Chapter 1 Flashcards
Rider
A form Changing the provisions and attached to a policy (also known as an endorsement).
Risk Management
The process of analyzing exposures that create risk and designing programs to minimize the possibility of a loss.
Insurable Events
Any event, whether past or present, which may cause loss or damage to a person having an insurable interest or create a liability against him/her.
Risk
A condition in which a chance of loss exists. The two types of risk are
a) Speculative - chance of gain or loss
b) Pure Risk - only the chance of loss and no chance of gain.
Loss Exposure
The extent to which one may be affected by a peril
Peril
The cause of a possible loss.
Hazard
A specific situation that increases the probability of a loss arising from a peril or that may influence the extent of the loss. There are 3 types of hazards.
1) Physical
2) Moral - Dishonesty - giving false information on an application.
3) Morale - indifference - driving without seat belts, smoking, driving too fast.
Methods of Handling Risk
RRATS
Risk Reduction - Reducing but not preventing
Risk Retention - self insurance - retaining responsibility for the loss.
Avoidance - not being involved in the activity
Transfer - to another company
Sharing - pooling the risk of a large number of persons.
Requisites of an Ideally Insurable Risk
large number of homogenous units to make losses reasonably predictable.
Loss must be calculable
Loss must be accidental
Cause Financial Hardship
Exclude catastrophic perils such as war, nuclear hazard and illegal operations.
Principle of Indemnity
The insured is restored to the same financial condition as prior to the loss. The insured should not profit from or lose from an insurance transaction.
Law of Large Numbers
A principle stating that the larger the number of exposures considered, the more closely the losses reported will equal the probability of loss. The probability of loss is more predictable, thus a loss ratio is more readily available.
Reinsurance
Primary Insurer who originates the application (ceding company) and the company or companies who share in the risk (reinsurance insurers).
a) Automatic - Ceding company transfers the amount of insurance in excess of retention level.
b) Facultative - Negotiation between ceding and reinsurance company.
Adverse Selection
The insuring of risks that are more prone to losses than the average (standard risk). These risks tend to seek or continue insurance at a higher participation than does an average (standard) or above average (preferred) risk.
Hold Harmless Agreement
Contractual agreement removing the liability of one party from a second party. Used mostly in group health replacements and could be considered a measure of risk avoidance.
Insurable Interest
On one’s own life is usually unlimited.
Possibility of an economic loss due to sickness or death. In life insurance, insurable interest must exist at the time of application, but not necessarily at time of loss.
Buy-Sell Agreement
An agreement among owners of a firm that provides the continuation of a business upon the premature death of an owner.
Cash Value
Money accumulated in a permanent policy which the policyowner may borrow as a policy loan or receive if the policy is surrendered before maturity. Surrender charges may be assessed at policy surrender. Upon maturity or endowment that cash value is paid to the policy-owners.
Non-participating Policies
Do not pay dividends
Personal Uses of Life Insurance
VESCEL
Viatical Settlements - life insurance policies purchased from a terminally ill insured.
Estate Creation - dependents and beneficiaries
Survivor Protection - dependents
Cash Accumulation - accessible to owner
Estate Conservation
Liquidity - upon death to pay creditors, taxes, and final expenses.
Determining Amount of Personal Life Insurance Needed
Human Life Approach - actual future earnings
Needs Analysis Approach - Immediate Death
Human Life Approach
Individual's After Tax earnings Individual's annual expenses Value of personal assets Number of years remaining at work Ages of all family members to determine dependency period time value of money Present salary of all wage earners.
Needs Analysis Approach
Coverage needed upon premature death.
All financial needs caused by immediate death.
Subtract assets available
Determine age of dependents.
Regardless of age, some needs are permanent, such as retirement, disability funds, and funeral expenses while some are disappearing such as mortgage and education.
Income Objective
Capital Liquidation - assumes both principal and interest are liquidated over the relevant time to provide income for the dependents.
