BAIC 1 - Insurance and Insurance Policies Flashcards
4 Risk Management Techniques
- Avoidance - prevent a risk from happening (don’t purchase a home….)
- Retention - acceptance of a risk (do nothing, self-insurance)
- Control - Loss prevention (sprinklers)
- Transfer - Another party accepts the risk
Criteria for insurable risk
- Calculable, not subject to change
- Accidental
- Insurable Interest
- Part of a large homogeneous group
- Risks must be independent loss (does not occur at the same time within the entire group)
- Coverage provided at a reasonable cost to insured and insurer
Peril (Definition)
Cause of loss
Two types of risk
Speculative Risk, Pure Risk
4 Types of hazards
- Moral - intentional or exaggerated (fraud)
- Morale/attitudinal - carelessness
- Legal - laws and precedents
- Physical - unsafe conditions
Difference between short-tailed and long-tailed
Short-tailed: payments are quickly completed and claim quickly closed
Long-tailed: claim that can stretch into years
Regulator (Definition)
Any government agency with the authority to approve or disapprove the actions of a business and to issue general rules for business
Indemnification/Principle of Indemnity
Compensation for loss, injury, or damage suffered
The insurer agrees to pay no more than the actual amount of the loss (Insured should not profit from a covered loss under a policy)
Insurable Interest
When loss of or damage to something would cause the party with the interest to suffer financial loss or another tangible deprivation
Hazard
Condition that increases frequency or severity of a loss
Liability
A burden imposed by law, due to being ‘at fault’ for an event, usually requiring payment to those negatively impacted
Definition of Insurance
Coverage by a contract that binds one party (the insurer) to indemnify (make whole) another party (the insured) against a specified loss in return for premiums paid
Parts of an insurance policy
Declarations - unique information on insured
Exclusions - what losses will not be covered
Conditions - rules insured and insurer agree to observe
Insuring Agreement - States insurer’s obligation to indemnify insured and which perils
Definitions - define terms used in the policy
Endorsements or Riders - attachments that add, delete, change, or replace something already printed in the policy
Distinguishing characteristics of an insurance policy
Contract of adhesion Utmost good faith Indemnity Fortuitous losses Exchange of unequal amounts Conditional Nontransferable
Preprinted vs Manuscript Policy
Preprinted- Ready-made, off the shelf policy developed for use with many different insureds
Manuscript - Developed to meet a unique coverage; generally a one-of-a-kind policy
Multiline vs. Monoline Policy
Monoline - one line of business
Multiline - package coverage for multiple lines of business
First Party Coverage vs. Third Party Coverage
First Party - Covers policyholders property (auto physical damage, auto no fault coverage (PIP), Medical payments)
Third Party - Liability Coverage purchased by policyholder as protection against possible lawsuits filed by third party
What is a coverage trigger
Event that determines when coverage under a policy applies
Occurrence Basis Coverage vs. Claims-Made Basis Coverage
Occurrence - Triggered by the incidence of the event
Claims-Made - Triggered by the reporting of the claim
What is a policy limit
Maximum amount payable by insurer to insured for any losses covered by policy
Policy Limit Considerations
Current Value (property lines) Replacement cost (property lines) Risk Tolerance (Liability lines) Affordability (liability lines) Inflation rates (both)
Reasons for policy limit
- Clarify insurer’s obligation to policyholder
- Reduce premium
- Allow Policyholder to choose amount of coverage
- Decrease risk of insurance company insolvency
Policy Limits: Automobile Liability Automobile PD Homeowners Property CGL Boiler and Machinery Workers Compensation
Automobile Liability - Single (BI and PD combined) or Split (Per claimant BI/per occurrence BI/Per Occurence PD ex: $10k/$20k/$50k); Financial Responsibility Limit (Minimum amount required by state law)
Automobile PD - Actual Cash Value vs. Replacement Cost vs. Stated Amount (Coverage limited by the inherent value)
Homeowners: Coverage sub-limits
Property - Per specific item
CGL - per occurrence; aggregate
Boiler and Machinery - per object
Workers Compensation - No limit
What is a deductible?
Portion of the covered loss that is not paid by insurance
Reason for a deductible?
- Limit creation of small claims and save expenses
- Reduce claim payments for large losses
- Decrease amount of premium that must be charged for coverage
- Encourage loss control on the part of policyholder
Fixed Dollar Deductible
Amount to be paid by insured for each claim ($0 deductible is also known as full coverage)
Fixed Percentage Deductible
Amount paid by insured is set at a fixed percentage of either the loss amount or the Amount of Insurance (AOI) purchased
Time Deductible
Amount of time that insured must wait before indemnification may begin (sometimes called elimination period)
- common in workers comp and rental reimbursement coverages
- usually explicitly stated in the insurance policy
Disappearing Deductible
Amount paid by insured decreases as size of loss increases
Disappearing Deductible example Suppose d = $1,000 and D = $3,000. What is the deductible amount (ded) when: 1.Loss = $500? 2.Loss = $4,500? 3.Loss = $2,000? 4.Loss = $1,500?
