC Section 1035(a) as a like-kind exchange if the current owner is named the new owner of the policy or annuity contract. At some point a conversion analysis must be considered to determine if another contract is better than the current policy owned. Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies: A contract of life insurance for another contract of life insurance or for an endowment or annuity contract; or A contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity; or An annuity contract for an annuity contract. Take as an example a deferred annuity contract owned by Lauren. Lauren bought the annuity from Company A for $100,000. The current value of the annuity contract is $150,000. Lauren wishes to purchase a better annuity contract from Company B. If Lauren surrenders the annuity from Company A to buy a new $100,000 annuity from Company B she will owe income tax on the gain of $50,000. With a 1035 exchange, Lauren can exchange her current annuity for Company Bs annuity without owing taxes on the gain. Her cost basis in Company Bs new annuity contract is the same as her previous basis in Company As contract of $100,000. However, financial planners need to consider issues in an exchange such as: New expenses and commissions on the new policy. Early surrender charges paid on the old policy. Higher premium on the new policy due to older age when issued. Higher premium as health has declined since the issue of the original policy being exchanged. New contestability period: a two-year period from the issuance of the new policy during which the insurance company could challenge a death claim based upon misstatement on the application. Tax consequences on surrendering an existing policy that has an outstanding loan. The IRS also permits a 1035 exchange to transfer funds from an annuity contract into an existing contract with a different company. Annuitants may wish to do a partial 1035 exchange to obtain better benefits from a new annuity contract or from another existing annuity contract while keeping the benefits included in their old contract. A partial 1035 exchange can also minimize the income tax on a distribution as long as the surrender or distribution is not made within two years of the partial exchange. Using the previous example, if Lauren wanted to withdraw $50,000 from her annuity contract she would be taxed on the $50,000 at ordinary income rates. Instead, Lauren does a 50% partial 1035 exchange and transfers $75,000 from Company As contract (valued at $150,000) into a new contract. Each contract will now have $75,000 and a cost basis of $50,000 which is ½ of her original basis of $100,000. When Lauren withdraws $50,000 now from Company As contract, she will only have a taxable gain of $25,000. A distribution occurring within 24 months is deemed to be abusive by the IRS, and multiple contracts would be treated as one contract when determining taxable gain and the tax-free return of basis. Exceptions to this two year rule include distributions made for unexpected events such as divorce or unemployment.

PRACTITIONER ADVICE: When determining LTC need, one must consider:

Family history (What is typical life expectancy and how is health in later years?) Availability / ability of loved ones to provide care (Are there younger generations available nearby? Are they willing / able to provide care?) A number of adult children express the emotional strain and sadness felt from bathing a parent, especially of the opposite gender. Also, there is the guilt of placing a parent in a home. But what about the strain on the adult child's personal life when a parent has to be cared for at home? Financial ability to pay for LTC out-of-pocket. (Is an LTC policy needed? Is Medicaid an option?) Desire for options in care. (Qualifying for Medicaid may sound like a cheap way out, but limitation of choice can create a terrible strain on the individual and family members.) The elderly person's sense of independence and dignity. (How does the parent feel about their children having to care for him/her?) These are only some of the issues to be considered. Due to the numerous psychological aspects of LTC planning, this area of risk management and insurance planning is often neglected.

Financial Responsibility Laws

Financial responsibility laws require drivers to furnish evidence of financial responsibility to retain their driver's license or their auto's registration. Most drivers purchase liability insurance, which is acceptable evidence of financial responsibility. Alternative evidence would be a surety bond or a deposit of assets. Drivers must establish their financial responsibility after they have been involved in an automobile accident or after they have been arrested for a serious traffic violation. Among the states that have passed compulsory insurance laws are Arkansas, Indiana, Massachusetts, New York, Louisiana, and North Carolina. In these states, drivers must show evidence of their purchasing at least the minimum required amount of insurance before the state issues automobile license plates. A few states operate unsatisfied judgment funds. These states use revenue collected from license plate sales or from insurance premium taxes to make payments to injured victims of uninsured motorists.

Risk management with companies having international operations

Firms with international operations may have property and employees in several different countries. These firms must devote special attention to identifying all their property, including that being transported between locations. International businesses need specially trained staff to implement their risk management programs. Two problems these companies face is: 1. Valuation of property in foreign countries may be difficult due to currency fluctuations. 2. Lack of local insurance facilities.

Hazards

Hazards are conditions that increase the probability of loss from a peril, by increasing either the frequency or the severity of potential losses. For example, every home faces the peril of destruction by fire. Storing oily rags near the homes furnace would be an example of a hazard. The hazard increases the chances of the peril occurring. If an insured materially increases a hazard, the insurer may suspend the insurance coverage. Hazards can be separated into four categories: 1. Physical Hazards involve physical characteristics such as type of construction, location, occupancy of building, having frayed wires on plugs, steep stairs with no railing, or smoking in bed. 2. Moral Hazards involve dishonest tendency such as exaggerating losses in a theft claim or auto insurance fraud (e.g., two cars intentionally bump each other with many passengers claiming injury). 3. Morale Hazards involve an increase in losses due to knowledge of insurance coverage such as having a different attitude toward a loss because the loss will be covered by an insurance company (e.g., leaving a car unlocked, ordering unnecessary medical tests, or a jury's tendency to grant larger amounts of money in situations where an insurer will have to pay). 4. Legal Hazards involve increased frequency and severity of losses such as legislative action (e.g., ADA requirements or mandated insurance coverages).

Commercial Package Policy

Historically, business organizations had to purchase several different insurance policies when weaving together a complete insurance program. A small or medium-sized manufacturing or retail firm might have needed five separate policies to achieve its insurance objectives: property insurance, liability insurance, crime insurance, automobile insurance and transportation insurance. Specialized firms such as building contractors, jewelry firms and firms operating aircraft needed even more policies. Since 1987, a package or combination of policies has allowed many firms to make one insurance purchase providing all generally needed coverages. The Insurance Services Office (ISO) designed the Commercial Package Policy (CPP) to provide insurance coverage to a broad range of profit and nonprofit organizations including manufacturing firms, schools, retailers and apartment building owners. In fact, most property owners except private homeowners can use this policy. Insureds must purchase at least two of the package's components, but may purchase as many additional components as they need. The CPP is preceded by declarations and conditions applying to the entire package.

Armstrong Investigation

How effective was the regulation provided by the states? Based on subsequent revelations, one must conclude the states were probably much better at taxation than they were at regulation. In 1905, New York State made an extensive investigation, known as the Armstrong Investigation, into the life insurance industry. The revelations revealed scandalous behavior. The investigation revealed business practices such as unethical business acquisition methods, unjustifiable home-office expenses, unethical political influence and other problems.

INSURANCE COMPANY SELECTION MODULE

INSURANCE COMPANY SELECTION MODULE

INSURANCE POLICY SELECTION MODULE

INSURANCE POLICY SELECTION MODULE

Consideration of Liabilities in Needs Analysis

Identifying an individual's liabilities is an important part of the information gathering process. A review of an individual's liabilities shows which ones are to be paid at death and which ones should be transferred to heirs. Most liabilities are paid at death. However, some may be assumable by others (such as, some mortgage loans), or they may be in more than one person's name. If the home mortgage loan is to be paid, its outstanding balance is included. If it is not to be paid off at death or at incapacity, it is excluded. However, mortgage loan payments would be included as an ongoing income need. PRACTITIONER ADVICE In addition to existing liabilities at the time of incapacity or death, planning must include those liabilities that are created by the incapacity or death. For example, costs not covered by medical insurance and/or final expenses such as funeral, probate and estate liabilities need to be considered. Individuals who do not seek professional advice with this process often tend to miss some of these variables when identifying their needs.

PRACTICE STANDARD 400-1

Identifying and Evaluating Financial Planning Alternative(s) The financial planning practitioner shall consider sufficient and relevant alternatives to the clients current course of action in an effort to reasonably meet the clients goals, needs, and priorities.

Key Employee Life Insurance

If a business were to lose a key person, its earning power could be harmed, perhaps seriously. Key employee life insurance can protect business firms from financial problems caused by such losses. The first step in the risk management process is to identify the key person. It may be the president, the chief researcher, a top salesperson or an engineer. Losses of key people have the potential of causing severe losses, more so than property losses. The next step is to measure the financial loss the key persons death would cause. Such a measure will usually involve an estimate of what it would cost to replace the key employee. To measure the loss, firms also need estimates of the effect on profits while a replacement is hired and trained and has achieved the same level of productivity. After identifying and measuring the potential loss, the business purchases a life insurance policy on the key employees life. The business is the owner and the beneficiary of the policy, and the key employee is the insured. The business pays the premiums. The key person must be insurable and must give permission for the purchase for this arrangement to work.

Inflation Protection of LTC

If a policy is purchased with no inflation protection, the benefit amount remains at its original level indefinitely. The client needs to be aware of purchasing power risk (detailed further in the Investment Course), which is the risk that inflation will erode the real value of the investor's assets. In this case, the value of the long-term-care policy is the client's asset. For example, assume a client purchases a long-term-care policy without inflation protection for $275 per day and a 3-year term. In addition, inflation for long-term-care costs is a constant 4.5% increase over the next 20 years. Twenty years later the client is a resident in a nursing home, receiving a $275 per day benefit when the actual cost per day is $663. This is calculated as: n = 20; I = 4.5; PV = ($275); FV = $663. A majority of LTC policies offer some kind of inflation protection for an additional premium, which is designed to ensure that the benefit amount increases with the cost of living. As shown in the example above, inflation protection of 4.5% would fully hedge the purchasing power risk. A 3% inflation protection on the policy would increase the daily benefit to $497, calculated as: n = 20; I = 3; PV = ($275); FV = $497. Any shortfall will erode assets that would normally be distributed to beneficiaries upon the policyholder's death. As the financial planner, you will need to help the client determine whether it is worthwhile to pay the increased premiums or whether this would constitute paying for benefits that may never be utilized in the future. Many companies offer options such as: Increasing the benefit amount by 5% of the original amount per year. Increasing the benefit amount by 5% compounded annually. Adjusting the benefit amount annually according to increases in a price index, such as the consumer price index in the United States. PRACTITIONER ADVICE The inflation rider is the most expensive rider. The Compound Inflation rider can equal half of the total premium, especially for younger insureds. For people in their fifties though, it doesn't make sense to buy LTCI without the inflation protection. How much coverage would a daily benefit of $200 provide twenty-five years from now?

Gift of Insurance Contract

If an insured irrevocably assigns all rights in an existing insurance contract for less than an adequate consideration, a gift of the contract is made, and gift taxes may be due. Of course, if the owner receives an adequate consideration for the transfer, it is a sale, not a gift. If the owner gifts an existing contract upon which premiums remain to be paid, such as a whole life insurance policy, the value of the gift is the policy's fair market value, which is its replacement cost. If a comparable contract is not ascertainable, the fair market value equals the interpolated terminal reserve plus the value of unearned premiums and any accumulated dividends, and less any policy indebtedness. The reserve value, not the cash surrender value, is considered, although the difference often is negligible except in the early policy years. If the policy owner gifts a single-premium or paid-up life insurance policy or annuity, the value of the gift equals the replacement cost of the contract, which is the single premium that an insurance company would charge for a comparable contract issued at the insured's/annuitant's attained age. A comparable contract is one providing payments of the same amount. With term life insurance policies, the gifted amount is the value of the unused premium. If a new policy was bought for another person the gift is the gross premium paid by the donor.

Reformed

If mistakes have been made in a policy, the policy may be reformed; that is, the policy may be corrected so one party cannot take advantage of the other party's mistake.

Triple-Trigger Theory

If several insurance policies were in force when a developing injury is in progress, all the insurers would be responsible for providing coverage. This is called the triple-trigger theory. The three triggers are exposure, manifestation, and exposure-in-residence period. The three triggers are: Exposure, Manifestation, and Exposure-in-residence period.

Paul v. Virginia

In 1869, in Paul v. Virginia (8 Wall 168, L.ED. 357), the U.S. Supreme Court addressed the question of whether the state or federal government should regulate the insurance marketplace. The question before the court was whether insurance was a transaction in interstate commerce? If the answer was "yes," the Constitution of the United States would give the federal government the power to provide regulation. If the answer was "no," the states would provide the regulation. In this case, Mr. Paul, an agent of a New York insurer, was convicted of violating a Virginia law prohibiting solicitation of business without a state-issued license. Mr. Paul argued that he did not need a license from Virginia because his activities involved interstate commerce. The state, which stood to lose substantial tax revenue on insurance transactions, maintained Paul was a citizen of the state, conducting business in the state and, therefore, was subject to state regulation. The Supreme Court agreed with the state's interpretation. Thus, for about the next 75 years, the insurance transaction was not considered interstate commerce. It was a transaction to be regulated and taxed by the various states.

South-Eastern Underwriters Association

In 1944, in the South-Eastern Underwriters Association (SEUA) case, the U.S. Supreme Court reversed its historical position rendered in Paul v. Virginia. It now concluded that insurance was indeed interstate commerce. In this 4 to 3 decision, the Court declared the federal antitrust laws could be applied to insurance company operations. The facts in this case were as follows: The SEUA had a near monopoly on the property insurance business in the southeastern United States. To promote and extend its power, the association engaged in boycotts, ratemaking conspiracies, tie-in contracts and other abuses outlawed by federal antitrust legislation. Unfortunately for the consumer, the federal antitrust statutes apparently did not apply to these offenses because of the Paul v. Virginia decision 75 years earlier. In reversing Paul v. Virginia, the Supreme Court now concluded that the insurance transaction was in fact interstate commerce and, therefore, subject to federal regulation, including the antitrust laws. The SEUA decision wasn't the end of regulatory efforts in the insurance industry. There were two reasons for this: There was no existing federal insurance code, so the SEUA decision left the industry virtually unregulated. The industry and the state regulators expressed strong opposition to federal regulation. As a result, in 1945 Congress passed the McCarran-Ferguson Act.

Inland marine insurance covers:

In 1953, a second nationwide definition was adopted. This second definition, currently effective in a majority of states, provides for five types of property to be the proper subject of inland marine insurance: Property designated for export. Imported property until it reaches its destination. Domestic property in the process of shipment. Property used to facilitate transportation, such as bridges, tunnels, pipelines, and electrical transmission towers. Personal property that is easily moved and typically of significant value, such as jewelry, furs, cameras, and some types of electronic data processing property.

Universal Life Insurance

In 1979, a new type of policy, called universal life insurance, was created in an attempt to meet the interests of those consumers who liked the low cost nature of term insurance, and the cash value features of whole life insurance. This new hybrid product was to be more flexible than its predecessors with features that allowed the insured to determine whether it would function more like term or more like a whole life policy. The name universal was used to describe how it could be tailored for many peoples different needs. Some even touted universal life as the last life insurance policy you ever need to buy. Assuming premiums are paid as planned, and based on interest rate performance, funds should typically grow over time. However, due to the flexible nature of the policy, the insured assumes some risk that the fund will actually decline, because of skipped premiums, loans or lower than expected interest rates, creating a future need to pay more premiums to cover the increased cost of insurance. PRACTITIONER ADVICE Universal Life has more flexibility than Whole Life. It also carries surrender penalties that Whole Life does not. Make sure that the agent explains all of the advantages and disadvantages of this product.

Commercial Policy

In 1986, the ISO CGL policy format experienced significant change and was renamed the Commercial General Liability policy, also called the CGL. The new ISO CGL policies have two formats: Occurrence form Claims-made form

Risk-Based Capital

In 1992, after the well-publicized failure of three large life insurance companies and the financial weakening of others, the NAIC developed a new risk-based capital (RBC) requirement for life insurance companies. In 1993, an RBC requirement was developed for non-life (property) insurers. The difference between the fixed minimum amount of capital standard and the new RBC standard is that the RBC standard takes into account differences in a particular insurer's underwriting and investment practices in developing a capital and surplus requirement for that specific company. Risk-based capital is the estimated amount of capital needed to cushion the risks of operating an insurance company based on the risks inherent in a particular insurer's operations.

Introduction to PAP (Personal Auto Policy)

In addition to providing protection against damage and theft of the insureds car, the PAP provides liability protection. If a person says they were injured or their property was damaged due to an auto accident caused by the insured, the PAP affords protection against such liability claims. Under the tort liability system, injured parties must either sue the insured or be offered a settlement of the claim before collecting for their injuries. Several exclusions apply to restrict the scope of the liability coverage. The PAP begins with a declarations page, insuring agreement, and definitions. The coverage sections follow and the policy ends with a section covering the insureds duties after a loss and one containing general policy provisions. The declarations identify the named insured, the vehicles covered, and the premium charged for the coverage. The insuring agreement describes the insurance in broad terms. The PAP begins with definitions that apply throughout the policy. Personal Auto Policies vary from state to state. Some states, such as Massachusetts, are no fault states. In these states, an insured individuals policy will pay covered losses without regard to fault. This speeds up the claims settlement process. In other states, fault must be determined in order for the at-fault party or their insurer to pay a claim.

LTC Contract Provisions

In addition to the basic benefit provisions, Long-Term Care Insurance (LTCI) policies contain several other provisions that collectively define the quality of the policy. LTCI premiums are determined by the applicant's age, gender, medical condition, history, and the benefits provided. The three basic components that establish the premium and define the payment of benefits under LTCI policies are: the elimination period the benefit period, and the amount of daily benefit. Issue ages vary widely by company, such as 50-84, 55-79, 40-79 and 20-74. Some companies restrict LTCI policies to the above-age-40 market, primarily because of concern over AIDS. When a company's lowest premium is based on age 40, a person under age 40 wishing to purchase an LTCI policy would be charged the age 40 premium if found insurable. Actuaries remain uncertain about many aspects of LTCI pricing because they do not yet have a substantial body of experience on which to rely. The issue is further complicated as many LTCI policies rely on lapse-supported pricing; that is, those who lapse early subsidize persisting policyholders. Many believe that LTCI premiums are too high, even though premiums have declined in recent years. Typical first-year commissions paid to agents who sell the policies fall in the 50 to 80 percent range, and are important factors in LTCI insurance pricing. Group commission rates, however, are much lower. A major reason for such commission rates is the degree of difficulty in selling LTCI policies; historically, it has been difficult to convince individuals that the probability of their needing some kind of expensive care is increasing as they age. To encourage agents to work harder to get the message out and to reward their hard efforts, insurers needed to offer substantial commissions. With increasing awareness and innovative marketing, such as worksite marketing, prices may decline further. But it should be kept in mind that the LTCI policy is exceptionally complex for both insurer and customer. As such, care must be taken in pricing and in purchase. PRACTITIONER ADVICE When selecting a company for Long-Term Care Insurance, ask how long the insurance company has had LTCI policies. If they have more than 10 years experience in the market, the company's actuaries will have better information on claims experience, and can design a more accurate premium. Be wary of companies with their first LTCI product and unusually low premiums.

Regulatory Responses in Pricing

In an insurance marketplace, free price competition cannot be relied upon to promote customer welfare. So solvency regulation is used as a substitute for unrestrained competition. Insurers have to get prior approval from the regulator before using the rate, the first method used in solvency regulation. The second method is the open rate method. Open rating allows an insurer to use whatever rate it chooses after filing the rate and the supporting statistics with the regulator. Open rating, the more popular scheme, allows the regulator to disapprove any rates being used. Such regulatory disapproval means the insurer must stop using the rates. This approach allows more freedom for insurers to compete on prices, with some regulatory control retained.

Non-Forfeiture Options

In business, if one party fails to complete contractual arrangements as called for, the other party may void the contract and perhaps confiscate property to satisfy a debt. If a life insurance company were allowed to cancel a cash value life insurance policy for non-payment of premiums, it would work to the serious disadvantage of the consumer. Insureds in poor health and unable to make payments would be clear losers. Insureds with large savings accumulated in the life insurance policy would also be losers. To prevent such injustice, the law provides that life insurance policies having a savings value are not forfeited if the policies are lapsed. The development of the non-forfeiture option is associated with one of the first insurance commissioners of Massachusetts, Elizur Wright. Wright was a champion of the insurance consumer. When an insured stops paying premiums on a continuous-premium whole life policy, or other policy requiring more payments, the insurer grants three options: 1. cash, 2. term insurance, and 3. whole life insurance fully paid up, but for an amount less than the original policy.

Strict Liability Torts

In certain cases, tort liability is imposed in the absence of both negligence and intent to interfere with the plaintiffs legally protected interests. Such liability is known as strict liability, or liability without fault. In other words, a person is said to be strictly liable if legal responsibility is imposed, even though he or she has not acted intentionally and has exercised the utmost care to prevent the harm. Two other forms of strict liability are imposed upon: 1. Suppliers of defective products that cause personal injury or property damage, and 2. Upon common carriers for goods lost or damaged in transit.

Tax Implications

In general, commercial insurance premiums are a tax-deductible expense, as are uninsured losses. The main difference between the two is the timing of the expense. Insurance premiums are deductible when paid, while losses are deductible when incurred. The Internal Revenue Service has consistently opposed allowing tax deductions for advance funding of expected losses, even if companies claim to be engaging in self-insurance. Setting aside other arguments in the self-insurance decision, increasing deductibles or reducing the policy limits shifts the tax burden from the present to the future, assuming variable losses over the years but the same total loss for the period under analysis. Thus, this decision becomes, in part, a present value financial decision, raising the necessary issue of identifying the appropriate discount rate. In simple terms, paying insurance premiums implies a cost in forgone interest for the time between the premium payment and the loss. If losses are incurred during a period when a firm is not profitable, a new issue enters the equation because tax deductions may not be as valuable. To make the mathematics of the trade-off simple, we would like to hold all other factors constant, but this is an inappropriate assumption here. If a company experiences an uninsured loss of property, it may deduct only the book value, that is, the under appreciated value, of the loss, which may be less than the replacement cost of the loss.

Intentional Torts

In intentional torts, the tortfeasor acts deliberately with the desire to harm the plaintiff. Intentional torts may be classified according to the interest protected. A person may be held liable in tort for intentionally interfering with anothers person, property, or business relations. Tort law protects a person against harmful or offensive bodily contacts (and apprehension of such contacts), and confinement. It also protects intangible emotional interests, such as a persons peace of mind, reputation, or right to be left alone. Examples of these intentional torts include invasion of privacy and trespassing. The torts safeguarding a persons physical or emotional well-being from intentional interference include: Assault and battery: A victim is entitled to recover damages to compensate for the mental disturbance and physical illness or injury sustained. It is also a crime subject to state criminal law. False imprisonment: A person who intentionally confines another within fixed boundaries (for example, by being locked in a room), by physical force, threat of physical force, or other forms of duress. Intentional infliction of emotional distress: To recover, the plaintiff must prove the defendants intent to cause (or reckless disregard of the probability of causing) emotional distress, and the plaintiffs suffering extreme and severe emotional distress caused by the defendants conduct. Defamation: A communication is defamatory if it tends to harm the reputation of another as to lower him in the estimation of the community or to deter third persons from associating or dealing with him. Liability for defamation requires the statements to be false. The law recognizes two forms of defamation: libel (publication of statement by written or printed words) and slander (communication of statement by spoken words or gestures). In intentional and negligent torts, the law imposes liability because of the defendants fault in causing the plaintiffs harm. Intent and negligence simply represent differing degrees of fault. On the other hand, in strictly liability torts the defendant is held liable in the absence of either negligence or an intent to interfere with the plaintiff's legally protected interests. That is, the defendant is held strictly liable without fault.

Life Insurance with regard insurable interest

In life insurance, the policy owner must show a recognized interest in having the insureds life continue. This interest must be shown when the policy is purchased. People are presumed to have an unlimited insurable interest in their own lives and may purchase any amount of insurance on their own lives that an insurer will issue. The law presumes a husband and wife have an unlimited interest in each others life. Beyond close family relationships, an insurable interest must be demonstrated. Interests that generally can be demonstrated include creditors in the lives of their debtors, partners in each others lives, and employers in the lives of their key employees.

