Insurance Flashcards
Risk
A condition with the possibility of loss
A situation with an exposure to loss
Peril
The CAUSE of a loss
Examples:
Fire, windstorm, liability, collision, theft, sickness or injury
Hazard
A condition that may create or increase the chance of loss arising from a given peril. May increase frequency or severity of loss.
Concept of
Insurance
Pooling of risks and transferring them to an insurance company to replace uncertainty (a possible large loss) with certainty (coverage in exchange for a premium).
Law of Large Numbers
As the # of independent events increases, the likelihood grows that the actual results will be close to the expected results.
Ins company needs large # of similar exposure units
Adverse Selection
Adverse selection is the occurrence of people who need insurance the most being the most likely to purchase it. Insurance companies want to minimize their risk by also insuring healthy policyholders, yet unhealthy or high-risk individuals are more likely to apply for coverage
Adverse selection in the insurance industry involves an applicant gaining insurance at a cost that is below their true level of risk.
Someone with a nicotine dependency getting insurance at the same rate of someone without nicotine dependency is an example of insurance adverse selection.
Insurance companies have three options for protecting against adverse selection, including accurately identifying risk factors, having a system for verifying information, and placing caps on coverage. https://www.investopedia.com/articles/insurance/082516/examples-adverse-selection-insurance-industry.asp
Morbidity
Insurable Risks
For an insurance company to assume a risk, the risk must have ALL of the following characteristics:
1. Large # of homogeneous exposure untis to make losses reasonably predictable
2. Loss produced by the risk must be definite and measurable
3. Loss must be fortuitous or accidental
4. Loss must NOT be catastrophic to insurance company
Basic Rules of Risk Management
- Coverage for potential catastrophes should be purchased first (life, disability, health, homewoners, auto)
- Severity is more important than probability
- High probability will mean higher premiums or a decline of coverage by the carrier.
Risk Control
Risk ….
- Avoidance
- Diversification
- Reduction
Goes with risk financing (retention, transfer)
Examples of
Risk Avoidance
- Rent instead of buy
- Don’t buy a house with a swimming pool
Examples of
Diversification of Risk
Store assets at different locations
Examples of
Risk Reduction
- Install sprinker system, smoke detectors and burglar alarm for home
- Create safety programs for businesses
Retention of Risk
Deductibles in insurance policies
Coinsurance in insurance policies
Self-Insurance
Transfer of Risk
- Insurance
- Hold harmless agreements/hedging contracts
- Incorporation of your business
Type of Risk Management
HIGH Severity, LOW Frequency
Risk Transfer (aka Insurance)
Type of Risk Management
HIGH Severity, HIGH Frequency
Avoidance
Insurance premiums would be cost prohibitive
Type of Risk Management
LOW Severity, HIGH Frequency
Retention
Reduction
Frequency implies risk transfer (insurance) will be costly
Type of Risk Management
LOW Severity, LOW Frequency
Retention
Principle of Indemnity
A principle underlying insurance contracts (other than life) under which the insurer seeks to reimburse the insured for approximately the amount lost, no more and no less.
4 Principles Supporting Indemnity
- Insurable Interest
- The concept of actual cash value
- Other insurance (limit the ability to profit from a loss)
- Subrogation
1 of 4 Principles Supporting Indemnity
Insurable Interest
A right or relationship with regard to that which is insured so that the insured will suffer financial loss from a loss.
Must operate at issuance of policy AND at time of loss in property and casualty insurance. With LI, insurable interest must operate at time of issue, but need not be present at time of death
Contract Requirements
These must applly for a contract to be legally enforceable
- There must be an agreement preceded by an offer and an acceptance by the one to whom the offer is made (the application)
- There must be consideration (usually money)
- the principal must have legal capacity to execute contracts
* Incompetent/intoxicated adults have limited or no capacity to execute contracts
* Minors may have capacity to contract for necessities only - The contract must be for a lawful purpose
Contract Characteristics
. Unilateral
* 2. only one of the parties to an insurance contract (the insurer) makes a binding promise that if broken breaches the contract
Adhesion
* 3. Contract is accepted “as is” or not at all
. Waiver Provision
* Neither an agent nor the insured can alter a contract … only the president, VP, secretary, etc
Insurance contracts are aleatory contracts
Aleatory Contract
The amt of $$ spent by contract parties is typically unequal.
Something an insurance company can do to a contract
Recession
The contract is deemed null from its beginning due to fraud, misrepresentation, concealment, or mutual mistakes as to a material fact.