Capital Retention/Conservation - assumes the desired income will be generated by the investment earnings only, thus retaining or conserving the principal or capital invested.
Buy-Sell Agreement
Contractually establishes a price with the intent to purchase, at a predetermined value, the assets of a business should one of the contract participants predecease other participants. Sole Proprietorship, Partnership, or closed corporation stockholders.
Cross Purchase
Entity Plan
Key Person
Life insurance purchased to offset the expense and financial losses due to the death of a valued employee. This policy will provide funds for decreased cash flow, recruiting costs, cost of training and cost of replacing key employee. If owner is beneficiary, premiums are not considered business expense by the IRS.
Deferred Compensation
This is an incentive plan in which an employer promises to pay key employees certain amounts of money at a specified future date.
Income deferred
If employee dies, life pays employer to pay heirs.
If employee lives, used to pay compensation. Surrendered.
Supplemental Executive Retirement Plan - SERP
A non-qualified deferred compensation that allows employers to provide additional retirement income to key, highly compensated employees.
Split Dollar Plans
Not Tax Qualified
Upon an employee’s termination of employment the policy may be purchased from the employer at an agreed price.
Insures the employee’s life with premium payments split between an employee and the employer.
If death occurs while this employer, employer receives death benefit equal to cash value or premiums paid. Balance is paid to employee’s beneficiary.
A certain time should elapse.
Executive Bonus Plans
Arrangements under a Corporate Cross Purchase Buy-Sell Agreement where the corporation bonuses the premium to each shareholder to cover the cost of the policies they own on the other shareholder’s lives.
Each shareholder reports the premium he/she is bonused as additional compensation that presumably is deductible by the corporation.
Premiums are treated as compensation, not dividends.
Forbids, surrenders, withdrawals or other actions unless endorsed by the corporation.
Minimum Deposit Plans
This is a process where the policy loans are used to pay the premiums on cash value life insurance policies under a systematic plan of borrowing.
Loans are to be for the amount of each premium and no more.
Interest to be paid in cash in order to receive a deduction.
Third Party Ownership
Parent owns a policy on an under age child.
Buy-Sell Agreement
Key Person
Classes of Life Insurance Policies
Group Individual Ordinary Life Industrial (Home Service) Permanent Term Participating/Non-participating Fixed/Flexible/Variable
Group
Provides protection for an employee’s named beneficiary or creditor. The coverage may be changed only within the confines of the Master Policy. The coverage is normally written in a renewable term basis, providing no cash value or living benefits as found in individual policies.
Individual
Cash Value, may generate income in the form of an annuity. Individual life policies may build or preserve an estate or provide a living benefit for the terminally ill.
Ordinary Life Insurance
Any type of life insurance that is not group, industrial or government insurance. A large number of people are insured with an ordinary life.
Industrial Home Service
Small policies normally $250-$1,000 were originally sold to pay funeral expenses.
Monthly Debit Ordinary Policy (MDO). Used today with values of $5,000 to $25,000. Also called debit agent.
Permanent
A durable policy that remains level in amount and premium. Doesn’t require renewability and normally provides protection to age 100 or until the policy is surrendered or cancelled. Premiums are always higher than those of Term. It has cash value and death benefit.
Term
lowest of premium outlay, and designed for someone with large insurance needs but small cash flow. Temporary, no cash value and it is level or decreasing. Used to meet short term obligations or mortgages.
Participating
Pays non-taxable returns of premium to mutual owners.
Nonparticipating
Stockholders with all future values guaranteed.
Fixed
The policy has a fixed amount of coverage, benefits, and premium. Without riders, future inflationary trends and money values will depreciate the policy’s effectiveness.
Flexible
Universal & Variable Universal Life, gives more flexibility in terms of premiums, investment objectives, and other policy benefits. Protection against inflation.
Variable
Uses separate accounts for the cash value accumulation. These are normally mutual funds.