Other Risk Considerations

In making the trade-off between lower premiums and lower policy limits, or between lower premiums and higher deductibles, the risk manager should consider the following factors: 1. Tax implications 2. Ability to pay for losses 3. Psychological factors 4. Social and ethical concerns

Medical Insurance Benefit

In the case of employer-provided medical insurance benefits, employers can deduct medical and health insurance premiums and the premiums are deductible to employees as medical expenses subject to 7.5% of their adjusted gross income (AGI). Benefits to employees are not included in their gross income, therefore they are not taxable to an employee unless the benefits exceed the actual medical expenses incurred. In self-insured accident and health plans, the employer pays an employees medical expenses directly instead of paying for insurance premiums. Benefits to highly compensated employees may be taxable if the plan discriminates in favor of such individuals. Highly compensated employees must report any medical reimbursements they receive in their gross income if these same reimbursements are not made available to other employees. As health insurance benefits realistically are not available for other types of consumption or for savings, it is logical that they should not be subject to a tax levied on net income. Another important policy justification for the health benefit exclusion is to encourage the purchase of private insurance to minimize the role of government in bearing the burden of health care costs.

Contact Rules

In the early 1990s, an interesting question regarding the extent of UM coverage arose in an Alabama court. Some jurisdictions have followed the no-contact rule established in this case, while other states continue to require contact between an insured's automobile and a hit-and-run vehicle. Consider the following hypothetical circumstances. Assume an insured swerved her automobile to avoid a truck bench seat left on an interstate highway. In swerving the auto, the insured driver lost control and the auto rolled over, injuring the insured and a passenger. Assume the insured presents a claim for recovery to her insurer for medical expenses and loss of income, claiming the obstacle in the road was left by a hit-and-run driver. In many states, insurers might deny this type of claim, believing the insured must show contact between her vehicle and a second vehicle driven by a hit-and-run driver. The rule evolved because some drivers causing one-car accidents (for example, drivers hitting a telephone pole or driving into a ditch) would fraudulently claim a hit-and-run driver caused the accident. In the case under discussion here, the Alabama court, following the no-contact rule, ruled that UM coverage was provided to insureds legally entitled to recover damages from owners or operators of uninsured motor vehicles, regardless of contact. The court ruled that despite the lack of proof, one could reasonably infer that the truck bench seat arrived in the road through the use of a motor vehicle, which it shortly classified as a hit-and-run vehicle. The court's finding, that the damage was caused by a hit-and-run vehicle, entitled the injured motorist to pursue a UM claim.

Prices

In the market for most consumer goods and services it is assumed that the law of supply and demand, operating through open competition, determines prices. Competition, however, does not necessarily work to the consumer's advantage in the insurance marketplace. Part of the problem with competition in insurance is that insurers must set prices before costs are fully known. Although lacking the complete details of cost is not unusual in manufacturing, the life insurer or liability insurer might have to wait 50 or more years to learn them. If an insurer overestimates its costs, the company makes money. If the insurer underestimates its costs, ultimately the company becomes insolvent. The consumer would be worse off if the insurance was purchased from a company that under-priced its insurance and became insolvent than if too much was paid for protection. In neither case, however, would the consumer's welfare be maximized. Unfortunately, a consumer unaided by expert opinion is not a good judge of the fairness or adequacy of an insurance company's rates. Free price competition cannot promote consumer welfare in the insurance marketplace. The question confronting regulators in such a case is how much freedom in pricing should the industry be allowed. There are two main regulatory responses to this question: 1. Prior approval 2. Open rating

Defining Long-Term Care Insurance

In the past, long-term care (LTC) was synonymous with nursing home care, giving it a negative connotation. Few elderly relish the prospect of spending their last days in a nursing home. These days LTC has taken on a broader meaning and no longer carries the stigma associated with it earlier. The New York State Insurance Department defines LTC as follows: LTC refers to a broad range of supportive medical, personal, and social services needed by people who are unable to meet their basic living needs for an extended period of time because of accident, illness, or frailty. LTC involves receiving the assistance from other people to perform the essential Activities of Daily Living (ADLs) when these tasks can no longer be performed independently. ADL assistance may be provided at home by formal (paid) caregivers, such as home health aids, by informal (unpaid) caregivers, such as family members or friends, or in a nursing home. This definition makes it clear that LTC, as it applies today, means more than nursing home care.

Benefit Periods of LTC

In the past, policies paid the daily benefit for a period of time up to the benefit period chosen at policy issuance. But now, an improved feature is a maximum lifetime approach to defining benefit payments is common. In this way, the benefit period can extend beyond four years by using services costing less than $100 per day. This pool of money concept is becoming more popular than the traditional specified daily limit with policies sold today due to the flexibility it affords.

Unilateral Contract

In unilateral contracts, only one party makes an enforceable promise. Insurance contracts are unilateral in that only the insurer makes a binding promise. The insured can cancel the policy at any time without recourse, while the insurer is limited to specific situations (such as failure of the insured to pay premiums) when it may cancel a policy. The insured does not promise to pay the premiums and cannot be sued for failure to do so. Insureds cannot collect for losses if they do not pay premiums, because timely payment of the premium is a condition of the contract. Contracts in which both parties make enforceable promises are called bilateral contracts. Insurance is not considered a bilateral contract. The most popular term insurance policies these days are those that come with a premium guarantee period, for example, 20-year level term. The insurance company is committed to honoring the contract and not raising the premium for 20 years. The policyholder however, is not committed to keeping the policy for 20 years, and can cancel at any time.

Incidents of Ownership

Incidents of ownership are the legal rights of the policy owner of a life insurance policy, such as the right to change the beneficiary, the right to take a loan, or the right to the dividends. If the insured has any incidents of ownership, or if the proceeds are payable to the insured's estate by naming the estate or the executor as the beneficiary of the policy, the proceeds of the life insurance policy are included in the gross estate and may be subject to the estate tax. For example, assume John Adams names his son, Fred Adams, as beneficiary of his $1 million life insurance policy. The following tax consequences occur when John dies: Assume John retained one or more of the incidents of ownership in the policy. Therefore, at his death, the proceeds are included in John's gross estate and potentially subject to estate tax. Fred, the beneficiary, pays no federal income tax on the proceeds. Now assume that John transfers all ownership rights in the life insurance to his wife Ann. In this second case, there is no federal estate tax on the life insurance proceeds when John dies because he did not own the policy at his death. If Ann dies before John, however, then the value of the policy at the time of her death, the policy's replacement cost value, is included in her estate. John must also survive for three years after the transfer to avoid having the policy added back to his gross estate. Fred would owe no federal income tax on the proceeds in this case, but his mother would be construed to have given the son a $1 million gift. This complication is one reason why people often use life insurance trusts to own life insurance in estate plans. TEST TIPS: Understand the difference in income and estate tax treatment of death benefits. Many people get confused or jump to conclusions too quickly in this area and make mistakes.

Incidents of Ownership effecting Taxation

Incidents of ownership include any economic benefit in a life insurance policy. A life insurance policy owner has "incidents of ownership" in the policy, such as the right to borrow against the policy, assign or transfer the policy, receive cash values and dividends or change the beneficiaries. Retaining any incidents of ownership in a policy causes the death benefit to be included in the insured's estate, which may be subject to estate tax. Inclusion occurs even if the policy is transferred to a new owner or to a trust more than three years before the insured's death, if any incidents of ownership are retained. Now, assume instead that six years ago John transferred all ownership rights in the life insurance policy to his wife Abigail, not to Fred, and that he died this year. In this case, the life insurance proceeds would not be included in John's estate because he did not own the policy or have any incidents of ownership at his death, and he had transferred the policy more than three years before he died. If Abigail had died before John, however, then the value of the policy at the time of her death - the replacement cost value - would be included in her estate. Fred as beneficiary would owe no federal income tax on the proceeds he received, but his mother (as policy owner who is not the insured) would have given him a $1 million gift of the proceeds. This complication is one reason why people often use irrevocable trusts to own life insurance as part of their estate plan. If, however, the gross estate is below $5 million, there will be no federal income tax or estate tax due, and therefore, no need to create an irrevocable life insurance trust (ILIT). PRACTITIONER ADVICE Remember, estate taxation is not the same as income taxation. The beneficiary will generally receive the death proceeds without having to pay any income taxes on those funds. Also, if the beneficiary has no incidents of ownership in the policy, his or her estate will not need to include any policy values upon death. Also, although there may be no federal estate tax consequences, there may be state estate tax liabilities due to lower limits than the $5,430,000 dollar federal exemption and inheritance taxes.

Indirect Loss

Indirect losses are more difficult to identify than direct property losses. The direct cost of a machine can be seen and easily measured; however, the indirect loss of revenue from a machine that is inoperable and the impact on the overall operation can be more difficult to see. Often, it is difficult to estimate how long a machine or a building will be unavailable after a loss, or whether a loss will occur during a busy season or a slack period. Despite these challenges, risk managers must make careful estimates and judgments about the potential size of indirect losses.

Commercial Indirect Losses

Indirect losses occur after physical damage. Insurers categorize these losses as follows: Loss of Income: Loss of income is the decrease in revenue while you repair the damage. For example, if you own a restaurant and have a fire in the kitchen, you might be closed for several weeks while the kitchen is repaired. Continuing Expenses: Continuing expenses are expenses that continue even though the property has been damaged. Building on the kitchen fire example from above, a continuation expense would be the mortgage and real estate taxes that continue to be due even though the kitchen has to be repaired. Extra Expenses: Extra expenses are additional expenses incurred to keep your business going. For example, maybe you rent out an empty restaurant for two months in order to stay in business while your kitchen is rebuild.

Indirect losses

Indirect losses, also called consequential losses (such as loss of use), are a secondary result of an insured peril. If a tornado destroys a restaurant, the property damage is the direct loss. The loss of income during the period when the business is being reestablished is the indirect loss

Group Insurance

Individual consumers purchase individual life insurance on their own accord, whereas group insurance is provided to members of a well-defined group of people who are associated for some purpose other than purchasing insurance. Some contracts contain a conversion privilege, which allows the employee to convert the group policy to individual coverage when they leave their employer. Without this provision, the coverage ends when the employment terminates. Group Insurance is a means through which a group of individuals who usually have a business or professional relationship can gain access to insurance more easily than individual coverage, but usually with less flexibility or reduced optional benefits. The group entity (such as an employer or professional association) is the contract owner and each member is provided with an insurance certificate outlining his or her coverage. PRACTITIONER ADVICE: While many employers offer group life insurance coverage, it is important to understand the differences between group and individually purchased policies. Group policies are sold based on group rates, accounting for volume and a mixed risk assessment. Individual policies, on the other hand, are priced according to the cost of marketing to the individual and based on their specific risk factors. Typically, a healthy non-smoker will find an individual policy to be less costly, though it may require a more extensive application process. On the other hand, a person whose health condition limits his or her ability to purchase life insurance individually may find group coverage to be the only option.

Medical Expense Coverage

Individuals not covered by group or government health plans need protection through individual policies. Individuals not covered by group or government health plans are: Self-employed persons, Students no longer covered by their parents' insurance, Persons under retirement age and not in the work force, such as early retirees and persons between jobs, Those whose employers do not offer medical expense coverage, Part-time, temporary, or contract workers not eligible for coverage through their employers, Unemployed persons not eligible for government-sponsored health programs for the poor, and Children, spouses, and other dependents ineligible for coverage or too costly to cover under an employer-sponsored plan. Some individuals falling into these categories rely on spouses or other family members to include them under the family coverage options of their employer-sponsored plan. For some, the need for individual coverage is permanent; for others, it is temporary. Individuals whose basic need for health insurance is met through group or government plans at times still find individual policies useful because they supplement their other coverages. They may merely need a hospital indemnity policy that will pay an additional fixed amount for each day of hospital confinement, or they may want a policy to cover truly catastrophic expenses, with a deductible of several thousand dollars.

ISO

Insurance Services Office Insurance Services Office, Inc. (ISO), a subsidiary of Verisk Analytics, is a provider of statistical, actuarial, underwriting, and claims information and analytics; compliance and fraud identification tools; policy language; information about specific locations; and technical services. ISO serves insurers, reinsurers, agents and brokers, insurance regulators, risk managers, and other participants in the property/casualty insurance marketplace.[1] Headquartered in Jersey City, New Jersey, United States,[2] the organization serves clients with offices throughout the United States, along with international operations offices in the United Kingdom, Israel, Germany, India and China.[3]

Investment Activities

Insurance companies are not free to invest funds in all available alternatives provided by the capital markets. Also, as inferior investments may jeopardize insurer solvency, the states have established strict limitations on the types of investments insurers may make. State regulation specifies the classes of acceptable and unacceptable investments and the method used to value assets. Life insurance companies hold vast amounts of the publics savings and the life insurance contracts may extend over long periods of time. These situations do not arise in non-life insurance. So life insurers are generally not allowed to make risky investments. Typical restrictions on life insurers include a limitation on the total amount of common stock a company may own. For example, in New York, the limit is about 10 percent of the insurer's admitted assets. Property insurers are not as severely restricted from purchasing common stock and have done so to a considerable extent. Life insurers offering newer products based on the performance of a portfolio of equity investments may do so within the framework of special rules for these products.

Unearned Premium Reserve

Insurance companies operate under what is called statutory accounting, because it is required by statute, that is, the laws of the states. This procedure differs from the GAAP (Generally Accepted Accounting Principles) that most businesses are required to follow. For example, insurers can only count their collected premiums as income only as they are earned. Expenses, however, are charged against the revenue as soon as they occur. Property insurers need an unearned premium reserve because insureds pay for their insurance in advance, typically one year at a time. For example, when homeowners pay annual premiums, during the first month the insurer earns one-twelfth of the premium and must show eleven-twelfths of the premium in its reserve account. The unearned fraction represents eleven of the twelve months of the year that have not passed and for which the premium has been paid.

Participating and Non-Participating Whole Life

Insurance companies owned by policyholders are called mutual insurance companies. Participating (par) whole life policies, which are typically sold by mutual companies, provide their owners with the right to share in surplus funds accumulated by the insurer because of deviations of actual experience from assumed experience. This provision is known as the Annual Apportionment of Divisible Surplus. If there is a divisible surplus, the insurer must pay dividends. The participating plan involves a relatively large initial premium followed at the end of the year by a dividend. The participating premium is relatively large because insurers use conservative estimates of mortality, administrative expense and interest earnings. For instance, mortality losses may be estimated at 20 percent higher than the actuarys statistics predict. When the bad results do not occur, the unnecessary premium is returned to the policyholder as a dividend. The return of the overcharge is not comparable to the payment of common stock cash dividends, and it is not treated as a dividend for tax purposes. It is viewed as merely a return of the insureds overpayment of premium. Nonparticipating policies are life insurance policies issued by insurance companies that are owned by stockholders, rather than policyholders. Non-participating whole life policies fix policy elements, that is, the premium, the face amount and the cash values, if any, at policy inception. These elements are guaranteed and make no allowance for future values to differ from those set at inception. Non-participating (non-par) policies use more realistic projections of operating results and require a lower initial premium, although, in the long run, participating policies may prove less costly. Non-par policies do not pay dividends to policyholders at the end of the year, but modern forms credit excess interest payments if the insurer earns investment returns beyond the guaranteed rate. Most whole life insurance sold worldwide is participating. A significant proportion is non-participating but with some non-guaranteed element. The amount of guaranteed-cost, non-par whole life sold is small in most countries. This small share is not surprising because companies are understandably unwilling to offer liberal pricing guaranteed for decades into the future. Conservatively priced products providing long-term guarantees do not compete well against those where the insurer does not guarantee every policy element.

Rescission

Insurance contracts also may be ended by rescission. Rescission is an agreement (contract) by both parties to end a contract. All the requisites of a contract are required. If rescission is mutual, both parties voluntarily relinquish their rights and duties under contract. If one party feels it was the victim of fraud, it may ask the court to rescind the contract. Rescission is a well-recognized equitable remedy from English common law. PRACTITIONER ADVICE Applicants for life insurance are sometimes tempted to lie about their cigarette smoking because the premiums are so much lower for non-smokers. If the insured dies within the contestable period, and the insurance company discovers the person smoked, the company will rescind the contract and the only payment to the survivors will be the return of premiums.

Incontestable Clause

Insurance contracts are contracts made in utmost good faith. This means an applicant may not answer questions untruthfully or conceal information an honest person would reveal. If an insured is untruthful or conceals material facts, the insurer may go to court and contest the policy for the purpose of voiding the policy. The incontestable clause states that, if there is a valid contract between the insurer and insured, the insurer may not contest the policy to void it after the policy has been in force for two years (occasionally one year) during the lifetime of the insured. Thus, a life insurer has only a relatively short period of time in which to uncover any fraud. Generally, after the specified time has elapsed, even if a notorious fraud is uncovered, the insurer cannot void the policy. In general, the incontestable clause prevents an insurer from avoiding claims payments. It is interesting to note this clause was included voluntarily in the contracts of some life insurers after 1850. The motive was to establish public confidence. Such a public relations effort was required because a few disreputable life insurers were voiding contracts on the slightest technical grounds.

Principles of Indemnity

Insurance contracts provide compensation for an insureds losses. The insured should not profit from an insurance transaction. Otherwise the insurance will provide an inducement to fraudulently cause losses or overstate claims. Indemnity means the insured should be restored to the same financial position occupied before the insureds loss. Any departure from this rule should be on the side of undercompensation. Insurers enforce the principle of indemnity through the insurable interest requirement, actual cash value settlements, and the operation of subrogation clauses.

Legal definition of Insurance

Insurance is a contractual arrangement whereby one party agrees to compensate another party for losses, in exchange for consideration paid (i.e., the premium). Thus insurance law is a branch of contract law. The insurance policy, like all contracts, is an arrangement creating rights and corresponding duties for those who are parties to it. In analyzing an insurance contract, you should remember that a right created for one party represents a duty (obligation) for the other party.

Financial definition of Insurance

Insurance is a financial arrangement that redistributes the costs of unexpected losses.

Unequal Knowledge

Insurance is an intangible good. As such, it is difficult for a consumer to evaluate the product's performance until it may be too late to argue. For example, if an inferior television set is purchased, a consumer usually knows about it later and begins to demand that it be repaired to specifications, replaced, or a refund granted. The problems created by an inferior insurance policy ordinarily are not readily apparent to the consumer. When the discovery is made, it usually is after the insured has made a claim for payment. This is a poor time to learn one's insurance policy is inferior. Because the insurer's performance is difficult for the consumer to evaluate properly before a loss, regulators must help. An insurer has enormous advantages in technical expertise compared to the typical consumer. Therefore, one purpose of insurance regulation is to compensate for this imbalance. For example, it would be the unusual consumer who understands the meaning of an insurance policy as well as the insurer or is able to deal with the insurer on loss adjustment questions on an equal basis. The model for perfect competition calls for both well-informed buyers and well-informed sellers. As the market moves away from this ideal, competition deteriorates and problems arise. One manifestation of the deterioration of competition is the existence of different prices for identical goods. Informed purchasers also do not pay more for goods of inferior quality than for goods of superior quality. Unfortunately, both situations occur today in the insurance marketplace despite regulation. One can only imagine how much worse the situation would be for the consumer if there were no regulations. Part of the imbalance in knowledge between insurer and insured is explained by the complexity of the insurance contract.

Law of Large Numbers

Insurance pools reduce risk by applying a mathematical principle called the law of large numbers. Simply put, the law states that the greater the number of observations of an event based on chance, the more likely the actual result will approximate the expected result. There must be a dual application of the law of large numbers. First, the insurance company must have a large enough number of exposures from which to gather their loss experience, and then must have enough insured units so that the actual number of losses will be closer to the predicted number. Suppose an insurance pool expected one percent of its members to experience a loss, based not on reasoning, but on historical records of losses. The law of large numbers states that the greater the number of exposures in the pool, the more likely the one percent loss figure will be realized. By applying the law of large numbers, the insurance company can more accurately predict the dollar amount of losses it will experience in a given period. It must be emphasized that the law of large numbers only allows accurate predictions of group results and does not identify individual events.

Defining Insurance Regulation

Insurance regulation provides the insurance market with direction, management, control and correction. Regulation can also be defined as the rules by which the game is played. For example, in football, a rule against clipping means a player loses the freedom to block another whose back is turned. It also means all players have gained the freedom from being hit while their backs are turned. If the rule is broken, as is often the case, the offending team incurs a penalty. Insurance regulations have their parallels, as they restrict some freedoms in order to create others. Insurance regulation arises from two separate sources, both working together: the law, and the administration of the law. A third important participant in the provision of insurance regulation is the courts, including state, federal, original jurisdiction and appellate courts.

Maximum Living Benefit Payout

Insurers typically provide for a maximum total living benefit payout, irrespective of how large the policy's face amount may be. Also, they usually stipulate a minimum proportion that may be accelerated. For example, they may specify a percentage such as 25 percent or an amount such as $25,000. A concern of many companies is that an unlimited benefit amount may create moral hazard in the form of more fraudulent claims. It is not unusual for the insurer to secure a release from all interested parties such as the beneficiary and the assignee, and not just the policyowner, to avoid any future misunderstanding. The decision to exercise the right to accelerate a policy's payments will affect other policy benefits and values. Remaining death benefits, premiums, cash values and dividends are reduced proportionately. Thus, if a policyowner applies to accelerate 50 percent of the policy's face amount and if the insurer finds that the insured meets the conditions for acceleration, future premiums, cash values, death benefits and dividends will be reduced by one-half. PRACTITIONER ADVICE The Accelerated Death Benefit feature does not cost anything up front. While it is less confusing to request the benefit at the time of application, most insurers allow the feature to be added at any time. Only if the insured qualifies and decides to use the feature would there be a cost (represented as a percentage of the death benefit-typically between 5 and 10%). During any policy review, advisors should be sure to inform clients of this option.

Minimizes Worry

It has been frequently asserted that life and health insurance can be regarded not so much as producers of wealth, but as mechanisms for distributing funds from the fortunate to the unfortunate. In reality, life and health insurance can be important forces in the production of wealth, in that they can relieve the policyowner of worry and increase his or her efficiency. To the extent that concern about the financial consequences of loss of life or health causes an individual uncertainty and worry, life and health insurance could help reduce this concern. PRACTITIONER ADVICE The primary reason clients buy disability income and life insurance is to create a sense of security for themselves and their family. It's important for adults to fulfill their need to provide for their dependents and to know they have prepared for life's challenges as well as possible.

Long-Term Care Plans Taxation

It is easy to conclude that health insurance benefits utilized to pay for an operation or a physician's examination should, as a matter of public and tax policy, be excluded from income. However, uncertainty has existed about the tax treatment of Long Term Care (LTC) mainly because LTC involves a combination of services, some of which are health care related and others of which appear more like personal items (for example, room and board in an assisted living facility). This uncertainty was resolved for certain types of policies with the enactment of Health Insurance Portability and Accountability Act. The legislation clarified that qualified LTC costs and benefits generally will be treated the same way as other health costs and benefits. If policies and insurers follow the consumer protection standards included in the law, such policies receive the following tax treatment: In general, benefits are excluded from taxable income. Benefits paid by per diem-based policies are tax-free up to $380 per day in 2015. Per diem amounts above $380 can be excluded from income if expenses are equal or greater than this amount. Insurers must report to the IRS the amount of LTC insurance benefits paid. Insurance premiums and out-of-pocket spending for LTC services qualify as medical expense deductions, and are 100% deductible up to the age limit. For example, in 2015, the following deductions can be made at the ages indicated: Age 40 or under $380 Age 41 to 50 $710 Age 51 to 60 $1,430 Age 61 to 70 $3,800 Age 71 or over $4,750 Self-employed individuals who are sole proprietors can deduct LTC insurance premiums up to 100 percent of the premium. Employer contributions to an employee's LTC premium are excluded from taxable income of the employee. It is important to note that LTC insurance cannot be offered as part of an employers cafeteria plan.