Reformation
The contract can be amended when the original intent between the parties was not expressed
Subrogation
When an insurer pays a claim, it takes over the legal rights its insured had against a negligent third party
Collateral Source Rule
In tort liability, the plaintiff’s measure of damage should not be mitigated by payments received from sources other than the negligent party
Risk Financing
- Retention
- Transfer
Goes with risk control (avoidance, diversification, reduction)
Personal Risk
- Death
- Disability
- Poor health
- Unemployment
- Superannuation
Property Risk
- Real
- Personal
- Auto
Actions that create Liability Risk
- Negligence
- Intentional Torts
- Strict Liability
Legal Liability
2 Types of Torts:
1. Intentioanal
2. Unintentional
Tort
A wrongful act other than a breach of contract
civil action
Intentional Tort
assault, battery, libel, slander, false arrest
Unintentional Tort
Negligence or Carelessness
Attractive Nuisance
A pool that isn’t fenced
Vacant land where kids play
Land with access to a river or lake
Negligence per se
Standard of care is set by a statute
School zones and crosswalks
Strict Liability
Limited to manufacturers and distributors of products found to be defective.
Romaine w/ e.coli, cars w/defects, legal drugs that cause illness, death
Absolute Liability
An extra hazardous condition which results in losses to others
(keeping wild animals, blasting).
Workers comp falls under this.
Vicarious Liability
Respondeat Superior
When one person is held liable for the negligent behavior of another person.
manager at insurance agency who is responsible for the agents
Assumption of Risk
When one party recognizes and understands danger in an activity yet voluntarily chooses to encounter it, another party cannot be held responsible for the injury.
Contributory Negligence
Any negligence on the part of the injured party, although slight, defeats the claim.
jaywalking, drunk driving
Comparative Negligence
Any degree of negligence on the part of the injured party does not defeat the claim but is used in some manner to mitigate damages payable to the other party.
Pedestrian is 20% negligent, driver 80% … damages adjusted accordingly
Last Clear Chance
Any contributory negligence of the injured party will not bar recovery of damages if the other party, immediately prior to the accident, had a last clear chance to prevent the accident but failed to do so.
Road rage
Methods of Calculating LI Needs
- Income Replacement
* Capital Utilization (Human Life Value)
* Capital Retention/Preservatioin - % of Income
- Personalized Needs Approach
Calculating Capital Utilization
Human Life Value
Principal depleted at end of bene life
BEG
N = # years needed
PMT = Annual $$ amt
Inf Adj IR
Solve for PV
PV invested at Inf Adj IR will generate PMT tomorrow
and will increase each year until spouse dies (at N)
Calculating Capital Preservation
Capital Retention
Principal not dipped into
Money Needed each year/IR + 1st Year amt of money
*Danko says not to use Inf Adj IR … instead rate of return - inflation
When question does not give N assume it is Capital Preservation/Retention
5 Sources of info
Process of Underwriting
insurance
- An application for insurance
- Info from agent or broker
- Investigations
- Info bureaus
- Physical exams
Loss Adjustment Process
- Notice of loss
- Investigation
- Proof of loss
- Payment or denial
HO Insurance Policy
What does it cover?
- Dwelling
- Contents
- Personal Liability
Declarations Page
Contains things like name, address, etc of applicant
HO Insurance
Section I Coverage
A. Dwelling
B. Other Structures
C. Personal Property
D. Loss of Use
HO Insurance
Section II Coverage
E. Personal Liability
F. Medical Payments
HO Section I Coverage A
Dwelling
Dwelling + any attached structure (garage, decks, fences)
Land is specifically excluded from coverage
Not covered in renter’s policies
HO Section I Coverage B
Other Structures
Ex: pool, detached things like garages, fences, patios or living spaces
Not covered in renter’s policies
HO Section I Coverage C
Personal Property
- Covered anywhere in the world (not just when inside insured home).
- Sublimits for watercraft, jewelry and furs, silverware, money
- Property specifically excluded: animals, motor vehicles/aircraft, property of roomers or boarders, property in an apartment rented to others
HO policies generally don’t cover exposures related to being a landlord.
Endorsements can be added to cover property in a rented room (Landlord’s Furnishings)
HO Section I Coverage D
Loss of Use
Coverge for additional living expenses arising from damage to the insured property.
Necessary increase in living exp to maintain normal standard of living.
Normal monthly exp of $4K, increased by $1K d2 house fire - ins will pay increase of $1k
HO Section II Coverage E
Personal Liability
Provides protection for damages for which an insured is legally liable arising out of bodily injury or property damage.
