Insurance Flashcards
Law of Large Numbers
as the number of independent events increases, the likelihood increases that the actual results will be close to the expected results
the insurer needs a large number of similar (homogenenous) exposure unit
Principles of Risk and Insurance definition
Risk: a condition with a possibility of loss (a situation where an exposure of loss exists)
Examples: starting a business, owning real estate
Peril: the cause of a loss which insurance covers economic lss from certain perils
ex: fire, collision, windstorm, theft
Hazard: The condition that may create or increase the chance of loss arising from a given peril
Ex: home by a river, land on a earthquake fault line
Adverse Selection
Must be the same proportion of good and bad risks in the group insured as there were in the one from which the basic statistics were taken.
Morbidity: incidence and severity of sickness and accidents in a well defined class of persons
Morbidity Table: a statistical table showing the probable rate of death at each age, usually expressed as so many per thousand
Insurable Risks
large number of homogeneous exposure units
loss must be definite and measurable
must be accidental
must not be catastrophic (for the ins co)
Methods to avoid/reduce Loss
Avoidance: (do not drive, do not purchase property - rent it)
Diversification: duplication of assets or activities at difference locations
Transference: purchase insurance
Retention: recognizes that the risk exists and assumes losses (deductible, co-insurance, self-insurance)
Risk reduction: (sprinkler system, safety programs, smoke detectors)
Guidelines for Risk Managment
High loss severity and low loss frequency - suitable risk transfer
High loss severity and high loss frequency - suitable avoidance
Low loss severity and high loss frequency - suitable retention and reduction
Low loss severity and low loss frequency - suitable retention
Insurable Interest
PropertyCasualty: At inception AND at time of loss/claim
Life: at inception but NOT at time of loss/claim
Contract Requirements
Must be an agreement preceded by offer and an acceptance byt eh one t whom the offer is made
must be consideration) - Money
the principal must have legal capacity to execute contracts: adult,competent, not intoxicated
must be lawful
Contract Characteristics
Unilateral: one one of the parties to an insurance contract makes a binding promise that if broken breaches the contract
Adhesion - accepted “as is”
Waiver provision: only president, vp, secretary, etc. may alter contract
Aleatory: Outcome affected by chance with the amount of dollars given up is typically unequal (example: gambling contract)
Collateral source rule: legal principle applicable in the area of tort liability hold that the plaintiff’s measure of damage should be mitigated by payments received from sources other than the tortfeasor.
Parts of the Insurance Contract
Declarations: - factual statements that identify the specific person, property, or actively being insured and the parties to the transaction; They are not pre-printed, but specialized for individual contracts.
Definitions: explains key policy terms
Insuring Agreements: spells out the basic promises of the insurance company
Exclusions: spells out circumstances when the insurer will not pay
Conditions: spells out the detail the duties and rights of both parties
Negligences
attractive nuisances (swimming pool, vacant lot)
negligence per se - school zone
strict liability - product liability
absolute liability (keeping of wild animals) -workers comp
vicarious liability - respondent superior (principals responsible for their agents)
Defenses
assumption of risk (skiing, rock climbing)
contributory (being drunk)
comparative (20% negligent B is 80%)
Last clear chance (road rage)
approaches to calculating Life Insurance Need (2 methods)
Capital utilization approach: uses annuitization to provide needed incme but leaves no money at the end of planned-for period (PV of future need)
Capital needs approach (retention): uses interest only, so the original capital is still left at the end of income period (capital retention or interest only)
Participating vs. Non-participating
Participating: pays annual dividend to the policyholder, charges larger premiums with excess (willful overcharge), can be issued by stock insurance companies -
Non-participating: company retains the gains for its shareholder
Insurance Rating Service/Category
AM BEST = A++ to F
Standard & Poor = AAA to CCC
Moody’s = Aaa to C
Weiss = A+ to F
Homeowner’s - Coverage A
Covers dwelling and any structures attached to the dwelling such as a garage, decks, or fences and material sand supplies located on the next to the residence premises for construction, repair or alteration of the dwelling or other structures on the residence premises
NOTE = the land is specifically excluded from coverage
Homeowner’s Coverage B
Other structures are set apart from the dwelling by a clear space
Ex: outdoor swimming pool, detached garage, fences, patios, detached living space
Homeowner’s Coverage C
Personal Property is covered while anywhere in the world. Policy normally has special internal limits of liability.