LTC Tax Treatment

It is easy to conclude that health insurance benefits utilized to pay for an operation or a physician's examination should, as a matter of public and tax policy, be excluded from income. Uncertainty had existed about the tax treatment of LTC mainly because LTC involves a combination of services. Some services qualify as health care, while others appear more like personal services, such as room and board in an assisted living facility. This uncertainty was resolved for certain types of policies with enactment of Health Insurance Portability and Accountability Act of 1996 (HIPAA). The legislation clarified that qualified LTC costs and benefits generally will be treated the same way as other health costs and benefits. To be tax-qualified, a policy must: 1. Be guaranteed renewable 2. Not provide a cash value for any reason other than upon full surrender or death of the insured 3. Other than at full surrender or death, any dividends or refund may only be used to reduce future premiums or increase future benefits. 4. Generally, policies must not pay for services that would be covered by Medicare, unless Medicare is specified as a secondary payer. If policies and insurers follow the consumer protection standards included in the law, such policies will be considered tax-qualified and receive the following tax treatment: In general, benefits received under a LTC plan are excluded from taxable income. Insurers must report to the IRS the amount of LTC insurance benefits paid out to the recipient. Benefits paid by per diem-based policies to individuals are tax-free up to $380 a day in 2015, and are not taxable income as long as benefit payments above $380 per day do not exceed the actual cost of care for indemnity policies. This amount is indexed for inflation. Out-of-pocket spending for LTC services qualify as medical expense deductions subject to the standard limitation of 7.5% of AGI (adjusted gross income). Expenditures for long-term care insurance premiums that cover the taxpayer, spouse and dependents also qualify as medical deductions to the extent that total medical expenses, including the LTC premium, exceeds 7.5% of AGI. However, there are limits on the premium deduction based on the taxpayer's age. Self-employed individuals who are sole proprietors can deduct 100% of their LTC insurance premiums from their income and there is no 7.5% of AGI requirement. Employer contributions to an employee's LTC premium are excluded from the employees taxable income. Consequently, the employee cannot take an income tax deduction for the premiums paid. Employers can deduct the premiums paid for LTC coverage for employees as an ordinary and necessary business expense. Long term care coverage cannot be offered as part of an employers cafeteria plan. Passage of HIPAA has helped to increase interest in LTC insurance through these tax changes. HIPAA also prohibits cash refunds except at death or upon full surrender of the polic

Calculating Benefits

It is important to understand how benefits are calculated. Lets assume that coverage for the Deutsch family includes a $250 deductible per person with 80% co-pay up to a stop loss of $5,000. If their son, Richard, suffers a broken arm with expenses that total $4,900, how much of those expenses will be covered by the insurance? The Deutsches must pay the first $250 of expenses, according to the terms of the deductible. The insurance company will then pay 80% of the balance of the covered expenses of $4,650 or $3,720. The Deutsches are responsible for paying the balance due, 20% of $4,650 or $930. Their total out-of-pocket cost under this plan would be $1,180 (calculated as $250 deductible + $930 co-insurance). Notice that the $4,900 medical expenses are broken out as follows: the insurance company paid $3,720 and the insured paid $1,180. However, one must be careful not to exceed the stop loss of $5,000 when calculating the out-of-pocket expenses. Once the insured has met the stop loss amount for the year, all other medical expenses during the year will be paid by the insurance company. To show how the stop loss will work, consider instead that the sons medical expenses are $24,900. To calculate this, first subtract the $250 deductible. Next, compute the insureds co-insurance of $24,650 x 20%, which equals $4,930. Notice the $250 + $4,930 totals $5,180, which exceeds the $5,000 stop loss. Therefore, when the stop loss amount is exceeded, the insured pays the $250 deductible + $4,750 co-insurance for a total of $5,000. This will be the maximum payout for the insured for the year. The company will pay $19,900 ($24,900 total - $5,000 insured portion).

Owner with regard to insurable interest

It is the applicant who must demonstrate the insurable interest at the time of application. The insurer needs to know that the person who will be receiving the death benefit has an adequate relationship to the person being insured. The owner of the policy is the party who can enforce the contractual rights such as naming the beneficiary, assigning the policy, taking out loans from the insurer, and designating the dividend options. In most situations, the person being insured will be the owner of the contract. For estate planning purposes, a spouse or a trust may be the owner. In business situations, the company or the partners could be the owner of the life insurance contract.

Occurrence-Based Liability

It requires the carrier providing the insurance at the time of the injury was sustained to pay the claim, even if the claim is made up to 25 years after the policy expired.

Life Insurance Reserves

Legal Reserve = Present Value of Future Death Claims - Present Value of Future Premiums.

Encourages Thrift

Life insurance can constitute an excellent means of encouraging good spending and savings habits. Many individuals who might not otherwise save regularly will nevertheless regularly pay premiums on a life insurance policy. If the policy has a cash value, this can constitute a type of semi-compulsory savings plan.

Assures Income

Life insurance can furnish an assured income in the form of annuities. Annuities prove valuable to those older persons who have succeeded in saving only a limited amount of capital and who have no one to whom they particularly care to transfer this sum on death. For example, Jackson, age 65, has accumulated $100,000. This amount represents the total funds available to him in his retirement years. Due to the limited size of the fund, Jackson will be obliged to invest it in a careful manner. Rates of return for such investments probably would not exceed 3 to 5 percent. Consequently, he would be limited to between $3,000 and $5,000 per year from the investment. On the other hand, Jackson cannot afford to take a portion of the principal for living expenses because this would reduce the available annual income in the future. The danger confronting Jackson is just the opposite of that facing Richard who wants insurance against premature death. Richard wants insurance because it is not known how long he will live. Jackson is confronted with the danger of living too long, that is, outliving available income. Richard feels that death or disability might intervene too soon and therefore wants insurance to hedge against that risk. Similarly, Jackson, who feels that the income is too limited or that he might outlive this income, can hedge against those risks by buying an annuity.

Blue Cross/Blue Shield

Life insurance companies and the Blue Cross and Blue Shield plans are the traditional providers of individual health insurance. These companies offer basic medical insurance policies which pay first-dollar coverage, meaning they pay for the entire medical expense incurred starting with the first dollar owed. An advantage is that the insured does not pay any deductibles for this type of policy, but will pay higher premium costs. Blue Cross and Blue Shield plans pay benefits directly to the participating hospital or physician after the medical bills are submitted to the insurer. The benefit provided by Blue Cross coverage is a predetermined number of days in the hospital, ranging from 70 to 365 days in a semi-private room. With hospital costs averaging more than $1,000 a day, this is no small benefit. In addition to room charges, Blue Cross plans also pay for almost all services provided by hospitals while the insured remains hospitalized. Examples of these services or incidental hospital expenses include X rays, drugs, anesthesia, and laboratory charges. Blue Cross pays the hospital a fee for each day the patient remains in the hospital, based on a pre-negotiated contract rate. Blue Shield plans cover surgical and physicians services in much the same way that Blue Cross provides hospital benefits. Blue Shield plans make payments directly to the physician on behalf of an insured who has received medical care. In some cases, Blue Shield benefits do not equal the amount charged by the physician, and the patient must pay the difference.

Furnishes Profitable Investment

Life insurance policies and annuities are adapted as accumulation devices. These policies can be reasonable long-term savings instruments, if they are selected carefully. Interest credited to policy cash values is typically tax deferred. This fact enhances the attractiveness of the contract as a savings vehicle. Life insurance and annuities can furnish a profitable and safe investment service, but life insurance policies also make it possible for the policyowner to arrange for the safeguarding of the policys death proceeds and values. Many jurisdictions accord life insurance values special protection against the claims of the creditors of policyowners and beneficiaries. The beneficiary might lose the funds provided to heirs through life insurance death proceeds through speculation, unwise investments, or excessive, unnecessary expenditures. Sound financial planning suggests that such a contingency should be contemplated by the individual and can be discouraged or even prevented through judicious use of life insurance settlement options and trusts.

Policyholder Loans

Life insurance policies with cash surrender values have a loan provision. This provision gives the policy owner the ability to borrow an amount of money less than to the cash value of the policy. The company generally has the right to delay making the loan for up to six months. The interest rate charged for the loan is stated in the policy. Unless the policy provides for variable rates, it remains unchanged, even though general interest rates fluctuate. Interest rates typically range from 6 to 8 percent. Since 1980, life insurers typically have used variable rates that change with general interest rates. The policyholder loan is secured by the cash surrender value of the life insurance policy. There is no legal requirement for the insured to repay the loan. If the loan is outstanding when the insured dies, however, the insurer deducts the amount of the loan from the insurance proceeds. Taking a loan against a life insurance policy is one alternative to surrendering the policy for its cash value. Taking a loan leaves the policy and some of the life insurance protection in force. PRACTITIONER ADVICE Policy loans are easy to get, do not show up on an insured's credit report, and do not have to be paid back. The disadvantages are that a loan will lower the projection of accumulated cash at retirement, and in most cases, will cause a lower dividend to be paid.

Living Benefits

Living benefits are those that are taken before the death of the insured. They would include dividends, savings and accelerated death benefits. The dividends received from a mutual life insurance company are not subject to federal income tax. The Internal Revenue Service (IRS) views these dividends as a return of part of the premium and not as earned income. The general rule regarding the savings feature of whole life policies is, if the insured withdraws the savings value and if this value exceeds the insureds adjusted basis (premiums paid less dividends received), the excess is subject to federal income tax in the year of the withdrawal. For example, Bill Shakespeare purchased a whole life insurance policy 35 years ago when he was 25 years old. He decides to retire at age 60 and he withdraws the cash value of his life insurance to buy a recreational motor home. Assume Bills total premiums ($50,000) less dividends he received ($21,000) equal $29,000. If Bill withdraws $35,000 in cash value, $6,000 ($35,000 $29,000) is subject to tax. For the past 35 years, Bill has not had to report the interest income on the savings value of the policy, since the growth of the cash values is tax deferred. When the withdrawal is made, however, the excess of the cash value over his adjusted basis is subject to the income tax at ordinary rates.

Long-Term Care Coverage

Long-term care insurance coverage provides financial protection against those insured incurring exceptional long-term care expenses. This is due to their need for assistance in connection with the essential activities of daily living. Coverage is triggered by an insured's inability to perform such activities and usually is paid in fixed amounts.

Federal Loss Control Regulation

Loss control engineering became increasingly important in the United States with the passage of the Occupational Safety and Health Act of 1970 (OSHA). This federal law is designed to promote a safe working environment for employees. OSHA Creates two duties for employers: 1. Removal of all recognized hazards from the work environment, and 2. Compliance with the standards for a safe working environment. Imposes heavy fines for noncompliance. Provides a provision for imprisonment in some cases where employees injuries are fatal. Provides for on-site reviews by OSHA inspectors. Requires extensive record keeping by employers, and Requires that employers enforce safety regulations rather than merely post signs or provide safety equipment.

Loss of consortium

Loss of consortium is a claim for damages suffered by the spouse or family member of a person who has been injured or killed as a result of the defendant's negligent or intentional, or otherwise wrongful acts.

Loss Data

Loss records are the foundation of a RMIS. They include details of: Injuries to workers, Liability claims, and Asset losses. Federal law (OSHA) mandates complete records of employee injuries, and companies and their insurers often require relevant data before and after losses. Computerized databases record information on the frequency, severity, causes, and final outcome of losses. This information is analyzed by date, location, individuals involved, or in some other meaningful way. If patterns of loss emerge, then the risk manager is alerted to take corrective measures. Sometimes simple analysis reveals these loss patterns. In other cases, risk managers use more sophisticated statistical techniques, such as regression analysis, to identify a problem.

High Limit of Liability

Major medical insurance plans have high limits of liability, such as $50,000, $100,000, or even larger. A common limit these days is $1 million.

Major Medical Insurance

Major medical insurance policies provide coverage for potentially large medical expenses rather than paying for the first dollar of loss. This coverage provides valuable family protection but can be expensive. Characteristics of Major Medical Coverage 1. Deductible Provision 2. Participation Provision 3. High Limit of Liability

Deductible Provision

Major medical policies cause insured's to pay an amount of medical bills equal to a substantial deductible. This deductible lowers the insurer's costs since the first dollars of all losses are not covered. Secondly, in marginal cases where treatment may not be necessary, the insured has a strong incentive to avoid overuse of medical care. Some policies apply the deductible to each illness or accident, but limit the total amount deducted to some annual maximum. PRACTITIONER ADVICE: Remember, deductibles are a form of risk retention on the part of the insured. When an insured selects a higher deductible, the insurer doesn't have to provide coverage as soon, thus saving the insurer money. Insurers pass along some of these savings to those insured's who choose higher deductibles, in the form of lower premiums. The opposite, however, is also true. A lower deductible increases insurer cost, thus comes at a higher premium to the insured. So, when selecting the proper deductible, the insured must balance risk tolerance (based on probability, frequency, and severity of loss) with affordability.

Business Automobile Insurance

Many businesses own, operate, or authorize the use of vehicles. Vehicles can suffer or cause property loss. More importantly, from a dollar standpoint, they can injure people, including the organization's own employees. In many cases, large firms will self-insure vehicle property damage. They will generally seek to insure some or all of the liability exposure associated with vehicles. Business firms wanting to insure their vehicle exposure can add the commercial auto component to their CPP. The commercial auto component of the CPP provides both liability and property coverage. Special forms are available to firms in the automobile business.

Accelerated Death Benefits

Many insurers allow an accelerated death benefit or the early withdrawal of death benefits in cases where the insured is terminally ill. The IRS issued a regulation applying to the taxation of these early payments in June 1993. These regulations provide that payments meeting a three-part test will be identified as a qualified accelerated death benefit: The insured must be terminally ill. The reduction of the remaining face value of coverage is limited. The cash value of the remaining death benefit may not be reduced. Payments that meet the above criteria are benefits that may be received on the same tax-free basis applying to conventional death benefits. REAL-LIFE EXAMPLE: A single mother was diagnosed as terminally ill with a form of brain cancer. This young woman was able to receive 92% of her life insurance policys death benefit in order to prepare for her remaining time with her young daughter. Her policy stated that if she died within 6 months of the payment, the remaining 8% held as an administrative cost by the insurer would be paid as a death benefit. Hospice care was arranged for her at home, so she could be with her family. The balance of the unused money was invested for her daughters future, which gave her peace of mind that her daughter would be financially well off. Because she passed away within the 6-month provision of the policys accelerated proceeds benefit, the insurer paid the remaining amount, providing additional security on a tax-free basis. However, if the mother had passed away after six months, the additional 8% of proceeds would not have been paid out to her beneficiary.

Taxation of Accelerated Death Benefits

Many insurers allow for an accelerated death benefit, or the early withdrawal of death benefits, in cases where insureds are terminally ill. The IRS issued a regulation applying to the taxation of these early payments in June 1993. These regulations provide that payments meeting a three-part test will be identified as a qualified accelerated death benefit, in which case the benefits may be received on the same tax-free basis applying to conventional death benefits. These cases include: The insured must be terminally ill. The reduction of the remaining face value of coverage is limited. The cash value of the remaining death benefit may not be reduced.

Terminal Illness Coverage

Many insurers offer some type of terminal illness coverage that pays an amount, if the insured is diagnosed as having a terminal illness. This amount is a specified maximum percentage, typically 25 to 50 percent, of the life insurance policy's face amount. Some companies will permit acceleration of the full policy face amount. Most provisions require that the insured have a maximum of either six months or one year to live. The insurer requires satisfactory evidence that the insured suffers from a terminal illness. Many companies have no explicit charge for the coverage because they believe that they can absorb the costs of prepaying a portion of what would be a certain death claim anyway. However, some companies assess an administrative expense charge, for example, up to $200, for processing the request and may reduce the amount payable to reflect lost interest. The benefit may be included in any type of policy. PRACTITIONER ADVICE: Since accelerated death benefit / terminal illness payout options vary among insurers, this is another reason why it is important for professional advisors to help consumers to select top-quality insurers. Most of the large, top-rated companies offer the highest payout percentages. It is important to research companies' financial strength and policy provisions such as living benefit payout options.

Preserves Estate

Many people will leave substantial estates upon their deaths. In such instances, death taxes can be substantial. For example, large estates may be subject to as much as a 35 percent marginal tax rate in 2012 under federal rules and possible state estate and inheritance taxes. Life insurance can be a natural means of providing funds to pay estate taxes. The heirs can be assured of having sufficient cash from the death proceeds to meet any tax obligations and thereby retain full ownership of estate assets. There are also arrangements whereby the death proceeds themselves avoid taxation.

Risk Management Information Systems

Many risk managers now use Risk Management Information Systems (RMIS) to do the following: Record, track and analyze losses Maintain records of plant, property, and equipment and record how they are protected from loss Perform statistical analysis of past losses and to forecast losses Some companies have their RMIS tied to national networks that track: Occupational Safety and Health Act (OSHA) bulletins relevant court decisions, and proposed state and federal legislation. To achieve maximum effectiveness, RMISs must be tailored to the needs of individual organizations. As each organization faces different physical hazards, different liability exposures, and differences in property value fluctuations, a standard RMIS cannot be as useful as a system carefully designed to solve a particular organizations specific problems. Traditionally, many of these activities were done without the speed and integration a computer allows. With RMISs, more timely, accurate, and comprehensive output permits more precise and efficient risk management decisions.

Long-Term Care Coverage

Many societies are experiencing rapid individual and population ageing. With age comes a lessened ability to fully take care of oneself. By age 75, the odds of requiring some long-term care increases to 60 percent. However, the long-term care need is not confined to the elderly. The demand for long-term care insurance can be expected similarly to grow as more and more persons become aware of the extraordinary costs of long-term care. Various factors have converged both to decrease the ability of families to provide care and to increase the demand for long-term care. Long-term care insurance refers to a broad range of supportive medical, personal and social services for people unable to look after themselves over a long period of time. The need for long-term care insurance could be for several reasons: The continuing demise worldwide of the extended family and the rise in single-parent households. Families' increasing reliance on the incomes of both spouses, with the result that neither spouse may be available to assist elderly parents, who are living alone in old age in unprecedented numbers. A more mobile society, meaning that children are less likely to live near elderly parents. Reduced fertility rates, which means fewer children to provide care. Increasing life expectancy due to modern medicine's ability to prolong life, which does not always translate into physical independence.

Health insurance can be classified into three categories:

Medical expense insurance, Long-term care insurance, and Disability income insurance.

Medicare

Medicare is health insurance for people age 65 or older, under 65 with certain disabilities, and any age with End-Stage Renal Disease which is permanent kidney failure requiring dialysis or a kidney transplant. The cost for Medicare will vary depending on the plan, coverage and services used. Most people get their Medicare health coverage in one of two ways, the original Medicare Plan or the Medicare Advantage plans like HMO's and PPO's which is called Part C. The Part C alternative combines Part A (Hospital Insurance) and Part B (Medical Insurance). Most Part C plans cover prescription drugs. If it does not, then it may be possible to purchase Part D (Prescription Drug Coverage). The original Medicare Plan provides Part A (Hospital Insurance) and optional coverage for Part B (Medical Insurance), Part D (Prescription Drug coverage), and Medigap (Medicare Supplement Insurance) Policy. Most people are eligible for Part A coverage without having to pay a monthly payment/premium if they or a spouse paid enough Medicare taxes while working. If someone does not qualify for premium-free Part A they may be able to buy it, but they may have to enroll in Part B and pay a premium for it too. Medicare Part A helps cover inpatient care in hospitals, including critical access hospitals and skilled nursing facilities, but not custodial or long term care. If you meet certain conditions it may cover hospice care and home health care as well. Medicare Part B helps pay for medical services like doctors' services, outpatient care, and other medical services that Part A doesn't cover. Part B helps pay for covered medical services and items when they are medically necessary and some preventive services. Most people will pay the standard monthly Part B premium. However, as of January 1, 2007 the Part B premium is based on modified adjusted gross income once annual income exceeds a certain amount. Medicare Part D (Prescription Drug Coverage) is available through private companies that work with Medicare to provide prescription coverage. There are different types of Drug Plans. Once enrolled in a plan you may switch plans from November 15-December 31 of each year. In most cases a separate monthly premium is paid. Premiums vary by plan. If you decide not to enroll in a Medicare drug plan when you are first eligible you may pay a penalty if you choose to join later. A co-payment or coinsurance, and in some cases, an annual deductible will also need to be paid. Prescriptions are filled with pharmacies that have contracts with Medicare.

Medicare Supplement Insurance

Medicare supplement insurance, also known as Medigap insurance, is designed specifically to supplement benefits provided under the Medicare program. This coverage typically pays for such things as the various Medicare deductibles, additional expenses when Medicare coverage ends, and the difference, if any, between the "reasonable payment" provided by Medicare for a physician's services and the amount actually charged by the physician. Insurers base the premiums for Medigap coverage on the insured's age when the policy is issued and the amount of coverage provided. Like Medicare, Medigap policies typically do not cover expenses for intermediate or long-term custodial care. The National Association of Insurance Commissioners (NAIC) has developed 10 standardized Medicare supplement insurance plans with each covering a core group of minimum benefits. The law imposes a $25,000 fine for insurers selling contracts not meeting the following standards: Open Enrollment - Insurers must accept individuals age 65 or older who buy Medigap policies within six months of enrolling in Medicare, regardless of their health status, claims experience, or medical condition. Preexisting Conditions - Insureres can exclude benefits for conditions diagnosed six months before the policy was issued. Duplicate Coverages - Insureres cannot sell a Medigap policy to a person who already has a Medigap policy unless it is a replacement policy. Loss Ratios - Medigap policies must return in benefits at least 60 percent of the premium earned on individually purchased Medigap policies, and at least 75 percent of the earned premium on group policies. Guaranteed Renewable - Insurers cannot cancel or refuse to renew Medigap policies solely because of the insured's health condition. Policies can be cancelled only for nonpayment of premiums or material misrepresentation. Additionally, Medicare drug discount cards have been available since June 1, 2004. Unfortunately for consumers, there are more than 30 cards to choose from, and each offers discounts on different prescription medications. Seniors can only have one Medicare drug discount card, but can also have private drug discount cards. Consumers should carefully research all alternatives.

Settlement Options

Most death benefits are paid in lump sum. Typically, the insurance company sets up a money market account for the full amount and delivers a checkbook to the named beneficiary. However, the policy owner can designate settlement option before death, e.g. to prevent unwise spending. The Settlement Options provide additional flexibility. Settlement options include: 1. Fixed amount 2. Cash 3. Life Income 4. Interest only

Community Care

Most elderly are happier and healthier when they can maintain as much control over their own affairs and as much independence as possible. LTC policies usually provide benefit payments for those insured who require assistance but who are able to remain in their homes or communities. The benefits, usually stated as a percentage (such as 50 percent of the full nursing home benefit) are available for a variety of programs and services. PRACTITIONER ADVICE Many LTC policies now offer a rider, for an additional premium, that increases the home care benefit to 100% of the daily benefit. This gives the client more financial support to stay in their community, and makes the policy easier for them to understand, e.g. "I will get benefits up to $200 a day, whether I get care at home or in a nursing home."

Disability Coverage

Most individuals are concerned about the possibility of incurring high medical bills and, therefore, seek and maintain medical expense insurance coverage. However, only a small proportion of the wage-earning population has disability income coverage. Most disability income insurance is issued on a group basis, with a substantial portion issued to individuals. Policies sold to individuals are issued on a guaranteed renewable or non-cancelable basis. The basic benefit arrangement in the policies of the major insurers consists of a monthly benefit for total disability and a waiver-of-premium provision. Supplemental coverages include a monthly benefit for residual or partial disability; a monthly benefit paid when certain social insurance programs fail to provide benefits; a cost of living benefit; and a guarantee for purchase of additional insurance at a later date.