Specific exclusions include:
1. liabilities from business activities or professional services
2. Usage of motorized land vehicles (except recreational vehicles or motorized golf crds used on property)
3. usage of watercraft unless < 50 hp or sailboat < 26ft
4. aircraft usage
5. bodily injury to a person who is eligible for worker’s comp
Included in all policy types, including renters
HO Section II Coverage F
Medical Payments
Provides limited amount per person of coverage for necessary medical expenses of persons other than the insured who are injured while on the insured location.
NOT liability coverage
included in all policy types, including reters
Perils
3 Broad Types
- Basic Form
- Broad Form
- Open Perils
Peril
Basic Form
Basic Form of Perils Examples (HARVEST WFL):
Windstorm
Hail
Aircraft
Riot
Vandalism
Vehicles
Explosion
Smoke
Fire
Lightning
Theft
Peril
Broad Form
Basic (HARVEST WFL) + RAF
* Rupture of a System
* Artificially generated electricity
* Falling Objects
* Freezing of plumbing
Peril
Open Peril
The insurer agrees to pay for damage by any peril except those specifically excluded.
Open perils coverage is generally the right choice for the CFP exam because it covers unusual risks that are not named under the Basic and Broad Forms.
8
Exclusions
to all HO Forms
OPEN WIF
1. Ordinance of law
2. Power Failure
3. Earthquake
4. Neglect
5. Nuclear Hazard
6. War
7. Intentional Loss
8. Flood
Req HO amt
Is always 80% of replacement value
Req Ins for commercial bldgs
90% of replacement value
- CFP board likes to test this
Life Insurance Options
Nonforfeiture Options
3
Nonforfeiture options, dividend options, settlement options
- Cash
- Reduced paid-up insurance
- Extended Term
Nonforfeiture options, dividend options, settlement options
Life Insurance Options
Dividend Options
Nonforfeiture options, dividend options, settlement options
- Cash
- Reduced premium due
- Accumulate w/interest
- Paid-up additions
- One-year term (5th dividend)
Nonforfeiture options, dividend options, settlement options
Life Insurance Options
Settlement Options
Nonforfeiture options, Dividend options, Settlement Options
- Cash
- Interest Only
- Fixed Period
- Fixed Installment
- 4 life-income options (pure or single life; period certain; joint and survivor; refund)
Nonforfeiture options, Dividend options, Settlement Options
Non-Forfeiture Option
Extended Term Insurance
Paid-Up Term
1 of 3 NF Options
Maintains original death benefit for a limited number of years
So that insured doesn’t have to forfeit policy d2 premium non-payment
1 of 3 NF Option
Non-Forfeiture Option
Cash Option
2 of 3 NF Options
Policy can be surrendered anytime for cash value less any policy indebtedness plus accumulated dividends. A 6-mo delay clause applies to distribution of cash value (tested, but not often practiced)
2 of 3 NF Options
Non-Forfeiture Option
Reduced Paid-Up
3 of 3 NF Options
- Face amount of policy will be reduced.
- The paid up insurance death benefit will be the amount the cash value would purchase as a net single premium.
- No additional premium due
3 of 3 NF Options
Part of NF options
Automatic Premimum Loan (APL) Provision
applies during grace period
- Policy will remain in force with a policy loan outstanding
- He can pay off loan w/int at any time
- Not required to re-instate policy
- 2 Variants
1. Reduced Paid-Up: to re-instate, must prove insurability
2. Extended Term: To reinstate must prove insurability
Per NAIC
Life Insurace Policy Illustration Model Law
Illustrations must include what?
applicable only to non-variable policies
- Name of insurer
- Name and address of producer
- Name, age, sex of proposed insured
- Underwriting and rating classification
- Initial death benefit
Primary diff b/w MEC and non-MEC
MEC is single premium policy after 1988
Once a MEC, always a MEC
Loans and withdrawals
Non-MEC: generally NOT taxable
MEC: generally taxable (this is a disadvantage of MECs)
Once a MEC, always a MEC
For LI policies
Transfer for Value
why is it important?
not applicable to tx to: insured, partnership, corp, divorce
The most important exception to general rule that LI death proceeds are federally income tax free to bene
If policy tx’d for valuable consideration, income tax exclusion is lost
Think viatical settlement
Tax-Free Exhange of LI Rules
Section 1035 Exchange
For LI and Annuity Contrtacts
- Exchange of one life insurance policy for another
- Annuity for annuity
- LI for Annuity
- LI or Annuity for LTC policy
Must have same owner/insured (or annuiant wrt annuity)
If these rules are met, the exchange is TAX FREE