- $500
- $0
- $500
- $750
Franchise Deductible
Insured collects full on the claim when it exceeds the deductible, but nothing when the loss is less (also named cliff disappearing deductible because it is like disappearing deductible where d=D)
Aggregate Deductible
Limit to total amount paid by insured for deductibles on multiple losses
Exposure and Exposure base
Exposure - Measure of the amount of risk covered by the insurance policy
Exposure Base - Choice of units for measuring exposure
Desirable properties for an exposure base
- Accurate measure of exposure to loss (proportional, continuous)
- Practical (easy to determine
- Difficult to manipulate
- Responsive to change
Exposure base for: Automobile Homeowners CGL Boiler and Machinery
Automobile - Car-Years, Car-Months
Homeowners - Amount of Insurance, house-years
CGL - Gross sales, payroll
Boiler and Machinery - number of objects
Premium (definition)
Amount policyholder pays to be covered by insurance
4 Components of Premium
- Loss Cost - Portion of premium that provides for payment of claims to policyholders and other claims-related expenses (includes LAE, does not include profit margins)
- Taxes, Licenses and Fees (state premium tax, licensing and renewal fees, guaranty fund…)
- Other Expenses (commissions and salaries, overhead/property)
- Profit and Contingency Provision - Profit: added to expected cash outflows to provide insurer with an expected total return to cover cost of capital; Contingency: helps develop a windfall in case the actual losses and expenses exceed expected losses and expenses
ISO’s scope of premium
ISO develops only the loss cost portion of the premium due to desire of the regulators and the public for the market for insurance to remain competitive
Loss Cost Multiplier (LCM)
A multiplicative factor that an ISO customer might have calculated in order to convert ISO loss costs to a full rate, which they will charge their policyholders (Different customers will use different LCM)
What does ISO have to do with the LCM?
Because ISO files only loss costs with regulators, each customer desiring to use LCM on top of ISO LC would need to make their own independent LCM filings with the states where they do business
Premium at Present Rates (PPR)
Premium that would have been charged for a set of insurance policies if the current rates had been in effect at the time
Loss Costs at Current Level
The premium that would be charged for a set of policies if the current loss costs had been in effect at the time, and if in addition there was no money collected for any other portion of the insurance rate, except the loss cost
**The equivalent of PPR for the work done at ISO is LCCL because ISO deals solely with the loss cost portion
Loss Adjustment Expense (ALAE and ULAE)
Loss Adjustment Expense - Additional expenses that can be incurred during a loss settlement
Allocated LAE - Claims settlement costs directly assignable to specific claims (more significant in liability than in property insurance)
Unallocated LAE - Costs associated with the claims settlement function not directly assignable to specific claims
New Definition of ALAE and ULAE
Defense and Cost Containment (DCC) - Expenses that vary with the amount of loss (legal defense fees, cost of expert witnesses)
Adjusting and Other (AAO) - Expenses that vary with the number of claims oro that do not vary with amount of loss or number of claims (adjustors’ fees, general claim overhead)
Ways for insurers to reduce losses
- Salvage - insurer is paid if a wrecker can salvage parts of damaged property which insurer has replaced for policyholder (Property)
- Subrogation - insurer pays the insured for their loss and the right to sue the liable party is subrogated to the insurer (Liability)
Liability vs. Property Loss Valuation
Liability - Settlement amount out of court, court awarded by judge or jury
Property - Partial Loss (cost of repair), Total Loss (Replacement Cost or Actual Cash Value)
Replacement Cost
Cost to replace property with property of like kind and quality at current prices; often used with homes and items that could need rebuilding
Actual Cash Value (ACV)
Multiple Interpretations
- Replacement Cost minus depreciation, where depreciation is calculated by formula or schedule
- Fair Market Value (if a market exists)
- Broad Evidence Rule - determined by considering a ll relevant factors (use, obsolescence, inflationary trends)
Frequency (ratio)
Number of Claims / Units of Exposure
Severity (Ratio)
Dollars of Losses / Number of Claims
Pure Premium (Ratio)
Dollars of Losses / Units of Exposure
Loss Ratio
Dollars of Losses / Dollars of Premium
Average Rate (Ratio)
Dollars of Premium / Units of Exposure