Residual Benefit Formula

Most insurers do not require that an insured sustain a prior period of total disability before claiming residual benefits. A residual claim can start from the date of loss (illness or injury), and the reduced benefit amount will be payable once the elimination period is satisfied. From a practical standpoint, the vast majority of residual claims follow some period of total disability. Residual claims make up only a small portion of all disability claims, whether from occurrence date or as continuation following prior total disability.

Activities of Daily Living

Most policies agree to pay benefits if the insured cannot perform basic living activities without assistance. The typical policy requires that the insured be unable to perform two of five or six ADLs (activities of daily living), depending on the policy. Because LTCI contracts are not standardized, the policies can contain any of the following list of activities of daily living (ADL): Eating Bathing Dressing Walking Toileting Continence Transferring, and Taking medicine. Some individuals can physically perform all ADLs and yet cannot be left alone safely. Thus, LTC policies also include a cognitive impairment clause, which permits benefit payments with respect to those who cannot safely perform essential ADLs.

Elements of a negligent act:

Negligence refers to a cause of action where a plaintiff may assert a civil tort case against a defendant. In order to meet a prima facie (on its face) case for negligence a plaintiff must definitively prove the following four elements: 1. That there was a duty on the part of the defendant to conform to a certain standard of conduct. 2. That that defendant breached that duty 3. The breach of duty was, not only the actual cause, but the proximate cause of injury 4. There are damages.

Entire Contract Provision

New York law requires that the written policy, including the application for the insurance when attached to the policy, constitute the entire contract between the parties. The entire-contract provision serves two purposes: 1. It allows the insured a chance to review the answers as they are recorded in the application. 2. It prevents the insurer from making any hidden document or undisclosed restrictions a part of the contract. Historically, some companies incorporated their by-laws in their contracts by reference only, thus frustrating beneficiaries seeking death proceeds. The entire-contract clause explains one reason the handwritten application is attached to each contract. Including the application provides a chance for policy owners to review the statements made in the application, which is now a part of the contract. Only information based on the attached statements can be contested within the contestable period. An insured must review the application carefully to see that the oral responses were recorded accurately. REAL LIFE EXAMPLE: A young insurance agent had been approached by a woman who wanted to purchase a life policy on her husband. Each time he stopped by their home, the husband was never there to sign the paperwork. Finally, the wife told him to leave the papers and she would have him sign. Though he was supposed to meet every applicant and witness all signatures, he saw this as the only way to complete the sale. To his embarrassment, what he had done was easily caught by the underwriter. It turned out that the husband was a well-known crime figure who had been sitting on death row all this time!

Property Insurance with regard insurable interest

No one may collect insurance proceeds unless a personal loss can be shown from the insured event. In some cases, courts have allowed recovery where the insured had a contract to purchase a structure, or the expectation of inheritance, but the transaction was not complete at the time of an insured loss. This description should make it clear that more than one party may have an insurable interest in the same property. In property insurance, this interest must be shown to exist when the loss occurs. A person may purchase insurance on property not yet owned. To collect the insurance proceeds, the person must demonstrate he or she suffered a financial loss from the insured event.

1. Consider the three scenarios given below identify which are considered collisions: 1. A car is stolen and the thief has a collision. 2. A car in Florida is under a coconut tree during a storm and a coconut falls and breaks the windshield. 3. A car hits a pheasant causing the bird to disintegrate on the windshield, in turn causing the driver to leave the road and hit a tree.

None are collisions. Breakage of glass and loss caused by missile, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, or colliding with a bird or animal shall not be deemed to be loss caused by collision, according to automobile insurance policy under collision coverage.

For reinstatement, evidence of insurability, beyond the good health of the insured, means, among other things, that the insured must:

Not be engaged in any dangerous occupations or hobbies, Not be awaiting execution for a crime, Pay all defaulted premiums with compound interest, and Repay any outstanding loans with interest. The requirements for reinstatement are the same as purchasing a new one with respect to insurability. Furthermore, reinstatement usually involves a larger outlay of cash than starting a new policy because all defaulted premiums must be repaid with interest.

Capacity

Not every person legally has the capacity to enter into a contract. State law defines the period of minority as ending at age 18. If a 13-year-old were to enter into a contract, it would be voidable at the youngster's option. If a minor chose not to void the contract, the youngster could ratify or affirm it when reaching age 18. Many state laws allow older minors (often beginning at age 15) to make binding agreements for insurance in specific instances. Insurance companies also must be qualified to enter into contracts. They must have a license to operate in each state in which they do business. The unauthorized insurer would be subject to fines and penalties by the courts if an insured were injured because of having dealt unknowingly with an unqualified insurer.

Increased Future Benefit

Often referred to as Automatic Benefit Increases, this optional rider means that at stated intervals, usually early in contract, the insurer offers to increase the monthly benefit. Typically the increase is by a certain percentage (e.g. 5%) so monthly benefit of $3,000 becomes $3,150. This is designed to help the insured keep pace with inflation and pay raises. If the increase is accepted, the premium will also increase by a small amount. PRACTITIONER ADVICE In most contracts, the insured can decline the increased benefit, but may lose privilege of future increase offers. It is usually a good idea to accept the higher benefit amount.

Affordable Care Act

On March 23, 2010, President Obama signed the Affordable Care Act. The law puts in place comprehensive health insurance reforms that will roll out over four years and beyond, with most changes taking place by 2014. The provisions in the bill fall under the following categories: New consumer protections Holding insurance companies accountable Increasing access to affordable care Improving quality and lowering costs Some of the most notable consumer protections that have gone into effect include: Prohibiting denying coverage for children under the age of 19 due to a pre-existing health condition. Prohibiting insurance companies from rescinding health care coverage after a person becomes sick. Eliminating lifetime dollar limits on insurance coverage for essential benefits, like hospital stays. The use of annual dollar limits has been restricted for new plans. Providing consumers with a way to appeal coverage determinations or claims to their insurance company, through an external review process. Maintaining a website for citizens to compare health insurance coverage options. Establishing consumer assistance programs within the states to help consumers navigate the private health insurance system. Other provisions of the Act hold insurance companies accountable by: Bringing down health care premiums. It is required that insurance companies spend at least 85% of premium dollars on health care services from large employer plans, and 80% for plans sold to individuals and small employers. Eliminating overpayments to big insurance companies that offer Medicare Advantage plans.

Overinsurance

One extreme that may occur due to the decision of a risk manager is overinsurance. Overinsurance can be defined as a point where: Deductibles are so small that the company is insuring expenses, that is, predictable losses or maintenance costs, or So much insurance is purchased that the firm's profitability is adversely affected because the firm is trying to protect itself against the maximum possible loss rather than the maximum probable loss.

Technology driving GLB passage

One of the major forces behind the passage of Gramm-Leach-Bliley (GLB) was technology. The appearance of personal computers, faxes, e-mail, pagers, digital cameras, palm pilots, mobile phones, scanners and the Internet has changed the way people solve problems and conduct business transactions. Moreover, change appears to feed on itself, as each new development seems to come more quickly and be accepted more rapidly than the preceding development. In case of the financial services industry this technology means that people who operate these tools may make better, smarter, quicker decisions. Computer and communication technology give people more information, including expert advice, and facilitate communications between customers and service providers twenty-four hours a day, seven days a week. As banks and other financial services providers believed that GLB offered them the potential for adapting all these technological possibilities to handle financial service transactions and better serve their clients, they lobbied for the new legislation.

Other Insurance Company Information

Other sources of information about specific insurance companies include insurance agents, state insurance regulators and satisfied or dissatisfied customers. All these sources may be subject to biases. Agents may have a monetary interest in recommending a company. Dissatisfied customers may be victims of their own misunderstanding. Moreover, stories about a few dissatisfied customers are more likely to receive public attention than the successful handling of thousands of claims in which customers were satisfied by their insurer's efforts. State insurance regulators may be forced to make limited comments because of the sensitive nature of their statements. In past years, the Consumers Union has published reports on automobile, long-term care, health and life insurance companies covering claims handling, cancellation, relative costs, customer satisfaction, and other characteristics in its magazine, Consumer Reports. Although a particular review may no longer be current, it presents information that a consumer would find useful in evaluating a company's desirability.

Aviation Insurance

Owners and operators of aircraft, airport operators, and companies building and supplying parts for aircraft such as navigation equipment, purchase aviation insurance. The term aircraft as used in insurance is quite broad. In addition to private and commercial airplanes, the term also applies to helicopters, hot air balloons, hang gliders, and space satellites. Aircraft owners purchase both property insurance to protect against loss caused by physical damage to the plane, and liability insurance to protect against lawsuits. Insurers call the airplane itself, including its electronic equipment, a hull. An aircraft hull policy provides protection either for damage caused by specified perils or on an open-perils basis. The cost of aircraft insurance is a function of the perils covered. For example, open-perils coverage is more expensive than specified-perils coverage, while ground and flight coverage is more expensive than a not-in-motion policy. The latter would provide property loss damage coverage but not liability coverage.

PRACTICE STANDARD 200-1

PRACTICE STANDARD 200-1 Determining a Client's Personal and Financial Goals, Needs and Priorities The financial planning practitioner and the client shall mutually define the client's personal and financial goals, needs and priorities that are relevant to the scope of the engagement before any recommendation is made and/or implemented.

PRACTICE STANDARD 200-2

PRACTICE STANDARD 200-2 Obtaining Quantitative Information and Documents The financial planning practitioner shall obtain sufficient quantitative information and documents about a client relevant to the scope of the engagement before any recommendation is made and/or implemented.

PRACTICE STANDARD 300-1

PRACTICE STANDARD 300-1 Analyzing and Evaluating the Clients Information A financial planning practitioner shall analyze the information to gain an understanding of the clients financial situation and then evaluate to what extent the clients goals, needs, and priorities can be met by the clients resources and current course of action.

PRACTICE STANDARD 400-2

PRACTICE STANDARD 400-2 Developing the Financial Planning Recommendation(s) The financial planning practitioner shall develop the recommendation(s) based on the selected alternative(s) and the current course of action in an effort to reasonably meet the client's goals, needs and priorities.

PRACTICE STANDARD 400-2

PRACTICE STANDARD 400-2 Developing the Financial Planning Recommendation(s) The financial planning practitioner shall develop the recommendation(s) based on the selected alternative(s) and the current course of action in an effort to reasonably meet the client's goals, needs, and priorities.

PRACTICE STANDARD 600-1

PRACTICE STANDARD 600-1 Defining Monitoring Responsibilities The financial planning practitioner and client shall mutually define monitoring responsibilities.

Loss of Key Personnel

Part of identifying the key-employee exposure is developing an estimate of where, at what cost, and how quickly a replacement may be hired and trained. The cost of the replacement would give the firm an estimate of the value of its exposure to loss. Key employees should have well-trained subordinates when this is possible. Key personnel may be identified using an organizational chart or a flow chart. Estimating the cost of key-employee losses is difficult because finding and training a replacement is a function of the job market Once key employees are identified, life insurance should be considered for them. In a Key Person policy, the business pays the premiums and receives the death benefits. These funds can then be used to recruit and train a new person, as well as cover the income lost due to an employee's untimely death.

Dividend Options

Participating life insurance policies pay dividends to the policy owner. Owners may exercise a choice as to what form the dividends take. The following are four standard dividend options: Dividends may be taken in cash. Dividends may be used to pay a portion of the next premium. Dividends may be left to accumulate interest. Dividends may be used to purchase single-premium, paid-up insurance. For example, a $50 dividend may purchase $123 of paid-up whole life insurance at age 40. At the insured's death, the beneficiary receives the sum of the paid-up additions, plus the face amount of the policy. Even if the insured has become uninsurable, the owner still may acquire more life insurance using this dividend option. If the insured decides at a later date that he or she would like to take some of his or her accumulated dividends in cash, he or she can redeem some of the paid-up additions for the original cash dividend amount. Since this option provides a good benefit for beneficiaries upon death while still allowing access to the cash during life, most insurers use the paid-up additions as the default option. Some companies offer other dividend options in addition to these four, including the option to use the dividend to purchase one-year term insurance. This so-called fifth dividend option often limits the term insurance the owner can purchase to the amount of the policy's cash value. Other companies allow the purchase of a combination of term and paid-up whole life with dividends. Using dividend options allows insureds to increase coverage without incurring acquisition costs and without having to provide evidence of insurability. Thus, dividend options create flexibility in a consumer's life insurance plan. PRACTITIONER ADVICE Because dividends are small, particularly in the beginning of the contract, it's best to select the paid up additions options. This allows the dividend to be used to increase the cash value in the contract, as well as the death benefit. Some clients think of it as a way to have their death benefit keep up with inflation.

Funding Business Agreements

Partnerships, sole proprietorships and closely held corporations often need to purchase life insurance to facilitate the transfer of ownership when a proprietor dies. If a proprietorship is sold at a predetermined price at the owners death, the arrangement relieves the spouse of having to worry about operating the business. Because the buyout allows the continuation of the business, and because most firms are worth more as going concerns than they would be in liquidation, the heirs benefit from the higher value. Often the business can be sold to a key employee. In any event, a life insurance policy on the life of the owner provides the cash needed to complete the purchase. The money will be there when it is needed. In general, the person who buys the business will be the beneficiary and also pays the premiums.

Homeowners Insurance

People purchase Homeowners Insurance (HO) to protect some of their most important assets, such as their home and its contents, which they cannot afford to lose. The ISO homeowners insurance program uses six forms. ISO forms HO-1, HO-2, HO-3, and HO-8 are used to insure an owner's interest in a home and its contents and provide personal liability coverage. Form HO-3 provides more coverage than HO-1 and HO-2. The HO-8 form covers houses having a replacement cost greater than market value. For example, if older homes having plaster walls and hardwood floors are destroyed, they could be more economically replaced using modern construction techniques (such as drywall and plywood) without loss in usefulness. HO-8 provides for functional replacement rather than replacement with material of like kind. The HO-4 form covers the contents and personal liability of renters. The HO-6 form covers the property interest, contents and personal liability of people owning a unit in a condominium or a cooperative building. The HO forms cannot be used to cover mobile homes or house trailers. The ISO makes available other, more limited forms for this property.

Personal Liability

Personal Liability comes under Coverage E of Section 2 and covers the obligations of the insured due to their negligence. The policy will pay up to the stated policy limits for legal obligations of the insured due to bodily injury or property damage. In addition, the insurer will pay for the legal defense costs, as long as it is a type of liability covered under the homeowner's policy. As with all insurance policies, there are some exclusions listed in the policy. For example, professional liability and motor vehicle liability are both excluded and should be insured elsewhere, e.g. through Malpractice insurance and Auto insurance. Aircraft liability and use of watercraft powered with inboard or inboard-outdrive motors are not covered. The standard coverage limit is $100,000, most agents recommend carrying at least $500,000. PRACTITIONER ADVICE Most people who own homes are required to carry Homeowners insurance because they have a mortgage. Renters and Condominium owners often don't bother with insurance, thinking they don't have much in valuable furnishings. They are unconsciously retaining the liability risks of someone getting hurt in their apartment. The Renters Coverage (HO-4), or Condominium Owners (HO-6) is one of the least expensive types of insurance, costing less than $200 a year in Massachusetts.

Policy Limits

Policy limits determine the maximum insurance recovery. Deductibles cause the insured to bear the first dollars of loss; that is, if a loss is equal to or is less than the deductible, the insured bears the cost. On the other hand, if a loss is greater than the policy limits, the insured bears the cost of any applicable deductible and the amount of loss above the policy limit. When choosing a deductible and a policy limit, a trade-off between the certain payments of an insurance premium must be weighed against the possibility of uninsured losses. Some general rules apply to these decisions. Increasing policy limits increases premium costs, but the increase is not proportional. That is, increasing policy limits often will not increase premiums by the same percentage. For example, the Red Ox Bar and Grill can increase the limit of its liability insurance from one million to two million dollars, a 100 percent increase, for a 40 percent increase in premium. Increasing the deductible generally reduces the premium for a given amount of coverage. The reduction in premium typically is not proportional relative to the increase in deductible. That is, the first dollars of a deductible may reduce the premium more than additional increases in the deductible. If the Red Ox increases the deductible on its fire insurance from $5,000 to $10,000, it can reduce its annual premium by 10 percent. If it raises the deductible from $5,000 to $15,000, it reduces its premium by 12 percent. In this case, the first $5,000 increase in the deductible causes a larger reduction in premium (10 percent) than the second $5,000 increase (2 percent). Several mathematical techniques have been employed to help provide insight concerning these trade-offs. In practice, though, no mathematical technique can solve these problems because no perfect method exists to add the subjective risk component to the equation. We can describe a worry factor or draw isometric curves of indifference worry factors, but the worry factor still only exists in business managers' minds. Since the perception of risk is subjective, all they can agree on is that the risk is greater. They cannot measure their difference in perception. Therefore, two risk managers may solve the same problem efficiently but differently. Thus, mathematical generalizations about efficient risk management portfolios may be appropriate in a theoretical construct but may not be useful in practice. Rather than a mathematical model to solve the lower premium-higher retention trade-off, a description of the relevant financial factors a risk manager must consider when making these decisions follows. Not all decisions are equally efficient. We can identify the extremes as: Overinsurance, and Underinsurance. Between the extremes of overinsurance and underinsurance, considerable latitude exists for an efficient risk management program.

Pollution

Pollution implies destruction of the environment by the introduction of toxic substances, heat or noise. Past and present industrial practices have resulted and continue to result in serious environmental damage. Industrial processes have adversely affected air, water and land. Everything from the ozone in the upper atmosphere to the water in the deepest ocean depths has been exposed to impurities introduced by humans. As a result of these deliberate actions, an untold amount of damage has been done and an untold amount of money will have to be spent to reverse the process. Many serious attempts at cleaning the environment have begun, while other problems seem to be getting worse. Attorneys identify the legal liability arising from such acts as environmental impairment liability. In the United States, hundreds of millions of dollars have been spent on legal battles to determine responsibility for cleanup costs.

Preferred Provider Organization (PPO's)

Preferred provider organizations (PPOs) are another alternative to traditional health care provision. PPOs, usually an association of cooperating physicians and hospitals, agree to provide employers with health care services for their employees at discount prices. PPOs differ from HMOs, in the following 3 ways: First, the employer's cost with PPOs is determined by use. A fee is charged for each use, but the fee is lower than the provider's usual charge for the service provided. Second, covered employees do not have to use the personnel or facilities of the PPO. If employees use non-PPO providers, however, the employees pay higher costs. For example, physicians may agree to charge PPO members less than their customary fee for a particular service. In addition, the employer's health care plan may provide reimbursement for 80 percent of the cost if a PPO provider is used, and only 60 percent if the employee uses a non-PPO physician. Third, the PPO arrangement may not provide coverage for annual physical examinations as HMOs do. PRACTITIONER ADVICE A common source of frustration for employees is deciding which health option is best for their family. Usually there is one plan that is less expensive up front, but imposes larger out-of-pocket expenses for seeking medical attention. The other option tends to provide more benefits for little out-of-pocket cost, but requires almost twice as much in payroll deductions. No one can predict future medical needs; however, if the family does not have young children who are active and exposed to illness in school, there are no senior family members with deteriorating health or anyone with a major health condition, it may be wise to choose the first plan. If potential medical visits and out-of-pocket costs are less than the additional premium required for the second plan, you may save money. If the opposite is true, it may be less risky to purchase the high premium plan. Either way, if a medical spending account is available, contribute an amount that approximates the anticipated out-of-pocket cost, as the deducted money avoids taxation.

Level Premium Term

Premium remains level for set number of years. Initial premium level is higher than that of annual renewable term policy, but tends to be lower on average over the entire term selected. Either allows for another level premium period upon renewal, or reverts to annually renewable premiums to expiration. PRACTITIONER ADVICE Most Term policies sold these days come with a Level Premium that is guaranteed for a set number of years. For example, Joe can buy a 20-year Level Term policy to cover the college education costs for his 5-year-old daughter. David can buy a 30-year Level Term policy to cover his new 30-year mortgage debt.

LTC Waiver of Premium

Premiums usually are level, although a few companies use increasing premiums based on attained age, either annually or at periodic intervals. As would be expected, the annual premium differs greatly from one LTC policy to another, depending upon age at issue, waiting period, benefits and other policy features. Of course, insurer financial stability and economies of scale also impact premiums offered from company to company as with all insurance products. Nearly all LTC policies provide for a waiver of premium, usually after 60, 90, or 180 days of confinement or days of benefits paid. Waiver of Premium provision means that the insured does not have to pay any premiums due while they are receiving benefits.

Pricing Guidelines

Pricing guidelines set out in the Viatical Settlement Model Act range from 50 percent for life expectancies of 24 months or longer, to 80 percent for life expectancies of less than six months. About one-half of the states have adopted some version of the models, although many have altered the minimum pricing requirements, especially for life expectancies of greater than 24 months. They recognize that the 50 percent standard was set when the only terminal illness covered was AIDS, which at the time typically involved a two-year life expectancy.

Professional Liability Insurance

Professional liability is caused by errors of professionals. It is sometimes called malpractice liability, or errors and omissions (E&O) coverage. Such insurance typically commits an insurer to pay all sums subject to policy limitations, that the insured becomes legally obligated to pay as damages resulting from providing or failing to provide professional services. In general, most professional liability policies do not give the insurer the right to settle suits without the insured's consent. The reason is that the professional's reputation and future earnings could be affected adversely by settlement of negligence claims even though sometimes it might be expedient for the insurer to offer a settlement. However, most of the newer professional liability policies have removed a previous requirement that the insurer obtain the consent of the insured before making an out-of-court settlement, to protect the insured's professional reputation. PRACTITIONER ADVICE As a financial professional, whether an insurance agent, financial planner, or other licensed advisor to the public, you will face liability risk to your clients. Errors and Omissions insurance is a necessary coverage in any advisor's personal risk management plan. Most professional associations offer E&O coverage to members at a reasonable cost.

Obligations of Property Owners to Others

Property owners have obligations to protect persons who come onto their land. The degree of care that should be exercised depends on the status of persons coming onto the land, the rights of other persons, and the landowners relationship to others, whether they are trespassers, licensees, invitees, or children. Landowners have no duty to exercise care to protect adult trespassers from property injury; however, they must not inflict intentional injury on the intruder. Licensees such as door-to-door salesmen may come onto the property with the owners knowledge or tolerance, and the owner is obligated to warn the licensee of unsafe conditions or dangerous animals. Invitees are invited onto the property for a purpose, and include customers and business persons providing services to the owner. The property owner must inspect the land and make it safe for others or warn of any dangers, since any condition that could cause harm to an invitee is a possible source of legal liability. The law imposes the greatest responsibility in the degree of care that must be exercised for children. Property owners must protect children from themselves, and from attractive nuisances that might attract and injure a young child.

Punitive Damages

Punitive damages are awards made to plaintiffs not as compensation for injuries suffered, but as a means of punishing defendants for outrageously offensive acts. What constitutes such an act is a question of fact. The insurer usually agrees to pay for injuries inflicted by negligence on behalf of the insured individual. Punitive damages usually imply gross negligence, something for which the insurer may not have contemplated making payment. Also, punishing an insurance company may not satisfy the courts' purpose of punishing wrongdoers. Thus, in a few states, state law prevents insurers from providing compensation for punitive damages. If insurance frustrates public policy, an event becomes uninsurable.

Pure Risks

Pure risk refers to possibilities that can result in only loss or no change. A factorys exposure to loss by fire is an example of a pure risk. A factory either burns or it does not burn. There is no gain potential from this possibility. Insurance deals only with pure risks. An insurable risk is a risk that meets the criteria for efficient insurance. To be considered efficient insurance, a number of things need to be true. 1. The premium must be reasonable. The insurer must be able to charge a high enough premium to cover claims and the expenses of being in the insurance business. 2. The risk must be financially measurable. 3. The loss must be accidental and not predictable. 4. The risk is not subject to a catastrophic loss. The risk cannot be so large that the insurer is unable to pay for the loss.

Income Objectives

Quantifying income objectives requires assumptions that render approximations only. Deriving a measure of a family's (or individuals) income needs involves: First, a determination of the annual net amount needed. All the important variables such as likely income resources (such as, government benefits), changing family responsibilities, and inflation have to be considered during the analysis. Second, for life insurance planning purposes, these annual net income amounts are converted to a single-sum (present value) equivalent. This involves assumptions regarding future interest rates. In cases of disability income and long-term care needs, the net amounts need not be taken to present values because these policies are usually denominated in monthly income. The two most common approaches to determining income objectives are capital liquidation and capital retention approaches. Capital Liquidation + Capital Retention = Income Objective

Renewability

Renewability is a feature of term life insurance that permits the policy owner to continue, or renew, the policy upon expiration of the term period, for a limited number of additional periods of protection. For example, a 20-year term policy may allow renewal for another 20 years at the end of the initial 20-year period. The premium, although level for a given period, increases with each renewal and is based on the insured's attained age at renewal time. A scale of guaranteed future premium rates is contained in the contract, providing the insured a sense of security in knowing there is a maximum ceiling to future premiums. Usually the insurance company charges a rate lower than that stated in the policy. The stated maximum premium is there as a safety valve for the insurer, should there be a need to raise rates in the future beyond the current scale. As the premium rate increases with each renewal, mortality experience increasingly reflects adverse selection. Resistance to the higher premiums and lower-cost product opportunities cause many insureds in good health to fail to renew. The majority of those in poor health will renew even in the face of higher premiums. Insurers try to accommodate this problem in their pricing structure, or through other means, such as through altering dividends, by limiting renewability to stipulated maximum ages, or by product designs that encourage, or require, conversion. The term renewability means simply that the policy can be continued beyond the original maturity date to the stipulated termination age, at a preset renewal rate, should the policy owner choose to pay the premium. Therefore, renewable term policies can be viewed as increasing-premium, level-benefit term life insurance.

Jim rents an apartment in Boston, parking his car on a city street overnight. He works weekends as a DJ and owns an extensive collection of CDs along with sound equipment. Often, he leaves this equipment in his car rather than lugging it all to the apartment after a long night. Jim is concerned about this expensive equipment being stolen. If Jim were to purchase insurance coverage for the equipment, which policy would be involved?

Renters Insurance: Personal property is always covered under a homeowners / renters policy, regardless of where it is being stored. Therefore, if the equipment is stolen from Jim's car, his renters policy would be the appropriate policy to cover the loss. Property coverage on the auto policy refers only to the vehicle itself, and all permanently attached items such as an installed stereo system.

Replacement Cost

Replacement cost means the dollar amount required to rebuild a similar structure meeting the building code requirements in effect at the time of original construction. Replacement cost of a building does not equal fair market value of the property, because market value would include the value of the land and its location. Location can be an important factor in property value but not in replacement cost. For example, it might cost the same to build a beautiful home in location A or location B. But if location B were downwind of an unpleasant-smelling agricultural plant, the homes market value would be less at location B.

Replacement-Cost Insurance exception to the rule of indemnity

Replacement-Cost Insurance is written when the insurer promises to pay an amount equal to the full cost of repairing or replacing the property without deduction for depreciation. If an insured loses an old, run-down building to a fire and a new building is built, the insured is obviously better off after the loss. Replacement-cost coverage is a typical feature of homeowners insurance policies and is also found in other property contracts.

Retention

Retention is the excess of premiums over claims payments and dividends. It covers the expenses and profit, and compensates the insurer for absorbing the risk. Also called a deductible, retention is the first dollars of loss that the insurance contract causes to be borne by the insured.

Risk administration

Risk administration includes costs such as the premiums you pay, as well as the time you spend analyzing your risk situation. As time goes by, the cost associated with your risk management program may prompt you to reevaluate your implementation strategy. Whenever you have a significant or "life-changing" event, you should review your Risk Management Plan. Events like marriage, divorce, having a baby, or your last child graduating from college are all reasons to sit down and look at your risk exposures and how you are handling them.

Risk Management

Risk management is a very important element of a personal financial plan. The practice of risk management can be defined as the identification, measurement, and treatment of exposures to potential losses. Risk management concerns losses that arise from damage or destruction of property, from liability, and with loss of income or additional expenses occasioned by death, incapacity, unemployment, retirement, and declining health. It is important to keep in mind that Risk Management and Insurance are not one and the same. Insurance is a tool (transfer of risk) that is used in handling potential financial loss identified during the Risk Management process. Proper Risk Management will utilize all other tools (avoidance, reduction, retention of risk) first, leaving insurance as a last option when sufficient loss potential still exists. This allows the client to maximize critical insurance coverage while allocating premium outlay most efficiently.

Deductibles and Policy Limits

Risk managers face a variety of problems while deciding how to handle loss exposures. One common problem requires determining how much loss exposure to retain and how much to transfer. This decision often involves consideration of two topics: 1. Deductibles, or retentions: The first dollars of loss that the insurance contract causes to be borne by the insured. 2. Policy limits: Determine the maximum insurance recovery.

Commercial General Liability

Risk managers may purchase liability insurance to protect their firms from direct, vicarious, and contractual liability losses. Traditionally, businesses have insured their liability exposures using the comprehensive general liability policy (CGL). In 1986, the ISO CGL policy format experienced significant changes and was renamed the Commercial General Liability policy (CGL). The new ISO CGL policies have two formats : An occurrence-based liability policy requires the carrier providing the insurance at the time the injury was sustained to pay the claim, even if the claim is made 25 years after the policy expired. The claims-made form obligates the insurer to pay only for claims first made against the insured during the policy period and arising from incidents occurring after the retroactive date stated on the policy.

Ability to Pay for Losses

Risk managers must evaluate the firm's ability to absorb uninsured losses, while considering a relatively large deductible or relatively lower policy limits to reduce insurance costs. The risk management statement of principles and procedures established the rule that the company would assume losses to buildings and contents equal to or less than one million dollars. To set an efficient retention limit, the firm must consider the following factors: The Liquidity of Assets Risk managers must ask if sufficient cash or near-cash assets are on hand at all times to cover retention, while assessing the liquidity of a firm's assets. Some questions to be considered are: Do regular operations generate sufficient cash to supplement available cash assets to cover the retention? Can borrowing supplement cash on hand and regular cash flow to cover the retention at all times? If a high retention is chosen, are there funds available to cover multiple uninsured incidents so that the firm's survival is not jeopardized? The Stability of Net Income If the firm would be exposed to uninsured losses, the variability of the firm's income should be considered. If substantial uninsured loss occurs in a cyclical industry at the bottom of the business cycle, the result would be more harmful than the loss that occurs during the peak of the cycle. During the peak of the cycle, more cash on hand, greater borrowing power and regular cash inflow is more likely than during a recession. On the other hand, business interruption losses would be greater during the peak of a business cycle. For these reasons, risk managers of company with steady profits could assume a greater degree of risk than a company with cyclical or seasonal profits. The Amount of Net Worth A firm's ability to absorb uninsured losses is a function of its net worth. Net worth measures the undistributed operating profits of preceding periods. It is not a measure of available cash. If a large uninsured loss occurs, the accounting result will be a reduction of net worth, that is, reduced profits for the current period, from what otherwise would have been reported. The Increased Cost of Capital Reductions in net worth can raise a firm's cost of capital by making the firm appear more risky to lenders or investors. The cost of capital penalty is felt in a reduced common stock price or in increased borrowing costs. A large loss, such as one equaling the entire amount of net worth, may preclude borrowing at any price. Hence, an important constraint in making the retention choice is the effect of uninsured losses on net worth. Several hypothetical possibilities must be reviewed to estimate the relationship between uninsured losses and cost of capital. Resulting estimates can provide useful insight, but will not provide definitive answers because, once again, post-loss cost of capital calculations requires the "other factors held constant" assumption.

Replacement value

Risk managers must know the propertys replacement value to estimate potential property losses. Because replacement cost often is unrelated to accounting book value (acquisition cost less depreciation), risk managers should keep a current price and source list for their property. Estimating replacement cost can be difficult when property must be custom built, and contracting costs can vary greatly. In an inflationary economy, the replacement cost of physical equipment is likely to be higher than its historical cost, and the risk manager should attempt to protect this greater value. During rapid inflation, some slow-moving inventories also may have market values significantly greater than their historical cost. Many insurance companies will insure replacement values but pay only depreciated value until the property is replaced. Insurers impose this strict condition to prevent firms from receiving the replacement value in cash and then not replacing the property.

Risks

Risk may be defined as the variation in possible outcomes of an event based on chance. This definition of risk is a useful one because it focuses attention on the degree of risk in given situations. The degree of risk is a measure of the accuracy with which the outcome of an event based on chance can be predicted. The more accurate the prediction of the outcome of an event based on chance, the lower the degree of risk for the insurer. Because insurance companies keep accurate statistics on losses that have occurred, they are better able to predict the number and total dollar amount of losses that will occur. Thus, one result of an insurance system's operations is increased accuracy in the prediction of losses, thereby reducing risk for the insurer. This accuracy of predictions is what allows an insurance company to establish adequate premiums to cover the anticipated losses. Risk can also be defined as the uncertainty concerning a possible loss. Although the variability concept of risk emphasizes the statistical aspects of risk and insurance, the uncertainty concept emphasizes the behavioral aspect of people exposed to risk. The definition of risk as uncertainty concerning loss is useful because it helps to explain why people purchase insurance. For example, if Steve does not purchase insurance, he may be uncertain about whether or not he will be able to pay for losses resulting from a possible fire at his home. Once he has purchased fire insurance, it becomes certain he should not have to pay for any covered fire losses to his home. In this case, the homeowner has transferred his uncertainty, or risk, to the insurance company.

Risk Reduction

Risk reduction is reducing the chance that a loss will occur or reducing the magnitude of a loss if it does occur. For example, embracing wellness programs adopted by employers and/or exercising regularly and adopting proper eating habits may reduce the risk of having a heart attack.

Risk Retention

Risk retention means retaining or bearing the risk personally. Retention is the most common approach to risk because it is the default strategy - not taking any action to transfer a risk means it is retained. Since people are not always aware of the risks they face, much of the retention is done unconsciously and unintentionally. For example, a person who retains any income losses caused by a disability is experiencing risk retention. Another example is a person who decides to insure their car with liability insurance but not collision or comprehensive insurance.

Risk Transfer

Risk transfer means transferring the financial consequences of any loss to some other party. For example, purchasing a medical expense policy from an insurance company transfers the financial consequences of incurring medical expenses because of loss of health.

Self-Insurance

Self-Insurance means that a firm or other organization may decide to deal with its own risks. They decide to operate much like a commercial insurance company and will engage in the same types of activities as a commercial insurer. When these activities involve the operation of the law of large numbers and predictions regarding future losses, they are commonly referred to as self-insurance. To self-insure a firm must set up a sound program with the following requirements. 1. Law of large numbers - The firm should be big enough to combine sufficiently large numbers of exposure units so as to make a loss predicable. 2. Financial Reliability - The firm should be able to accumulate funds to meet losses that may occur. Also, the firm needs to cover losses if they occur more frequently than predicted. 3. Geographic distribution of risk in the event of a catastrophe. Often the context in which the word "self-insurance" is used would be better described as risk retention. There are some important advantages and disadvantages of retaining risk through self-insurance. Advantages are: 1. Avoid expenses of commercial insurance market. Losses may be less than average experience. 2. Build up reserves if there is a long time between losses. 3. Avoid having to support higher risk firms that may be in a commercial pool. Disadvantages are: 1. No protection from catastrophic loss. 2. Paying losses rather than premiums may result in greater variation of costs from year to year. 3. Paying claims with its own staff may create adverse public relations. 4. Unable to take advantage of expertise and service provided by a commercial insurer.

Solvency

Solvency makes the result of the insurance transaction certain and predictable. Predictable results is the essence of insurance. Promoting insurer solvency is the most important goal of insurance regulation and are at the heart of all regulatory activity. One explanation for extensive regulation to promote insurer solvency is that individual insureds really are not capable of self-protection in this transaction. Insurance is nothing more than a contingent promise to be delivered in the future. The typical consumer cannot evaluate or monitor the solvency of an insurance company. Insurance accounting and actuarial procedures are technical and complicated. So, state insurance departments monitor insurers' solvency on the public's behalf. A second reason for the importance of solvency regulation is that if an insurer becomes insolvent, the problems for insureds can be very serious. The potential results of insurer insolvency include houses destroyed with no funds to rebuild, liability suits with only personal assets available to satisfy judgments or widows left with dependent children and unfulfilled financial plans. The scope and severity of problems arising from an insurer's bankruptcy explain why an insurer's solvency is of utmost concern to the public and hence to the regulators. A third explanation for solvency regulation is that life insurance companies (and, to a much smaller extent, property insurance companies) are responsible for sizable amounts of consumer savings. Legally, the relationship between insurer and insured is comparable to that of debtor and creditor, but the relationship bears a close resemblance to the fiduciary arrangement found between a bank and its depositor. Fiduciaries are held to strict requirements for their actions because they require public confidence. Because insurers' operations parallel those of fiduciaries, the insurer's solvency is a market suited for public regulation.

Promotion of Social Goals

Some insurance regulation is designed to promote social objectives such as making insurance more widely available or ending undesirable discrimination. For example, some people believe the public should have the right to purchase insurance at affordable rates. This belief has led many states to pass laws forcing insurers to accept applicants they would otherwise have rejected. Moreover, in some cases, insurers have been forced to use rates lower than they otherwise would have chosen. Such compulsion has been applied in automobile, health, and commercial and personal property insurance. Blanket rejection by insurers of certain exposures such as inner-city property (sometimes called redlining), day care centers, drivers with bad driving records or potential AIDS victims means some people find private insurance unavailable or unaffordable. Presumably the social goal of making insurance widely available takes precedence over other goals, such as freedom of the insurer to contract with whom it wishes. The goal of making insurance widely available, however, may conflict with the goal of insurer solvency if an insurer is forced to accept too many poor risks at inadequate rates. Likewise, if regulation forces insurers to overlook valid underwriting criteria to promote social goals such as making the insurance market more equitable, the resulting mandated subsidization conflicts with the goal of mathematical fairness to all insureds.

Supplemental Benefit - Disability Insurance

Some insurers might include one or more benefits in the basic benefit provisions. However, they are more frequently available for an additional premium as optional benefit riders attached to the policy. The benefits and the premiums of each optional rider generally are shown on the schedule page. Among the leading insurers, the most common optional or supplemental benefits are: Residual disability benefit, Partial disability benefit, Social insurance supplement, Inflation-protection benefit, Increased future benefit, and Guaranteed insurability option.

Dividend Illustration

Some life insurance policies represent better buys than others. Which plan, par or non-par, must a consumer purchase? Cost comparisons must be made intelligently to make the best choice. At this point, the consumer must remember that one comparison is clearly illogical. A consumer cannot make a straight comparison of premium dollars between participating and excess interest life insurance policies. Insurance companies usually provide a dividend illustration to prospective purchasers of participating policies. This illustration shows the proposed insured dividends that would be paid under the policy if the mortality, expense and interest experience implicit in the current scale of illustrated dividends were to be the actual basis for all future dividends. The dividend illustration is usually based on the recent mortality, expense and interest experience of the company. Important differences exist in the way insurers allocate amounts to be paid as dividends, and these differences can have a major impact on the dividend levels illustrated as well as on the dividends that are actually paid. PRACTITIONER ADVICE It's essential for clients to understand that dividends are simply projections, and not guaranteed. While insurance companies do a better job of highlighting the possibility of change, the planner or agent also needs to discuss this with the client.

Makes Savings Possible

Some might argue that they prefer to save rather than purchase life insurance. Certainly, good saving habits must be encouraged, but saving involves time, resources, and discipline. A savings program can yield only a small amount at the start, whereas an insurance policy guarantees the full face value or other benefit from the beginning. Thus, it can hedge the policyowner against failure, through early death or incapacity, to have sufficient working time to save adequately through other means. For example, if Janet saves $1,000 annually, it would take nearly 16 years for her to accumulate a fund of $25,000. This is assuming that she has invested annually at 6.0 percent compound interest. Even at that, her ability to accumulate such a savings fund is contingent upon her survival or well being for the full period. To depend entirely upon savings as a means of providing for the future could prove disastrous financially. It is generally accepted that the first requirement in providing for the future support of dependents is reasonable certainty. Insurance serves as a hedge against the possible failure to continue the annual accumulations of the savings fund because of early death or disability. Through life and health insurance, a fund of $25,000 can be assured.

Other Disability Benefits:

Some of the supplemental benefit provisions are listed below: Transplant benefit provides that, if the insured is totally disabled because of the transplant of an organ from his or her body to the body of another individual, the insurer will deem him or her to be disabled as a result of sickness. It also includes cosmetic surgery performed to correct appearance or a disfigurement. Rehabilitation benefit allows a specific sum, often 12 times the sum of the monthly indemnity and any supplemental indemnities, to cover costs not paid by other insurance or public funding when the insured enrolls in a formal retraining program that will help him or her return to work. Non-disabling injury benefit pays up to a specific sum, usually one-quarter of the monthly indemnity, to reimburse the insured for medical expenses incurred for treatment of an injury that did not result in total disability. Principal sum benefit is a lump sum amount payable if the insured dies accidentally. This provision requires that death be caused directly and independently by injury and that it occur within a specified number of days, usually 90 or 180, following the date of the accident. The principal sum amount benefit also pays a single sum, usually 12 times the sum of the monthly indemnity and any supplemental indemnities, if sickness or injury results in dismemberment or loss of sight and the insured survives the loss for 30 days. The lump sum is in addition to any other indemnity payable under the policy, and it is payable for two such losses in the insureds lifetime. The principal sum benefit usually is limited to the irrecoverable loss of the sight of one eye or the complete loss of a hand or foot by severance above the wrist or ankle.

Transfer for Value

Sometimes a life insurance policy is sold for a valuable consideration. This is known as a "transfer for value". A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. Under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer for value rule cannot be avoided by cancelling the transaction at a later time. Here is an example the transfer for value rule is. Assume that Mother is the owner and the insured on a policy with a death benefit of $400,000, a yearly premium of $7,300, and a cash value of $75,000. Mother sells this policy to Daughter (the beneficiary) for the $75,000 cash value. When Mother dies three years later, then Daughter, as owner/beneficiary, will receive the $400,000 death benefit amount of the policy. The $75,000 amount that Daughter paid for the policy plus the annual premium, which we will assume is $21,900 (calculated as 3 yearly payments of $7,300), is her adjusted basis in the policy of $96,900. The difference between the death benefit amount of $400,000 that Daughter received and her adjusted basis of $96,900 in the policy is $303,100 and is subject to income taxes at her marginal tax rate. There are exceptions to the transfer for value rule which will not cause the death benefit to be subject to income taxes at the insured's death. This occurs when the insurance policy is transferred to the following individuals or entities. The insured. The insured's partner. The transferor's spouse incident to a divorce. A new owner who takes the transferor's basis in the contract. To a partnership in which the insured is a partner. To a corporation in which the insured is a shareholder or officer.

Personal Property Coverage

Sometimes, the question is raised whether a specific item is real or personal property. If it is real property, it is covered under Coverage A. If it is personal, it is covered under Coverage C. The English common law rule is that land and anything permanently attached to land is real property. Thus, built-in appliances are real property. Wall-to-wall carpeting often presents a problem. In general, insurers consider wall-to-wall carpeting as real property if it lies over an unfinished floor and consider it personal property if it is placed over a finished floor. Coverage for personal property contents is provided under Coverage C- Personal Property for HO-02, 03, 05 and 08 homeowners forms. The amount of coverage is typically 50% of the dwelling coverage which can be increased, but cannot be reduced below 40%. For forms HO-04 and HO-06 at least $6,000 of minimum coverage is required to insure contents. Contents coverage protects personal property anywhere in the world except for the contents of a secondary residence. The amount of the coverage is limited to the greater of $1,000 or 10% of the coverage C insurance. Some personal property is not covered under Coverage C. This list includes: Property that is separately insured under the homeowners policy Animals, birds and fish Motor vehicles subject to registration and their accessories and equipment Aircraft and their parts Property associated with renting an apartment Business property Credit cards or fund transfer cards

Speculative Risks

Speculative risk refers to those exposures to price change that may result in gain or loss. Most investments, including stock market investments, are classified as speculative risks. Other speculative risks result from the potential gains or losses associated with interest rate changes, price movements of foreign currencies, and price movements of agricultural and other commodities. With speculative risk, the risk is man-made and did not exist naturally. The individuals goal is not merely to avoid loss, but rather to create risk in the hopes of actually gaining. Since insurance deals with pure risk that exists only when a chance of loss/no loss is possible, man-made speculative risks such as the stock market and gambling are not suitable for coverage. PRACTITIONER ADVICE: Often clients say they don't believe in buying insurance because they feel it is a gamble. This is odd, considering insurers do not take on speculative risk. When people say they won't buy disability insurance because they have to become disabled in order to win, they miss the point of insurance. The risk of disability already exists whether you purchase insurance or not. You either can become disabled or not; there is no gain potential in becoming healthier because you have a policy. On the other hand, when you bet $100 in hopes of winning $1,000 if your favorite football team wins the Super Bowl, your chance of loss or gain did not exist prior to your bet. You created this risk.

Split-Dollar Life Insurance

Split-dollar life insurance plans allow businesses to reward and retain valuable personnel. With this approach, both employer and employee pay a part of the premium for an insurance policy with a savings feature. The employers share typically equals the annual increase in savings amount. As the savings increase each year, so does the employers premium payment. When the annual increase in savings equals or exceeds the level premium, the employee contributes nothing for the insurance. Employees who terminate employment at this point, which is several years after the policy is in force, give up an important fringe benefit. In a split-dollar plan, the employer receives an amount equal to the savings value at the employees death. The employees beneficiary receives an amount equal to the face value less the savings value. For example, assume after 15 years the split-dollar life insurance policy has a face value of $100,000 and a cash value of $25,000. The total employer-paid premiums over the 15 years equal $25,000. At the employees death, the employer receives $25,000 of the death proceeds, and the employees beneficiary receives $75,000. From the employers standpoint, the cost of the policy becomes the forgone interest on the premium payments because the absolute amount of premiums is returned at the employees death.

Standard & Poors

Standard & Poor's was established in 1860 to provide insight and information to the financial community to help them determine the right value in the marketplace. Having a long history of ratings bonds and stock, Standard and Poor's now also does insurance company ratings.

Admitted Assets

State regulation requires insurers to categorize their assets as admitted assets or non-admitted assets. This accounting procedure is different from generally accepted accounting principles and represents an attempt to evaluate insurers' assets in the most conservative manner. Admitted assets are assets that are readily available to pay claims, such as negotiable securities and real estate holdings. State law allows only admitted assets to offset an insurer's liabilities. Non-admitted assets are not available to meet the company's liability to its insureds. Examples include equipment, office supplies, and furniture.

Subrogation

Subrogation is the legal substitution of one person in anothers place. Subrogation is supported by the theory that if a person must pay a debt for which another is liable, such payment should give the person a right to collect the debt from the liable party. In insurance, subrogation gives the insurer the right to collect from a third party after paying its insureds claim. A typical case of subrogation arises in automobile insurance collision claims. Subrogation prevents insureds from profiting on their insurance by collecting twice for the same loss. Subrogation also prevents negligent parties from escaping payment for their acts.

Merritt Committee Investigation

Subsequently, five years later, New York investigated its fire insurers in the Merritt Committee Investigation. The results again revealed many unethical and undesirable characteristics. These investigations resulted in a new insurance code for New York State and a vigilant attitude for New York's insurance regulators. Other states followed New York's lead in improving the quality of regulation of the insurance industry. The quality of the regulation provided by the states was not uniform, however. Some states were more effective than others, and for the next 50 years few states were as actively involved in insurance regulation as New York State.

Surgical Contracts

Surgical contracts provide coverage for the costs of surgical procedures. Some specify a maximum amount of coverage for a representative group of surgical procedures. The stated amount is the most the insurer will pay for one procedure. If a patient needs two procedures during one hospitalization, the more expensive treatment determines the payment.

Surgical Schedules

Surgical schedules identify a maximum dollar amount for the most difficult procedure and provide a representative list of other procedures and their reimbursement rates. Some modern surgical contracts offer coverage on a "reasonable and customary" basis. In this case, there is no need to schedule representative procedures or maintain different maximum levels of reimbursement. The insurer will reimburse the insured for procedures based on the reasonable and customary charges in that geographic area. As with all areas of cost-of-living, medical costs will vary from region to region. While this schedule may be appropriate in the Metro-New York area, the schedule for similar procedures in the Little Rock, Arkansas area may be based on a maximum cost of $750.

TAXATION OF INSURANCE MODULE

Taxation of Insurance Module

Term Life Insurance

Term life insurance furnishes protection for a limited number of years at the end of which the policy expires, meaning that it terminates with no maturity value. The face amount of the policy is payable only if the insureds death occurs during the stipulated term and nothing is paid in case of survival. Term insurance policies may be issued for as short a period as one year. Previously, they customarily provided protection for at least a set number of years, typically 10, 15, 20, or 30 years or to a stipulated age, such as 65 or 70. Modern policies provide coverage to age 95 or 98. Term insurance can be compared to property insurance contracts. At the beginning of the policy year, the insured pays a premium for the years coverage. If no loss occurs during the policy year, the insurer keeps the premium and the insured receives nothing. If the insured chooses to not renew the policy, there is no value paid back to the insured. Term is often referred to as "pure protection" or "pure insurance" because it pays a death benefit only and has no savings component. There is no equity position in the policy. Nothing is paid if death does not occur during the policy term. Initial premium rates are lower for term life insurance than for other life products issued on the same basis because the period of protection is limited and there is no savings component. Premiums for term coverage, however, can escalate rapidly as the duration of the policy lengthens. Term product prices are more easily compared than are prices of other life insurance products because term policies are structurally simpler than other policies. Two features applicable to many term life policies deserve special attention before discussing specific term products: Renewability Convertibility

Accelerated Benefits Guideline

Terminal illness and catastrophic illness coverages provide that policy death benefits are reduced on a one-for-one payout basis. Cash values are reduced on either a one-for-one basis or in proportion to the death benefit reduction. According to the NAIC Accelerated Benefits Guideline for Life Insurance, prospective buyers of these coverages must be given numerical illustrations. These reflect the effects of an accelerated payout on the policy's death benefit, cash values, premium and policy loans. Additionally, consumers must receive a brief description of the accelerated benefits and definitions of the conditions or occurrences triggering payment. Any separate, identifiable premium charge must be disclosed. The NAIC and others have been concerned that such benefits, especially the catastrophic illness coverage, could be "oversold." In the 1960s and before, certain dread disease policies with limited coverage, fell into regulatory disfavor because of fear-based selling tactics and numerous claim disputes. Allegations of so-called post claim underwriting were widespread. Clearly, a weakness of these earlier policies and of this latest variation is that other illnesses can be equally devastating, yet no benefit is provided for them. The importance of an adequate health insurance program is underscored. CASE STUDY Mike works in a print shop running a printing press. He is 34, married with two children, ages 2 and 4, and earns $27,000 annually. His wife stays home to raise the children. He has basic health insurance provided through his employer, for which he contributes $25 per week. He has no life or disability insurance but has recently been approached by an agent who sells "Cancer" policies to blue collar workers. The sales presentation sounds good; if he dies of cancer his wife would receive $100,000. If he is disabled by cancer, he would receive $500 a week for 2 years. It would only cost him $5 per week. Should Mike jump on this offer? Given that he has no Life or Disability insurance in place, has three dependents, and the cost seems reasonable, why wouldn't he? Assuming he is in good health, it would be wise for Mike to speak with an agent who could assess his needs and budget for "regular" life and disability policies. While it may cost less, the catastrophic policy is more restrictive and requires him to experience one specific contingency in a world of many risks. If you were offered a car insurance policy for $200 per year that would pay $15000 if your car were in an accident with an at-fault tractor-trailer driven by a member of the Teamsters union, would you buy it? Not likely. You would probably keep your traditional policy at its higher premium due to its broader coverage.

Patients' Bill of Rights

The American Hospital Association adopted a Patient's Bill of Rights in 1973, which was later revised in October 1992. The bill supports a patient's right to effective health care in hospitals and in health care institutions. Congress has also considered legislation to protect consumers in managed care plans, but to date, this legislation has not been passed. Major provisions of the bill include the following: Click here to read The American Cancer Society's detailed summary of the Patient's Bill of Rights. This page will give you an understanding behind the history of the Bill of Rights and information about the Bill that is used today.

Commercial (or Business) Income Coverage

The Building and Personal Property form of the CPP may be used to cover indirect losses if the insured pays the appropriate premium specified by the insurer. Determining the amount of coverage a business needs and explaining how the business income form is filled out involve interesting accounting issues, but are beyond the scope of this module.

Property Covered in Commercial Coverage

The CPP provides property insurance in the building and personal property coverage form. The form for building and personal property coverage identifies the building(s) covered as those listed on the declarations page. Insurers insist on careful identification of the property covered to respect the principle of definite losses. In addition to covering the building, the CPP covers the insured's business personal property. Business personal property includes such items as machinery, furniture and inventory. Inventory includes raw material, work in process and finished goods available for sale. The declarations establish the limit of recovery and the appropriate premium. The third category of covered property is personal property not owned by the business but in its care, custody, or control. This category would be especially important to firms holding or using borrowed property, such as on-site displays or special tools.

Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act, was passed in November 1999 to provide a framework for regulating all financial services providers, including insurance companies. This law leaves insurance regulation primarily where it has historically been: in the hands of state insurance commissioners. The Act permits banks, insurance companies, securities firms and other financial institutions to affiliate under common ownership and offer their customers a complete range of financial services. In establishing the ability of financial institutions to affiliate under common ownership, the Act established the Federal Reserve as the umbrella supervisor.

Health Maintenance Act

The Health Maintenance Act of 1973 (as amended) dramatically increased the use of HMOs. This federal law required certain employers to offer an HMO option in addition to their regular health insurance plan. Recently, about 600 HMOs covered approximately 36 million members. Because they stress prevention, provide broad coverage, and do not require long claims forms to be filed, HMOs have proved popular, especially with younger people, who usually require less care for chronic illness. Many employers have found HMOs to be a cost-effective choice in providing health insurance to their employees. Some employers have found, however, that when younger employees choose HMO coverage and older employees remain in traditional plans, any savings realized from the HMO are spent on the increased cost of the traditional plans. As noted, when given the option, younger people often choose the HMO because of the emphasis on prevention and the reduced amount of paperwork. HMOs are organized in two different forms: Individual practice HMO, and Group practice HMO.

Human Life Value Approach

The Human Life Value formula is based on the person's income earning ability. Human life value is the present value of income lost as a result of the person's death. The question is, how much money is needed for investment now, in order to provide replacement income for a set number of years? This approach is still the most popular method of measuring economic value of human life in situations like wrongful death lawsuits. This method is not an accurate way to estimate how much life insurance is needed because it does not take into consideration other resources. In some cases, part of the income may be replaced from other sources such as life insurance, group life, and social security survivor benefits. When interest rates are higher, it appears that less capital is needed to be invested. This approach also does not take into account whether there is anyone who needs to have the income replaced.

HO Property Coverage

The ISO homeowner's insurance program uses six forms that insure an owner's interest in a home and its contents. They also cover the contents and personal liability of renters. The HO forms cannot be used to cover mobile homes or house trailers. The ISO has other, more specific forms for this type of property. The insurer's limit of liability is divided into two sections: Section 1 provides property insurance protection and is divided into four coverages - (or insuring agreements) A through D, each with a separate limit of liability. Section 2 provides personal liability coverage and is divided into two coverages (E and F). Coverage is identical for the entire series of homeowners policies. The homeowner's package is divided coverage. Each coverage (A through F) is treated separately. Dollars may not be transferred among the various coverages. The maximum amount the insured can collect is the sum of all the coverages. That is, if a property loss is total, an insured theoretically could collect the total amount of Section 1, Coverages A through D. If a liability loss occurred in addition to a property loss, the Section 2 coverages, E and F, would add to the amount the insured could collect under the policy.

Long-Term Care Insurance Model Act

The Long-Term Care Insurance Model Act specifies minimum standards that products must meet to be considered long-term care insurance. The model includes the following major provisions: Insurers must provide an outline of coverage and summarize the features of the policy. Policies must contain the following minimum standards: The individual policy-owners must have a 30-day "free-look" period during which the policy can be canceled and the premiums returned for any reason. Waivers denying coverage for specific health conditions are prohibited. Insurers may not offer substantially greater benefits for skilled nursing care than for intermediate or custodial care. Insurers must have a minimum loss ratio of 60% on their LTCI policies. Policies must be guaranteed renewable, although state insurance commissioners may allow cancellation under limited circumstances. Coverage for Alzheimer's disease must be included. Inflation-protection option must be offered. Policies must be incontestable for misrepresentation after 2 years. Policies may not be cancelled for non-payment of premium without the insurer providing 30-day written warning sent to the insured and a person designated by the insured. (This is to avoid a mentally impaired insured forgetting to pay the premium.) PRACTITIONER ADVICE Because of the complexity of LTCI policies, and the number of companies now competing in this market, it is essential to work with an experienced agent in the selection and purchase of the most appropriate policy.

National Assoc. of Insurance Commissioners (NAIC)

The NAIC is a private, nonprofit association of the state insurance commissioners that provides some uniformity to state insurance regulation. The NAIC was formed in 1871 by the state insurance regulators to help coordinate the regulation of insurance companies that did business in many different states. Although it has no legal power to enforce regulation, it has significant influence, and its Model Laws are frequently adopted by the states. The NAIC supports state regulatory efforts in a number of ways, some of which are listed below: It maintains an extensive insurance database and computer network linking all insurance departments Analyzes and informs regulators about the financial condition of insurers Coordinates examinations and regulatory actions with respect to troubled companies Establishes and certifies states' compliance with minimum financial regulation standards Provides financial, reinsurance, actuarial, legal, computer and economic expertise to insurance departments Values securities held by insurers Analyzes and lists non-admitted alien insurers Develops uniform statutory financial statements and accounting rules for insurers Conducts educational and training programs for insurance department staff Develops model laws and coordinates regulatory policy on significant insurance issues Conducts research and provides information on insurance and its regulation to state and federal officials and the general public.

Needs Analysis Approach

The Needs Analysis Approach looks at how that income was being used, instead of simply replacing lost income. There are three steps to this analysis. 1. Identify the needs that would arise or continue following death of the individual - death expenses, mortgage payoff, readjustment period, income for dependents. 2. Total the resources that would be available such as life insurance, employer-provided benefits, Social Security survivor benefits, savings, retirement plans. 3. Measure the difference between the needs and the resources available. The resulting shortfall is the insurance need. REAL LIFE EXAMPLE Sean, a 37 year-old father of two, dies leaving behind his wife and his 4 year-old and 6 year-old sons. Sean has both individual and group life insurance. In addition, because he was a person with "high earnings" his Social Security survivor benefits will be $2,000 a month to his family, totaling more than $300,000. If these benefits were not counted in the calculation, it would appear that Sean's family would not be adequately protected.

Definitions Used in PAP

The PAP begins with definitions that apply throughout the policy. Two of these terms, you and your covered auto, merit special attention. A. Throughout this policy, you and your refer to: 1. The named insured shown in the Declarations; and 2. The spouse if a resident of the same household. B. We, us and our refer to the Company providing this insurance. C. For purposes of this policy, a private passenger type auto shall be deemed to be owned by a person if leased: 1. Under a written agreement to that person; and 2. For a continuous period of a least 6 months. D. Bodily injury means bodily harm, sickness or disease, including death that results. E. Business includes trade, profession or occupation. F. Family member means a person related to you by blood, marriage or adoption who is resident of your household. This includes a ward or foster child. G. Occupying means in, upon, getting in, on, out or off. H. Property damage means physical injury to, destruction of or loss of use of tangible property. I. Your covered auto means: 1. Any vehicle shown in the Declarations 2. Newly acquired additional autos 3. Substitute autos (rental cars) 4. Owned trailers 5. Loaner vehicles while your car is being serviced or repaired

Split Limits

The PAP may be written with split limits only by using an endorsement. When Coverage A is written with split limits, such as $50,000/$100,000/$5,000, the insurer pays a maximum of $50,000 to any one injured person and a maximum of $100,000 for any one accident regardless of the number of injured people. The first two amounts are available for bodily injury liability per person and per accident respectively. The third number indicates that the insurer will pay up to $5,000 for property damage liability for each accident. Lets compare the single limit and split limit types of liability coverage more closely. If the insured's single victim sustained $100,000 in damages, he would receive this amount under a $100,000 single limit policy. However, if the insured had $50,000/$100,000/$5,000 split limits, the victim would receive only $50,000. Lets say there were three victims, sustaining $100,000, $75,000, and $50,000 in injuries respectively. Under the single limit plan, the $100,000 limit would be apportioned to the victims based on order of claim being filed and settled up to the limits, and the insured would be liable for the balance. Under the Split Limit plan, two victims would be able to collect $50,000 each, and the insured would still be liable for the balance. As a second example, using $250,000/$500,000/$5,000 split limits, assume Hannibal Moe, the elephant trainer, causes a collision injuring four people and they file suit in the following order (the insurer pays claims in the order in which the suits are settled): A's injuries total $400,000, B's equal $100,000, C's equal $250,000, and D's amount to $500,000. With split limits, A can collect $250,000, the maximum the insurer will pay for any one person. B will collect $100,000, bringing the total paid by the insurer to $350,000. The remaining $150,000 ($500,000 - $350,000) will go to C. In all, $150,000 of A's claims, $100,000 of C's claim, and D's entire claim will not be satisfied by Hannibal's insurance contract. Not only will Hannibal be liable for the unsatisfied claims, but he will also pay for any additional defense costs because the company's obligation to defend ends after it pays the limit of liability.

Monthly Indemnity

The amount of the monthly benefit and the length of each benefit period are selected when applying for disability insurance. Disability contracts will vary based on these factors. For example, contracts are more expensive if benefits can be paid for life. Many insurers will terminate or modify benefits when the insured reaches age 65 to integrate the disability contract with Social Security retirement benefits and private pension plans. The monthly benefit amount is calculated as a percentage of the insured's income, usually 60% to 70%, up to the company's underwriting limits. The reason for this reduced benefit amount is to discourage malingering and encourage rehabilitation. Monthly benefit limits also take into account other compensation that may be available to the disabled insured (for example, employer sick-pay plans, government programs such as Social Security Disability, and other personal or group insurance). Insurers may also reduce these limits for individuals with significant earned or unearned income, or for those whose net worth exceeds $3 million. For example, high wage earners may have their benefits reduced to 50% of their earned income to adequately cover their expenses and encourage rehabilitation. Most insurers impose a dollar limit on the maximum monthly benefit that will be provided. Nevertheless, under the regular limits of the leading disability writers for personal insurance, an insured with adequate income in the more favorable risk classifications may acquire up to a maximum of $15,000 to $20,000 in monthly indemnity for total disability. This amount generally is separate from indemnity limits established for special business insurance policies, such as overhead expense insurance, which helps business owners pay the necessary bills to keep their businesses running while they are disabled. Insurers generally limit the amount of coverage under short-term policies to 60% of the worker's weekly wage. Long-term coverage may be written up to 70% of the worker's monthly wage. During a period of partial disability, a person who works part-time while recuperating may receive a residual disability benefit. However, indemnity may be reduced since the insurer pays the difference between the insured's pre-disability income and post-disability income. This provision in a disability contract is known as a rehabilitation benefit.

Present Interest

The annual exclusion is available only when the gift is one of a present interest. A present interest is a situation in which the recipient must have possession or enjoyment of the property immediately. An example is a gift of cash or property that can be used immediately by the recipient. The exclusion is not available for gifts of a future interest in property, that is, any interest in property that does not pass into the recipient's possession or enjoyment until some future date. This would occur if a trust beneficiary can only receive the remainder interest in the trust corpus, not an immediate income interest, or if the beneficiary would not receive distributions from a trust until a later time. Life insurance policies that are gifted to individuals are gifts of a present interest, since the new owner can keep the policy, sell it or gift it to someone else. The donor who gifted the policy can take an annual exclusion up to $14,000 against the gift tax value of the policy in 2015. Life insurance policies that are transferred into an irrevocable trust are treated differently. The beneficiaries of the trust do not have a present interest in the policy until the insured dies. Therefore, the gift tax value of the policy cannot be reduced by annual exclusions for each beneficiary in the trust. That is why many irrevocable life insurance trusts (ILITs) contain Crummey provisions -- Crummey v. Commissioner., No. 21,607 (9th Cir. 25 June 1968) -- which create a present interest for beneficiaries. A Crummey power allows trust creators (grantors) to use annual exclusions for each beneficiary to reduce the gift tax value of the policy transferred into the trust, and to reduce any taxable premium amounts that are transferred into the trust annually. Gift-splitting can also be used to reduce the gift tax value of the policy and premiums, as long as a spouse is not a beneficiary of the trust.

Applicable Credit

The applicable credit or unified credit is a tax credit that can be applied to offset estate and gift taxes. The practical effect of the unified credit is to eliminate transfer taxes on total lifetime and testamentary transfers. For example, the unified credit of $2,117,800 offsets gift and estate taxes up to $5,430,000. The transfer tax on $5,430,000 is $2,117,800, so once the credit is subtracted from the tentative tax, the tax liability (which is the amount owed) is zero. Prior to the passage of EGTRRA 2001 and up through 2003, the unified credit available for taxable transfers made either during lifetime or after death was identical. In 2004, the applicable credit began to increase for estate tax purposes, but for gift tax purposes it stayed at a constant $345,800 (tax on an asset equivalent value of $1 million). For 2011 and 2012 (and following years), the gift tax and estate tax rate schedule is unified again. GIFT TAX APPLICABLE CREDIT Year / Exemption Equivalent / Applicable Credit 2001 / $675,000 / $220,550 2002 - 2009 / $1,000,000 / $345,800 2010 / $1,000,000 / $330,800 2011 / $5,000,000 / $1,730,800 2015 / $5,430,000 / $2,117,800 ESTATE TAX APPLICABLE CREDIT Year / Exemption Equivalent / Applicable Credit 2001 / $675,000 / $220,550 2002 - 2003 / $1,000,000 / $345,800 2004 - 2005 / $1,500,000 / $555,800 2006 - 2008 / $2,000,000 / $780,800 2009 / $3,500,000 / $1,455,800 2010 / NA / NA 2011 / $5,000,000 / $1,730,800 2015 / $5,430,000 / $2,117,800

International/Global Competition

The banks of the European Union (EU) were allowed to combine all financial service functions well before the passage of Gramm-Leach-Bliley (GLB) in the United States. In fact, even after the passage of GLB, the EU banks have more flexibility than their U.S. counterparts, as EU banks can take equity positions in non-financial firms. This is currently not possible for U.S. banks. The potential for global competition provided an incentive for U.S. banks to want a level playing field with their international competitors. That is, U.S. banks believed that if they had to compete with other nations' banks, they wanted to be of comparable size and offer comparable services to their clients.

The Benefit Amount

The benefit of the personal disability income policy is always payable as a fixed amount of monthly indemnity. The indemnity for total disability generally is written on a valued basis, which means that the stated policy benefit is presumed to equal the actual monetary loss sustained by the disabled insured. This amount is not adjusted to the insureds earnings or other insurance payments at the time of claim for total or partial disability. During a period of residual disability, however, indemnity may be reduced in proportion to lost earnings of the insured. These limits are intended to minimize the creation of moral hazard in the form of over-insurance, which occurs when benefits equal or exceed a disabled insureds pre-disability income.

The Benefit Period

The benefit period is the longest period of time for which benefits are paid under the disability policy. Usually, the benefit period is the same for sickness and injury and is available for durations of two or five years, to age 65, and for life, provided continuous, total disability begins before a specified age, e.g. age 55. Long benefit periods are more consistent with sound personal risk management principles. The longer the benefit period, the higher the premium. All insurers include a provision that deals with consecutive or recurrent episodes of disability and identifies when theres either a new or continuing claim. The provision states that the company will consider recurrent periods of disability from the same cause to be one continuous period of disability, unless each period is separated by a recovery of six months or more.

Benefit Period

The benefit period is the longest period of time for which benefits will be paid under the disability policy. Usually, the benefit period is the same for sickness and injury and is available for durations of two to five years, to age 65, and for life provided continuous, total disability begins before age 55 or age 60. Most disabilities are of short duration. Roughly 98 percent of all disabled persons recover before one year has elapsed, and most disabled individuals recover within six months of the time disability began. However, if disability lasts beyond 12 months, chances of a return to productive work diminish markedly, particularly at older ages. For example, a 35-year-old worker, disabled for at least 90 days, can expect, on average, to be out of work for more than 3 years. The effect of extended disability can be financially devastating. Long benefit periods are more consistent with sound personal risk management principles. The longer the benefit period, the higher the premium, with all other things being equal.

Benefit Provisions of LTC

The benefit provisions in LTCI policies outline what will be payable by the insurer if an insured event occurs. These provisions relate to the types and levels of care for which benefits will be provided, any prerequisite for benefit eligibility, and the level of benefits which are payable. However, no policy guarantees to cover all LTCI expenses; there are always certain limits and/or "cost-sharing" amounts the insured incurs. The policies offered by many companies provide a choice of elimination periods before benefits become payable. The schedule of the benefit periods offered might range from two to five years. Some insurers even offer a lifetime benefit period, which works out to be quite an expensive option. PRACTITIONER ADVICE: Given that approximately 90 percent of all nursing home confinements last less than 5 years, a 5-year benefit is often a suitable selection. Of course, affordability of premiums is a constraint to consider. Community-based care is less expensive than nursing home care, and is usually preferred by the elderly. The maximum daily benefit varies by contract from 50 percent to 100 percent of the maximum daily benefit for nursing home care. The length of the benefit period is often the same for both of the coverages, but different insurers require different waiting periods. LTCI policies now offer some kind of inflation protection rider for an additional premium.

Inflation Protection Benefit

The cost-of-living-adjustment (COLA) benefit under disability income policies provides for adjustments of benefits each year during a long-term claim so as to reflect changes in the cost of living from the time that the claim began. Adjustments are computed by the rate of change shown in a price index, such as the U.S. consumer price index. At one time, insurers marketed COLA riders offering fixed-percentage increases. This practice resulted in some benefits outpacing the rate of inflation and led to moral hazard problems. The method of adjustment is relatively complex, but generally it calls for a comparison of the index for the current claim year with the index for the year in which the claim began. If the index increased or decreased since the start of the claim, benefits for the next 12 months are adjusted by the percentage change in the index. The percentage change is limited to a specified rate of inflation, generally ranging between 5 and 10 percent compounded annually. The adjusted policy benefits may increase or decrease each year as the index rises or falls, but the benefits cannot be reduced below the level specified in the policy on the date of issue. Some insurers apply a cap to limit increased benefits to a maximum of two or three times the original indemnities. Others place no limit on the maximum increase of adjusted benefits before the insured is age 65.

Declarations of Commercial Coverage

The declarations usually are the first page of most insurance policies. The declarations establish the insured's identity and the location of the business. This section also shows the different component coverages purchased and the premiums charged.

Last Clear Chance

The doctrine of last clear chance is another modification of the contributory negligence rule. In general, when a plaintiff's negligence contributes to the loss, nothing may be collected if the court applies the contributory negligence rule. Assume that, despite the plaintiff's negligence, the defendant had a clear chance to avoid the injury. For example, assume the plaintiff, Denton Fender, was waiting to make a left turn but failed to use his turn signal. Assume the defendant, Manuel Transmission, had a clear chance to avoid the accident, but hit Denton anyway. In this case, the sequence of events in court would likely be that: 1. The plaintiff, Denton, establishes negligence, 2. The defendant, Manuel, establishes contributory negligence on Denton's part, and 3. The plaintiff then establishes that the defendant had a clear chance to avoid the accident despite the plaintiff's negligence. Assuming no further legal steps by the defendant, the plaintiff would receive full recovery.

The Elimination Period

The elimination period is also called a waiting period and refers to the number of days at the start of disability during which no benefits are paid. It is a limitation on benefits, somewhat like a deductible in medical expense and property insurance policies. It is meant to exclude the inconsequential illness or injury that disables the insured for only a few days and that is more economically met from personal funds. Elimination periods range from 30 days to one year, with three months being a common elimination period. Premiums are lower for policies with longer elimination periods. The major insurers allow for a temporary break in the elimination period. Thus, the insured is not penalized for any brief attempt to return to work before the elimination period has expired at the start of disability. PRACTITIONER ADVICE The 90-day elimination period is the most popular and the most economical. Clients need to realize that since disability benefits are paid monthly, they won't receive their first check until after they have been out of work for 120 days. The financial planner can help minimize this shortfall by having the client keep 3 - 6 months of liquid assets in an emergency fund.

Estate Tax Treatment

The estate tax, introduced at a modest level in 1916, can have great impact on wealthy estates. The federal estate tax is arrived at by adding the taxable estate to adjusted taxable gifts, which are taxable gifts made after 1976, to yield the tentative tax base. The reason for this addition is that the estate tax law is part of a unified transfer tax law that applies to transfers made at death and even during life. It is necessary to add the value of lifetime taxable transfers (gifts) back to the tax base to derive the appropriate marginal tax bracket. The appropriate tax rate is then applied to the tentative tax base to derive the tentative federal estate tax. From this tentative tax is subtracted certain credits for gift and other taxes paid as well as the unified credit. Generally, a federal estate tax return must be filed and any estate taxes paid within nine months of the death of any U.S. citizen or resident who leaves a gross estate of more than a specified exempted amount. The exempted amount in 2015 is $5,430,000. An extension of up to 10 years may be granted for payment of taxes by the IRS for "reasonable cause," including those taxes associated with certain closely held businesses. The federal estate tax is a graduated tax, starting at 18 percent and building to a 40 percent marginal rate for taxable amounts over $5,430,000 in 2015. The gross estate, the starting point for estate tax computation, consists of the value of the decedent's interest in all property. Allowable deductions are then subtracted from the gross estate, which results in the taxable estate. However, the unified credit is a tax credit that can be applied to offset the taxable estate. PRACTITIONER ADVICE In the past people focused their estate planning strategies primarily on the federal tax laws. Now that Congress has reduced the federal estate tax, many States have revised their laws so that they can continue to collect taxes. In some states, e.g. Massachusetts, there may be state taxes owed on estates that are exempt from federal estate tax.

Establish Objectives

The first step in the risk management process is to establish objectives. When discussing life insurance, the question is, what are you trying to accomplish? Do you want to support your dependents in their current lifestyle? Does the parent doing child care wish to be able to stay home & take care of the children? Are there other goals to be met, like funding college education? It is important to establish not only overall financial objectives, but also specific sub-objectives. An individual must determine the income levels with his or her spouse for personal insurance planning purposes. This will help in determining the income level needed in case of death or incapacitation of either spouse. The objective translates into future needs that could be greater or less than the current family income. A commonly stated objective is to allow the family to maintain its current living standard after a family member's death or incapacity.

Fixed-Amount Option

The fixed-amount option provides the beneficiary with regular, fixed-income payments. Interest income is earned on balances remaining with the insurer. Federal income tax applies to the interest portion of these payments. The payments continue until the death proceeds and the interest thereon is exhausted. This option is a logical choice when people need income for a limited period, such as while social security benefits are unavailable or for an education fund. Using this option, the beneficiary can receive an insurance payment before each tuition bill. PRACTITIONER ADVICE This option is useful for a client who wants to know she will get a certain needed amount, for example, a monthly check to cover her mortgage payment.

Statistical Analysis

The following are the steps that risk managers take in employing statistical techniques to identify specific problems: They draw logical conclusions from the data by making intelligent comparisons such as: comparing the current years data to historical data of the company, and comparing company data to national averages that may be provided by a trade association or from a companys insurer. The risk managers evaluate the effectiveness of the risk management program, especially the loss prevention program. They may consider many other variables when conducting the annual loss analysis, but usually limit their investigations and focus on those variables most subject to change and improvement. The risk manager will develop a comprehensive report for senior management to review, as the data apply to the core business of the firm. The risk management department may become overburdened with the masses of data and reports that computers store and produce. Therefore, operating a RMIS is not without problems. If loss data are inaccurate, subsequent analysis or forecasts will be misleading. Therefore risk managers should ensure that the following are maintained: Data integrity. Backup data storage. Records of acquisition and disposal of property. Records of all the firms property, its cost, replacement value, preferred vendors and how this property will be replaced if lost, including location, amounts and turnover. Database that can be analyzed to identify products, people or locations that produce an extraordinary number of lawsuits. Records to track claims after the company is given notice of suit and assess the effectiveness of counsel in representing the companys interests in lawsuits. Insurance policy records and insurer information because a company may deal with several different insurance agents or brokers and have many insurance policies in force.

Generation-Skipping Transfer Tax

The generation-skipping transfer tax (GST) is levied when a property interest is transferred to persons who are two or more generations younger than the transferor. For 2015, the GST exemption is $5,430,000. The transferor for property subject to the federal estate tax is the decedent and, for property subject to the gift tax, the transferor is the donor. The GST tax is intended to ensure that transfer taxes are paid by wealthy persons who might otherwise avoid a generation of transfer taxes by passing their property to heirs (so-called skip persons) beyond those of the next generation. The tax is in addition to any federal estate or gift taxes owed because of the transfer. For example, a grandmother may gift property directly to her granddaughter rather than to her son. In the absence of the GST, this gift could avoid all transfer taxes that otherwise might have been incurred if the transfer were first to her son, and then by the son to the granddaughter. The amount of the GST tax is a function of the property value transferred and the applicable tax rate. For 2015, a total of $5,430,000 may be transferred during his or her lifetime, free of GST tax. If the spouse joins in the transfer, the lifetime exemption is doubled through gift splitting. The value of transferred property in excess of the exemption is subject to the maximum prevailing transfer tax rate of 40%. The GST tax is of little importance to persons of modest wealth, but those with greater wealth could incur substantial taxes under this provision.

Gross Estate

The gross estate, the starting point for estate tax computation, is composed of the value of the decedent's interest in all property. There are some exceptions. Outright ownership of property is not required for its value to be included in the gross estate. The value for estate tax purposes is the fair market value of the property at the date of death or, if a lower estate value would result (for example, due to investment losses), six months after death - the so-called alternate valuation date. The IRS may impose a penalty of 10 to 30 percent of the amount of tax owed if property is found to be undervalued. Special valuation rules are available for real property used for farming and other business purposes. Decedents who are owners of life insurance policies, or have any incidents of ownership in life insurance policies, will have the death benefit included in their gross estate at death. If an owner gifts their life insurance policy to another person, or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within three years of their death, the death benefit proceeds will also be included in their gross estate. A decedent who owns a life insurance policy on another person's life, will have the replacement cost value of that policy included in their gross estate at death. A person who is an owner of a policy but is not the insured, can transfer that policy any time prior to death, and the value will not be included in their gross estate at death. The difference from the example above is that the owner/insured is subject to the 3 year rule in policy transfers, while the owner who is not the insured is NOT subject to the 3 year rule for policy transfers.

Taxation of Health Insurance

The income tax treatment of amounts paid under individual health policies is reasonably straightforward. Generally, amounts received under such policies are amounts received for personal injuries and sickness and are treated as reimbursements for expenses incurred. Health insurance provides full or partial reimbursement for a wide range of health care expenses incurred by employees and their eligible dependents. The particular coverage offered by plans continues to change and expand in response to changes in health services demand and technology.

Individual Practice

The individual practice HMO contracts with specific physicians and hospitals. These doctors and hospitals may provide service to the public in addition to members of other HMOs. Participants in the individual practice HMOs can choose a physician from among those participating in the plan. The physician then charges the HMO a fee for each patient seen. The group practice HMO has a limited number of medical providers that a member may use. These doctors and medical professionals often work exclusively for the HMO. PRACTITIONER ADVICE: If you are changing health insurance plans, either individually or through your employer, you should check to see if your current doctors are included in the HMO you are considering.

Liability

The insurer agrees to defend its insured in court as well as to pay legal judgments on behalf of its insureds as a part of the automobile liability insurance. This means that the insured does not have to pay for an attorney if sued. In the PAP, the cost to defend an insured does not reduce the money available to pay claims. The policy states: "In addition to our limit of liability, we will pay all defense costs we incur." The insurer would have become involved prior to any trial, as insureds are required to notify the insurer of any accidents within a reasonable period of time. This allows the insurer to start working with the other partys representatives to try to resolve the claim as efficiently as possible. The only time when the insured would end up in court without the insurer is if the insurer denied the claim, or the insured failed to involve the insurer. Real Life Problem: Mr. Stewarts neighbor, Mr. Jeffries, bumped into Mr. Stewarts car in the parking lot of their apartment building. Mr. Jeffries told Mr. Stewart he would pay for the damage out of his pocket. He wanted to avoid going to their insurers because he was afraid his premium would be raised. Mr. Stewart agreed and did not report the accident. After three months of trying to get Mr. Jeffries to pay the $800 in damage, Mr. Stewart called his insurance company. Because his policy required him to report all accidents within a reasonable period and not to try to settle any claim on his own, the insurer denied the claim. The lesson learned: Read your policy and understand not just your rights, but also your responsibilities.

Grace Period

The insurer will send the insured a notice of when the premium is due before the due date. If the insured neglects to pay a premium when it is due, the policy does not end immediately. If the insured forgets to pay the premium or decides to end the contract, the grace period provides 31 days to pay the premium without forfeiting any contractual rights and no questions asked. If there is enough cash value in the policy, the premium will be paid, reducing the cash value. If there is not enough cash value to pay the premium, the policy will lapse. The policyholder must pay the premium before the end of the 31 days provided by the grace period to avoid having the policy lapse. However, if the policyholder dies during the grace period, the insurer will pay the proceeds to the beneficiary, minus the overdue premium. For example, assume the policyholder has a stroke and is hospitalized on December 10th, and that the anniversary date of the policy is January 1st with an annual premium of $10,000 on a $450,000 Whole Life policy. If the $10,000 is not paid on January 1st and the policyholder dies on January 18th, the beneficiary of the policy will receive a death benefit of $440,000, as the premium is outstanding less than 31 days (January 1st January 18th). If the policyholder makes the premium payment in time, the beneficiary will receive the entire $450,000 death benefit.

Ratios

The main benefit of IRIS occurs when the computer analysis flags any ratios outside a normal range of expected results. Companies with the highest number of abnormal results receive the highest priority for examination by state examiners. After the first-phase computer analysis of the IRIS results, a second-phase analysis of companies with four or more ratios outside the normal range occurs. Logical explanations for abnormal ratios may exist, such as solid but rapid growth, a merger of two companies, or unusual investment results. Alternatively, firms with many abnormal ratios also may be in weak financial condition, but if caught promptly, insurance departments may be able to take action protecting policy owners' interests. The IRIS examination includes analysis of the following ratios: Change in capital and surplus Net gain to total income Commissions and expenses to premiums and deposits Investment yield Change in premium Change in reserves Regulators also use other sources of information when evaluating insurers, including SEC filings, financial ratings companies' reports, complaint ratios, news articles, and letters from competitors and agents.

Gramm-Leach-Bliley Act of 1999

The overriding purposes of the Gramm-Leach-Bliley (GLB) Act were to modernize the U.S. financial services markets, to formalize the regulation of these markets, and to make the markets more competitive, thereby providing benefits to consumers. The core provisions of the GLB allow the combination of banks, insurance companies and securities dealers into financial service holding companies. Regulation of each component part of such a holding company follows the historic pattern. This means that the Federal Reserve and the Treasury Department will continue to supervise banks, the federal Securities and Exchange Commission will continue to supervise securities dealers, and state insurance commissioners will continue to supervise insurance companies. The forces underlying the passage of GLB included the following: Consumer needs Banks wanting to expand the scope of the financial services they could offer International competition Technology

Commercial Transportation Insurance

The perils facing mobile property are broader in scope than the perils facing real property. In addition to such perils as fire, lightning, and windstorm, mobile property may be sunk, confiscated, and hijacked as well as collided with and stolen more easily than property attached to the land. The broader scope of the perils, the difference in ability to investigate losses, and the differing potential for salvage operations have resulted in marine insurance practices that are quite distinct from comparable property insurance practices. Mobile property, such as property to be exported, is generally covered by transportation insurance.

Elimination Periods of LTC

The policies offered provide a choice of elimination (waiting) periods before benefits become payable. Available elimination periods range from zero to 365 days. A longer waiting period warrants a lower premium, all other provisions remaining the same. PRACTITIONER ADVICE The 20-day elimination period may be selected to match the time period when Medicare stops paying 100%. The 60-day elimination period has a lower premium, and is more popular with clients who are willing to "self-insure" the first two months of care. Previously we learned to look at the balance sheet to determine how much cash is needed for a 6-month reserve and determine the current ratio (current assets / current liabilities). Assume a client would like to purchase a long-term-care policy and that long-term-care expenses are estimated at $120,000 per year or $10,000 per month. The client gets several quotes, and, in an effort to minimize the insurance premium, chooses a longer elimination period. The advisor should discuss with the client the cash flow needed to bridge long-term-care expenses that will not be covered until the policy starts paying. For example, if the client chooses a 6-month elimination period, point out that approximately $60,000 (6 months x $10,000 long-term-care expenses) is required to cover all costs until the elimination period has passed.

Residual Disability Benefit

The residual disability benefit provides reduced monthly indemnity in proportion to the insured's loss of income when he or she has returned to work at reduced earnings. In policies that provide for an own occupation definition of total disability, the residual benefit is payable only when the insured has returned to work in his or her own occupation. Most insurers allow the insured to be either totally or residually disabled to satisfy the elimination period of the policy and to qualify for waiver of premium. REAL LIFE EXAMPLE Gordy, a self-employed real estate agent, has a heart attack and surgery, and is out of work for 6 months. When he comes back to work under doctor's orders, he is told to only work 30 hours a week. In addition, he needs to rebuild his business after being out of touch with prospects for 180 days. Both of these factors contribute to his income being lower for the next 6 months.

Risk Management Process

The risk management process provides an excellent framework for analysis of the financial consequences of loss of health and premature death. The risk management process helps determine whether any insurance is needed and the amount needed. The term "insurance programming" has been used to describe the risk management process applied to personal insurance planning for decades. The process involves several steps: 1. Establish Objectives 2. Identify Loss Exposure 3. Measure Loss Exposure 4. Develop Plan 5. Implement Plan 6. Regularly Review Plan EGADIM

Joint and Several Liability

The rule of joint and several liability means that if a party is one of several responsible for a loss, even if that parties' contribution was the slightest of all, then that party is fully responsible for making restitution to the injured party if the other defendants are financially unable to do so. Joint and several liability may be called a "deep pockets" approach to recovery. Since 1986 more than two-thirds of the states have passed laws to modify the doctrine of joint and several liability, replacing it with several liability or a system for apportionment of damages based on the degree of fault.

Reasons for Insurance Regulation

The rules of the insurance marketplace are established by law, administered by public officials, and interpreted by the courts, all for the cause of public interest. Different rules govern the insurance transaction. The insurance transaction between consumer and insurer is made in a comprehensively regulated marketplace. Insurers generally are not free to write any contract they choose, are not free to charge any price they choose, and for some types of personal insurance must accept insureds they did not freely choose. The following three reasons explain why the insurance marketplace is regulated so extensively: 1. Guarantee financially strong companies. 2. Prevent unfair treatment of consumers. 3. Provide fair contracts at fair prices.

Rule #2: Never Over Expose

The second rule in choosing the proper amount of insurance is to never expose to loss more than you can afford to lose. For example, Tom and Gloria could not afford to lose their house. So they decide to insure it for an amount equal to its current replacement value. Gloria also went through her heirlooms and found that though they were of sentimental value to her, their loss or damage would not lead to any severe financial hardship. So they decided against insuring them.

Identify the Risk (Gather Information)

The second step is to identify the risk of premature death. Premature death can create loss in two ways - there are expenses related to the death itself, e.g. funeral expenses, uninsured medical costs, debts to be paid, and probate fees. This step involves gathering relevant quantitative and qualitative information to permit a sound identification of financial loss exposures arising from the individual's death or loss of health. It also includes identification and valuation of the individual's assets and liabilities, as well as the person's income and expenditures. The information is often gathered through a fact-finding questionnaire.

Conditions of Coverage

The settlement of covered property losses is detailed below. Loss of the following types of property is settled at actual cash value at the time of loss but not more than the amount required to repair or replace it based on the depreciated value at the time of loss: Personal property Awning, carpeting, household appliances, outdoor antennas and outdoor equipment, whether or not attached to buildings Structures that are not buildings For an additional cost, usually about 25% of the base premium, an insured may choose to purchase Replacement Cost coverage on their personal property. If this coverage is in place, any items will be replaced at current fair market replacement value rather than depreciated value should a covered loss occur.

Social Insurance Supplement

The social insurance supplement (SIS) or social insurance substitute evolved as a response to the underwriting problem that is created by the existence of substantial benefits potentially available for disability under workers' compensation or for disability or retirement under the U.S. Social Security Act. Most insurance companies take these substantial benefits into account and, to minimize moral hazard at a later time, sharply limit the amount of conventional disability income insurance that will be issued to applicants with incomes below $35,000, particularly those in their less favorable occupational classes. However, the insured may not always qualify for the anticipated benefits of the social insurance plans. He or she may suffer a loss that is not covered by workers' compensation or that does not meet the highly restrictive definitions for total and permanent disability under Social Security. If the insurance company has limited the amount of personal insurance, the individual will be underinsured each month by several hundred dollars or more. The SIS benefit was developed to meet this potential coverage gap. The supplemental benefit provides an amount of monthly indemnity that approximates the amount the insured might reasonably expect to receive from Social Security for total disability. The SIS benefit is paid when the insured meets the policy's definition for total disability but is not receiving benefits from any social service plan. It is payable as a fixed amount of indemnity that ceases when the insured begins to receive any income from a social insurance plan or it may be reduced by a dollar-for-dollar offset of the benefit actually paid under the social insurance plan. If the offset method is used, the insurer usually specifies a minimum amount below which the SIS benefit will not be reduced while total disability continues. PRACTITIONER ADVICE: Another way in which the SIS benefit is used is to reduce premiums when a client's budget is tight. Because the cost per $100 of SIS benefit is considerably lower than that of the basic benefit, accepting a lower basic monthly benefit and adding an equivalent amount of SIS benefit can cut premiums. This tactic is only advisable when the alternative would be to drastically cut the monthly basic benefit to a point where the need is not adequately covered.

Suicide Clause

The suicide clause is commonly included in the life insurance contract. New York law allows a life insurer to exclude payment for death by suicide if the suicide occurs within two years from the policy issue date. The purpose of the suicide clause is to control the moral hazard of a person purchasing a policy in contemplation of committing suicide. (Many insurance companies have a one-year restriction that is more favorable to the policyholder and permissible under law.) The policy will pay for death caused by other illnesses, including mental illness. If, during the underwriting process, there is a history of mental illness that causes the insurer to be concerned about possible suicide, the policy will not be issued. Therefore, after the two-year restriction, the company will pay for suicide deaths because the suicide presumably has been caused by mental illness that occurred after the policy's inception. Where there is no history of mental illness and the applicant is contemplating suicide, it is improbable that a suicidal person could wait two years to complete the act. Insurers often have a difficult time establishing that the insured's death resulted from suicide. In one case, within two years of the policy's effective date, an insured took between 30 and 40 sleeping pills, pulled the phone out of the wall and subsequently died. The autopsy and death certificates each listed suicide as the cause of death. Moreover, this was the second occasion within three months in which the insured had taken an overdose of sleeping pills. Nevertheless, the jury was instructed that the presumption is against suicide in all cases, and that suicide may be assumed only when no other conclusion could reasonably be drawn. As the jury thought it was possible the insured's death may have been caused by the motive of "self-indulgence," the insurer had to pay the claim. PRACTITIONER ADVICE If the policyholder commits suicide within the two years of issuance, the insurance company will pay the policyholder's estate all premiums paid without interest.

The Term Professional

The term professional refers to a person with special skills, education, or knowledge compensated to provide a service to the public. In many cases professionals are licensed by the states. Originally, the term was restricted to people employed in the areas of theology, law, and medicine. Today, the term is applied more widely. Professional liability insurance is a necessary purchase for accountants, actuaries, architects, directors of corporations, pharmacists, hair stylists, insurance agents and brokers, and other professions requiring special education or a license.

Measure Loss Exposure

The third step in the process is to analyze relevant data and loss exposures, in light of the individual's stated objectives. In risk management terms, analysis involves measuring the financial consequences of the losses. Loss analysis has two dimensions: frequency and severity. For personal insurance planning purposes, loss frequency information (such as, probabilities of death and incapacity) often has little utility to the individual. Sound risk management analysis presumes that potential loss could occur, and it attempts to measure the likely financial consequences. A plan of action is then developed to deal with the potential loss if it occurs. Applied to insurance planning for an individual, this means that you should assume a personal loss is about to occur. This analysis yields a measure of the potential loss severity from a financial point of view, for example, consequences of death. Financial objectives established by individuals usually fall into two categories: cash and income. Cash Objectives + Income Objectives = Financial Objectives

Consideration

The value exchanged between the parties to the contract is the consideration. The consideration is what each party gives to the other. Consideration may take a tangible form, such as money, or it may take the form of a promise to do or not to do a particular activity. There must be an exchange of consideration to have a valid contract. In an insurance contract, the consideration the insurer gives is a contingent promise to pay the insured; that is, the insurer agrees to make payment only if a covered loss occurs. If such an event does not occur, the insurer need not make payment. In return for the insurer's promise, the insured gives two things money and a promise to follow the provisions and stipulations in the insurance contract.

Waiver of Premium Benefits

The waiver-of-premium benefit under disability income policies characteristically waives any premiums that fall due after the insured has been totally disabled for the lesser of 90 consecutive days or the elimination period, and it allows for refund of any premiums paid during this period. Further premiums are waived while the insured remains disabled, until age 65. Some insurers also waive premiums that fall due within 90 days after recovery. The waiver-of-premium feature invariably terminates when the insured attains age 65.

Waiver-of-Premium Provision

The waiver-of-premium provision under disability income policies characteristically waives any premiums that fall due after the insured has been totally disabled for the shorter of 90 consecutive days or the elimination period. It also provides a refund for any premiums paid during this period. Further premiums are waived while the insured remains disabled, until age 65. Some insurers also waive premiums that fall due within 90 days after recovery. The waiver-of-premium feature invariably terminates when the insured attains age 65.

Other Provisions of the Affordable Care Act

There are other provisions of the Affordable Care Act that increases access to affordable care, improves the quality of care, and lowers health care costs. The Act provides increased access to affordable care by: Providing access to insurance for uninsured Americans with pre-existing conditions. Extending coverage for young adults by allowing them to stay on their parent's plan until they turn 26 years old. Expanding coverage for early retirees between the ages of 55 and 65, and covering their spouses and dependents. Rebuilding and expanding the primary care workforce by providing incentives to doctors, nurses and physician assistants to work in underserved areas. Holding insurance companies accountable for unreasonable rate hikes. Allowing states to cover more people on Medicaid. Expanding community health centers to serve new patients throughout the country. Increasing access to home and community based services to disabled individuals through Medicaid, rather than through institutional care in nursing homes. Some provisions of the Act that improves quality of care and lowers costs include: Providing small businesses with heath insurance tax credits to help them provide coverage to their workers. This credit is worth up to 35 percent of the employer's contribution to the employee's heath insurance. Offering relief for seniors who hit the Medicare prescription drug "donut hole" by giving seniors a $250 rebate. Offering prescription drug discounts for seniors who reach the coverage gap. Seniors will receive a 50% discount when buying Medicare Part D covered brand-name prescription drugs. Over the next 10 years seniors will receive additional savings on brand-name and generic drugs until the coverage gap is closed in 2020. Providing free preventive care for services such as mammograms and colonoscopies without charging a deductible, co-pay or coinsurance fee. Providing free preventive care for seniors on Medicare, such as wellness visits. Improving care for seniors after they leave the hospital by coordinating care and connecting seniors with community services to avoid unnecessary readmissions. Creating a new Prevention and Public Health Fund to invest in proven prevention and public health programs that keep citizens healthy. Cracking down on health care fraud by adding new resources and screening procedures for health care providers. Establishing a new Center for Medicare & Medicaid Innovation that will begin testing new ways of delivering care to patients to improve the quality of care and reduce the rate of growth in health care costs. Establishing an Independent Payment Advisory Board to develop and submit proposals to Congress to extend the Medicare Trust Fund. The focus is to reduce costs, target waste, improve health outcomes and expand access to high-quality care.

Riders and Options

There are three additional life insurance policy riders that can purchased for an extra cost. 1. Guaranteed insurability 2. Waiver of premium 3. Double indemnity The guaranteed-insurability option gives the insured the right to purchase extra insurance at certain intervals at standard contract rates, without further proof of insurability. For example, the insured may purchase an additional $25,000 worth of insurance every five years on the policys anniversary date until the insured attains age 40. If extra coverage is purchased, then annual premiums are increased based on the insureds age when the option was exercised. The insurer also sets limits on the total amount of extra insurance that can be purchased. The waiver-of-premium option exempts an insured from paying premiums while they are totally disabled. Despite non-payment of premiums, the disabled insured maintains all policy rights and can receive participating dividends and increases in cash values. Usually, there is a six-month waiting period that applies to this benefit. The double-indemnity option provides a higher death benefit amount if the insureds death results from accidental causes. The insurance company usually pays multiples of the policys face amount if the insured dies from specific perils included in the contract.

Insured, Owner and Beneficiary

There are three distinct classifications of interest in an insurance policy. Insured Owner Beneficiary The insured is the person whose death causes the insurer to pay the claim. The policy owner is the person who may exercise the rights created by the insurance contract. The owner and the insured can be the same person. Ownership rights in life insurance policies include the right to: Change ownership of the policy Assign the policy as security for a loan Name beneficiaries Receive dividends Take out cash surrender value Borrow against the policy A beneficiary receives the life insurance proceeds when the insured dies. A person, trust, estate or a business may be a beneficiary of a policy. A person cannot be both the insured and a beneficiary, however. A beneficiary is a revocable beneficiary when the owner can change the initial beneficiary selected, but an irrevocable beneficiary cannot be changed. Generally, the revocable beneficiary has no rights in the policy while the insured is alive, while an irrevocable beneficiary has a vested or guaranteed interest in the death benefit. An irrevocable beneficiary can prevent the policy owner from taking any action that would reduce their own interest in the policy, such as borrowing from the policy or assigning the policy as security for a loan. Policy owners should name primary (first) or contingent (second, third, etc.) beneficiaries. A common example of successive beneficiary designations is: "Proceeds to my wife (Mary Smith). If my wife predeceases me, then to my children (Huey, Dewey and Louie Smith) -share and share alike. If both my wife and children predecease me, then to the American Red Cross." If a primary beneficiary is living when the insured dies, the contingent beneficiary has no rights to the death benefit proceeds. Contingent beneficiaries will only have death benefit rights if the primary beneficiary predeceases the insured.

Policy Illustrations

There are two types of policy illustrations: proposed and in-force. An illustration for a proposed life insurance policy is designed to show how the life insurance policy will perform if purchased. The illustration will contain the annual premium (or premium paid in any of the other modes available), year end cash values (guaranteed and projected), dividend projections, loan provisions, surrender charges, and death benefits for each year. It is important to understand that several factors in the illustration are not guaranteed, e.g. dividends, interest rates, and/or costs of insurance. For this reason, policy illustrations are simply projections of policy values based on the combination of guaranteed and non-guaranteed elements. An in-force illustration is prepared for an existing policy. It begins with the current year and projects cash value and death benefits in the future, again based on a combination of guaranteed and non-guaranteed elements.

Psychological Factors

This discussion has avoided mathematically engineered solutions and general models. The reason is mathematical precision obscures the fact that, in practice, judgment or psychological factors play a significant, and in some cases indispensable, role in choosing deductibles and policy limits. The company itself does not make decisions. People employed as risk managers and corporate directors make corporate decisions. These people reach conclusions based on their experience, habit, intuition, attitudes toward risk and their ability to explain and sell their ideas to other managers. Professional risk managers often employ mathematics to quantify certain aspects of the retention decision. Estimates of potential losses can prove accurate and useful. Tax effects of different scenarios can be calculated. Financial ratios assuming different post-loss consequences can be developed. Nevertheless, when the final decision is made regarding the right retention or the best policy limit, the determination is made by a human being with various tolerances for risk, not by a risk-neutral corporation.

Major Medical Expense

Traditional life insurers and the Blues both offer major medical expense insurance. Under such traditional expense plans, the reimbursement formula applies to the total covered expenses, which is subject to a deductible and co-insurance. Thus, a plan could provide for the reimbursement of 80 percent of all combined covered expenses in a calendar year after a deductible of $500, up to a lifetime maximum of $1 million. A variety of modified comprehensive designs provide some first-dollar coverage. Starting in 1996, the IRS allowed tax benefits for individuals and small employers to fund medical expenses in medical savings accounts (MSAs) and subsequently in health savings accounts (HSAs). Provisions of Modified Comprehensive Designs: Hospital expenses are not subject to a deductible. Co-insurance is applied on the initial hospital expenses. Surgeons fees may be subject to a customary fee limitation. The deductible and co-insurance features for services such as physicians hospital visits and diagnostic tests may be waived or modified. Theres usually an annual out-of-pocket cap on expenses paid by the insured individual.

Comprehensive Policy

Traditionally, business firms insured their liability exposures using the comprehensive general liability policy (CGL). The Insurance Services Office (ISO) in 1940 initially developed the comprehensive general liability policy form and revised it several times thereafter. It was the first commercial liability form to combine different types of business coverage under a single contract. Coverage included bodily injury and property damage liability insurance for operations at (or emanating from) described premises. Any new locations or operations added during the policy year were automatically insured. Although some insurers still use this form, it has been largely replaced by the commercial general liability policy (which has the same abbreviation CGL) introduced by ISO in 1986.

Consumer Needs and Economies of Scale and Scope

U.S. consumers of financial services faced a large number of complex transaction alternatives offered by various types of financial firms before Gramm-Leach-Bliley (GLB). In many cases these alternatives provided similar benefits but had different costs and different risk potential. And the consumer could neither calculate the costs nor correctly evaluate the risk. One benefit of GLB presumably is to make the market(s) for financial services more transparent to more consumers allowing them to pursue their self-interests more effectively. It is also believed that those larger firms enjoying economies of scale and economies of scope will be able to pass cost savings on to their customers. Economies of scale imply lower costs per unit produced as firms become larger. Economies of scope imply that it is more efficient for one firm to offer several different types of financial transactions than for separate firms each to offer only one type of financial service. For example, economies of scale arise if a large firm could afford more efficient computer and communications networks or could spread its marketing costs over a larger number of units sold. Economies of scope arise if one visit could result in a mortgage loan, homeowners insurance, and perhaps insurance on the homeowner's life. If nothing else, it would be more convenient for consumers to fill out one form to complete these transactions than to complete three forms and have three different financial service providers process these transactions.

Underinsured Motorists Insurance

Underinsured motorists insurance helps cover shortfalls when the insured is injured by a motorist without adequate coverage. Assume, for example, Robert is injured in an auto accident caused by a driver having the minimum legal amount of insurance, $25,000. Assume Robert incurs $100,000 in medical expenses and lost wages. After winning a legal judgment, he collects $25,000 from the negligent drivers insurer. If the negligent driver had no other financial resources, Robert would bear $75,000 of his loss. Now, assume Robert has $500,000 of underinsured motorists insurance. In this case, Robert could collect the remaining amount of damages from his own insurer because it defines an underinsured motor vehicle as any vehicle that is insured for less than the amount of Roberts Coverage C liability limits. As with all losses paid by the insureds insurer to cover the negligence of another driver, the legal concept of subrogation goes into effect. In return for the amount paid by his or her insurer, the insured assigns to the insurer his legal right to sue for that amount. The insurer will then take legal action against the at-fault driver to recoup the money they paid. Subrogation does not prevent the injured party from suing for damages that were not covered by insurance.

Policy Reserve

Unearned premium reserves also exist for life insurers, but they are called policy reserves. Life insurers maintain a policy reserve that represents the difference between the mathematical liability of a future death claim and the value of future premiums the insured will pay the insurer. The policy reserve is best illustrated by reference to a level-premium whole life policy. With this contract the insurer is obligated to pay a death claim whenever death occurs. At the same time, the insured is scheduled to pay regular level premiums for life. Each year, the present value of the death claim increases as the insured ages and the probability of death increases. At the same time, the present value of future premiums decreases as more of the premiums are collected. As such, the policy reserve must increase to keep the equation in balance. As the insurer must keep investment assets to offset the policy reserve liability, the insureds have financial protection in the event of an insurer's financial weakness. Most life insurers do not calculate their policy reserves on an individual policy basis. Instead, they consider blocks of similar policies and calculate the reserve for the whole block of business.

Taxation of Death Proceeds

Unless the transfer for value rules apply (which will be covered later), life insurance proceeds are exempt from federal income tax. Proceeds must be paid by reason of the death of the insured, which means that the insured's death must have caused the maturity of the contract. Death proceeds include the policy face amount and any additional insurance amounts paid by reason of the insured's death, such as accidental death benefits and the face amount of any paid-in-full additional insurance or any term rider. Upon the death of the insured, there are various settlement options available that may be used to pay out the death benefit proceeds. The policy owner or the beneficiary can specify a payout option, and have the proceeds paid as a lump sum of cash, or as a series of payments. If the beneficiary takes a series of payments that includes interest earnings in excess of the death benefit amount, federal income tax is applied to the interest portion of each payment. In many cases, the life insurance policy owner is also the insured. When the insured owner dies, the death benefit amount is included in his gross estate. But if his gross estate is less than the exempt amount of $5,430,000 in 2015 there will be no federal estate tax due. Death benefit proceeds are not subject to estate tax if the surviving spouse is the named beneficiary. Although the death benefit amount is included in the insured owner's estate, an unlimited estate tax marital deduction is available which fully offsets the taxable death benefit amount. However, if the owner names his estate or others as the beneficiary of the policy, then the death benefit amount is included in his gross estate and taxed if his estate is worth more than $5 million. The policy owner who is the insured may transfer the policy to someone else or to an irrevocable trust, to keep the death proceeds out of his estate. However, the owner must outlive that transfer for three years, or the death benefit amount will be brought back into his gross estate for estate tax purposes. An individual who owns an insurance policy on someone else's life, will have the policy's replacement cost, rather than the death benefit amount, included in their estate at death. REAL-LIFE EXAMPLE Mary is the insured and owner of a $10,200,000 Whole Life policy. She also is the owner of her son Ron's $100,000 Whole Life policy, which has a replacement cost value of $12,300. Her husband Ray is the insured owner of a $1,000,000 Whole Life policy on his life. Mary and Ray are named as beneficiaries on each other's policies. Both are co-beneficiaries on Ron's policy. If Mary died, her gross estate calculation would include the $10,200,000 death benefit on her policy and the $12,300 replacement cost value of Ron's policy. This would significantly increase the value of her gross estate. Likewise, if Ray died, his gross estate would include the $1,000,000 death benefit from this policy. By changing ownership so that Mary and Ray now owned the Whole Life policy on each other's lives, they would dramatically decrease the value of their gross estates. Upon their deaths, since neither owned the policy on their own lives, the death benefit amount would not be included in their gross estate. Instead, only the replacement cost value of insurance they owned on the lives of others would be included.

LTC Renewability

Virtually all individually issued LTCI policies are guaranteed renewable, meaning the insured has a contractual right to renew the policy to some specified age, such as 79. But the company retains the right to revise rates on a class basis. In other words, the insurer reserves the right to change the premium charged but can do so only for all insureds of the same class of policies. The insurer can neither cancel nor refuse to renew the policy prior to the policy expiration unless the insured fails to pay a premium. Most policies are guaranteed renewable for life. Very few policies are issued on a non-cancelable basis, which means that the premium can not be changed and the policy can not be canceled. Insurers in some states are required to offer individual LTCI policies that contain non-forfeiture benefits. Such policies carry higher premiums than otherwise similar policies. Typical options include the right to cease premium payments, take a reduced paid-up policy that provides benefits for a shorter period, or receive a partial refund of premiums

Gift Splitting Privileg

When a married individual makes a gift to someone other than a spouse, it is regarded as made by one-half by each spouse*. This privilege of splitting a gift when made to a third party is extended only to property given away by a husband or wife. The taxpayer in such a situation is given the advantage of doubling the annual exclusion. REAL-LIFE EXAMPLE As part of their estate planning, Mr. and Mrs. Hall, begin to make gifts to their children. Under current rules, as a married couple, they can gift $28,000 ($14,000 x 2) to each of their three daughters, for a total of $84,000 ($28,000 x 3) a year. *The gift can be considered as made one-half by an individual and one-half by his/her spouse if he/she files a gift tax return to show that the couple agree to use gift splitting. He/she must file a Form 709, United States Gift Tax Return, even if half of the split gift is less than the annual exclusion.

Gift of Premiums

When an individual makes the premium payments on a life insurance policy or annuity contract that he or she does not own, the individual has made a taxable gift to the owner in an amount equal to the premium paid, subject to the $14,000 annual exclusion. For example, if Larry makes a premium payment on a policy owned by Kelley on her own life and under which Jay is the beneficiary, Larry has made a gift to Kelley in the amount of the premium payment. Similarly, premiums paid by an insured are gifts, if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate. Premiums paid by a beneficiary on a policy that he or she owns are not gifts.

Estimation of 2 types of Maximum Loss

When developing a risk management program, the risk manager should have a good notion of the 1) maximum possible loss and the 2) maximum probable loss. The maximum possible loss refers to the total amount of financial harm a given loss could cause under the worst circumstances. The maximum probable loss is the most likely maximum amount of damage a peril might cause under average circumstances. In many situations, it may be that nothing economically feasible can be planned for the worst possible case. Planning for the maximum probable loss that a firm might face every 50 or 100 years can be a valuable risk management exercise. Often a risk manager can make efficient plans for large-scale losses. Moreover, thinking through a whole sequence of events leading to such a loss could serve as a review of all the pieces of the risk management program.

Adverse Selection

When one party to a transaction has more relevant information or more control of outcomes than another party to the transaction, the party with superior information or control can take advantage of the situation. Insurance scholars call this possession of asymmetric information adverse selection. Adverse selection is also defined as the actions of individuals acting for themselves or others, who are motivated directly or indirectly to take financial advantage of a risk classification system. For example, adverse selection occurs when people who know their health is deteriorating try to purchase health insurance to cover the cost of a needed operation. Another example would involve a person trying to purchase fire insurance immediately after an arsonist threatened his property. The reason the term is called adverse selection is because the insurer is trying to select suitable people for coverage from an applicant pool that really doesn't represent a fair cross-section of the population. This is because those at risk tend to apply in greater proportion to those who are at lower risk. Thus, there is a tendency to select for coverage a higher percentage of adverse candidates. PRACTITIONER ADVICE Though many new life and health insurance agents get very excited when they receive an unsolicited request to purchase an insurance policy, most seasoned agents remain cautious. Experience shows that such inquiries usually come with a higher risk of adverse selection. It is important to ask these individuals appropriate questions to properly assess their situations. More times than not, an agent will discover that the potential client was compelled into action due to a known change to his or her health.

Whole Life Insurance

Whole life insurance is intended to provide insurance protection over one's entire lifetime. It should be viewed as permanent protection for long-term needs, like estate planning or planning for a disabled child. It provides for the payment of the face amount upon the insureds death regardless of when death occurs. The face amounts payable under whole life policies typically remain at the same level throughout the policy duration, although some policies pay dividends to increase the total amount paid on death. In most whole life insurance policies, the premium also remains at the same level throughout the premium payment period. Exceptions do exist, however, such as Graded Premium whole life policies, which have lower initial premiums that gradually increase for the first 10 to 15 years. Another variation is a Limited-pay whole life policy with higher premiums payable for a shorter time, e.g. until age 65.

Deductibles

are out-of-pocket costs the insured must pay for an insured loss. With a straight deductible the insured pays the first dollars of the loss up to a certain limit, while the insurer covers losses that exceed the deductible amount. Deductibles reduce the moral hazard by having the insured pay a portion of every loss, and they affect the insured's premium payments since larger deductibles result in lower premiums.

Employment Practices Liability

arises from hiring, terminating, and supervising personnel. The following are some of the reasons employers have been sued: negligent hiring, invasion of privacy, negligent supervision, negligent discharge, wrongful discipline and negligent evaluation.

Peril of legal liability

arises out of the general rule of law that people are responsible for any loss (injury) they cause another to suffer. Categories of situations in which one person injures another: Breach of contract Criminal acts Torts, or civil wrongs

Dwelling

comes under Coverage A of Section 1 that provides property insurance protection. Coverage A insures the dwelling and all attached structures (such as an attached carport or deck) of the insured person. Coverage A applies to the insureds residence premises shown on the declarations. A second home or summer cottage, which might be considered a temporary residence, is not covered because it does not appear in the declarations and should be covered under a policy specific to that property. The rule of property insurance is that if you can get insurance for the property on its own, it isn't going to be covered under another property's policy. What this means is, if you own a rental property, which is separate from your primary residence, it is not covered under your homeowners policy. This is because specific policies exist for non-owner occupied dwellings (Dwelling Fire Policies), which are more suitable for covering that type of risk. The same goes for your car. Since it should be insured under an auto policy, it is not covered under your homeowners policy even if destroyed while in your garage. The limits of coverage for the various insuring agreements found in Section 1 are determined as a percentage of Coverage A. If an insured needs additional protection, coverages B, C, or D may be increased. Coverage may not be reduced below the specified percentages. The insured must pay an additional charge for increased coverage.

Conditions

explain in detail the relationships, rights and duties of the insurer and those of the insured. Examples of conditions include payment of premiums for continued coverage, and contract provisions concerning concealment and fraud, cancellation rights, vacancy or un-occupancy, an increase in hazard, the appraisal procedure and time of payment by the insurer. Conditions in an insurance contract explain the duties the insured has when a loss occurs. The policy owner needs to promptly notify the insurance company of the loss, initially by telephone and then in writing, and also notify the police if theft has occurred. The insured's responsibilities and duties are stated in the contract and must be adhered to otherwise the insurer may withhold payment for part of the loss or void the entire contract. For example, the insured must protect the property from further damage, prepare an inventory of the damaged property which includes the amount of the loss, and cooperate fully with the insurance company's investigation. The insurer would not provide coverage before or after a loss for intentional concealment or misrepresentation of any material fact or circumstances, fraudulent conduct, or false statements made to the insurer. The insurer will investigate the loss to determine whether the loss was actually covered by the policy and to verify the policyholder's statements. Because property insurance contracts are contracts of indemnity, the insurer will not be liable for more than the insured's interest in the property, or for more than the limit of liability under the policy. Disputes concerning the value of property losses are settled through an appraisal procedure. This procedure requires that each party select its own appraiser, and the two appraisers select an umpire to resolve disagreements over disputed items.

The McCarran-Ferguson Act

he McCarran-Ferguson Act expressed the intent of Congress to allow the states to continue to regulate and tax the business of insurance. It found such continued state regulation to be in the public interest. Sec 2 and 3 of the law declare, however, if state law does not provide consumers with the type of protection found in the federal antitrust laws and the Federal Trade Commission Act, then federal laws will be applied. One challenge to the McCarran Act occurred in the late 1950s. In 1959, the Securities and Exchange Commission (SEC) felt it had the right to regulate a new insurance product being marketed-variable annuities. Since this new product had an investment component similar to mutual funds, the SEC believed the product fell under its jurisdiction as outlined in the Investment Company Act of 1940. However the insurance companies selling variable annuities argued they were exempt under McCarran-Ferguson. Joining with the SEC on the other side, however, were some members of the life insurance industry who apparently were not planning to sell variable annuities. The National Association of Security Dealers, that represented the interest of stockbrokers, also supported the SEC position. Perhaps the main reasons for resistance to SEC regulation by those who wanted to promote the variable annuity were the strong disclosure requirements and the acquisition expense limitations dictated by the Investment Company Act of 1940. The Act provides that the Sherman Act, the Clayton Act, and the Federal Trade Commission Act apply to the business of insurance "to the extent that such business is not regulated by state law."

Property risks

impact one's possessions and liability to others

Breach of contract

involves a failure, without a legal excuse, to perform contractual duties. The same action, for example, battery (touching another person without permission), may be both a criminal and a civil wrong. Reckless driving is another act that could be both a civil and a criminal wrong. Although the punishment for a criminal wrong may include making restitution to the injured victim, generally it does not. The injured victim must undertake civil litigation in an appropriate court to collect compensation for injury.

Definitions

of important words may be found in the glossary or throughout the insurance policy to avoid ambiguity or misinterpretations of coverage provisions.

Definition of a reasonable person

one who has normal possession of all faculties and senses; who thinks, speaks, and acts based on reason; and who is honest and moderate in all activities.

Legal liability insurance

provides protection against the financial impact of lawsuits. Liability losses occur as easily as property losses. You cannot see the loss a lawsuit represents in the same sense as you can see a burned home or a damaged car. Yet a $100 million loss resulting from a negligent act is a very substantial direct loss of property. Direct costs include attorney fees and court costs. Indirect costs include higher costs for goods and services, elimination of products and services, and a hostile environment where fear of lawsuits inhibits business and personal activity.

Morale hazard

refers to an attitude of indifference to loss created by/after the purchase of an insurance contract. The attitude, "Why should I care? I'm insured," is an example of the morale hazard. For instance, if a person doesn't bother to take precautions to secure his boat when a hurricane is approaching, because his boat is insured, this would be an example of a morale hazard. In contrast, if a person remains unnecessarily in a hospital to collect health insurance benefits rather than returning to work after an operation, the moral hazard is responsible for the increased severity of the loss. Insurers try to eliminate or minimize these hazards by carefully selecting their insureds and by including contractual provisions causing the insured to regret the loss despite the insurance coverage. For example, some contracts use deductibles to require insureds to pay the first dollars of a loss, and others require insureds to pay a percentage of each loss. In both cases, the insureds have reason to regret the losses while still receiving insurance compensation.

Insuring agreements

set forth the coverage provided by the insurance contract. It states the insurer's obligation to provide coverage as stated in the policy in return for the insured's compliance with all policy provisions and payment of premiums.

Why does a risk manager analyze flow charts?

to spot production bottlenecks, sole-source suppliers, or concentrations of valuable property. Flow charts also help reveal the consequential impact of losses. For example, a loss of raw material inventory in a storage facility might lead to cessation of the entire production process if the inventory cannot be replaced easily. Loss of shipping docks, however, may be overcome with temporary facilities. Losses at non-owned property, such as a sole-source supplier, or a key transportation component, such as a bridge or tunnel, could also have a significant impact on production.