Property specifically excluded the following: animals,birds, fish, motor vehicles/aircraft, property of roomers or boarders, property in an apartment rented to others
Sections of Homeowner’s Policy
Section I (Coverage: A, B, C, D) A= Dwelling and attached structures B = structures separated from dwelling (detached garage) C - contents and personal property D - loss of use
Section II (Coverage: E, F)
E - Liability
F- medical payments
Perils Covered Basic Form
The policy lists the perils covered
WHARVES/FLT
windstorm,hail, aircraft, riot, vandalism, vehicles, explosion, smoke, fire, lightning, theft
Perils Covered Broad Form
The policy lists the perils covered
Basic plus RAF
Rupture of a system, Artificially generated electricity, Falling objects, Freezing of plumbing
Exclusions
Open WIF
8 general exclusion that apply to all of the homeowners forms - ordinance of law, power failure, earth movement (earthquake) , neglect, nuclear hazard, war, intentional loss, flood
Homeowner’s Forms of Coverage
HO-1 - Dwelling HO-2 - Home HO-3 - Home HO-3/15 - (home)/HO-5 HO-8 (older home) HO-4 (renters) HO-6 (condo owner)
Replacement Cost Coverage
Replacement costXcoinsurnace = insurance required
Insurance carried/Insurance Required X loss - deductible = amount paid by insurance
Actual Cash Value = ACV
When losses are settled on a replacement cost basis, no deduction is made for depreciation. Under ACV, losses are settled under replacement cost less depreciation. For exam purposes, the dwelling (structure) will be covered under replacement cost coverage and personal property (contents) on an actual cash value basis
Auto Insurance Policy Parts
Part A - Liability (limited to third parties)
Part B - medical payments
Part C - uninsured motorists
Part D - damage to the covered auto
Personal Auto Policy = PAP
can be written on eligible vehicles owned and leases by an individual or by a husband or wife living in the same household.
vehicle rented to others as a public or livery conveyance is not eligible and must be insured under a commercial policy.
eligible vehicles include private passenger automobiles such as cars, vans, and sport utility vehicles.
vans and pickups are ineligible for coverage if they are used for transportation or delivery of god and materials.
Part A - Liability Coverage definition
Provides protection agains judgments and covered exposures resulting from bodily injury and property damage liability deemed to have been caused by the insured (BI/PD)
Part B - medical payments Med-Pay definition and coverage
Provides payments for the reasonable and necessary medical expenses of an insured as a result of an automobile accident
only expenses for medical services rendered within 3 years of the date of an accident are covered
Covered for Med Pay
named insured, spouse, and any family member occupying auto or when struck by a pedestrian
any other person who is injured while occupying covered auto
Part C - Uninsured motorist Coverage UM
insurer agrees to pay compensatory damages that an insured is legally entitled to recover from the owner or operator of an uninsured motor vehicle because of bodily injury. The coverage applies to claims for medical expenses, lost wages, and pain/suffering but does not include punitive or exemplary damages. Insured for uninsured motorist coverage as follows:
Named Insured and any family member
Any other person who occupies a covered auto
Any person who is entitled to recover damages due to injury to a person described above
Special NOTE! UM is liability protection, not medical payments
Part D
Coverage: Damage to your Auto
Collision: Defined as “the upset of your covered auto or its impact with another vehicle or object”
Other than collision: breakage of glass, or loss caused by the following: falling objects, fire, theft, explosion, earthquake, hail, water flood riot or civil commotion windstorm, contact with birds or animals.
Towing: is covered under collision and other than collision
Umbrella Liability Insurance
For exam, almost always a correct answer, since it is a smart coverage
Provides liability coverage (BI/PD) for catastrophic legal claims or judgments
Requirement policy owner to carry certain underlying coverage or specified minimum amounts
Note: Professional acts are specifically Excluded
Umbrella Liability Insurance exclusions
any act committed with the intent to cause personal injury or property damage
damage to property owned by the insured
business pursuits and workers compensation obligations
rendering of or failure to render professional services (malpractice)
directors’ and officers’ activities
workers’ compensation obligations
Business Owner’s policy BOP
designated for small-to-medium-size businesses
policy is packing that has real property, contents, and liability protection
Professionally liability is specifically excluded
Professional Liability
Malpractice: substandard conduct results in bodily injury (dr or dentist)
Errors and Omissions (e&o): substandard conduct results in property damage or monetary damages such as loss of money (fin planner, lawyers, accts, ins agents)
Workers Compensation
unlimited medical expenses including occupational disease benefits; no deductibles
disability income (total and partial); tax free; equal to employee’s average weekly pay
death benefits payable to family member
Rehabilitation - (medical and vocational)
can be referred to as absolute liability
Comprehensive Stop-Loss Coinsurance
1st - The insured pays a calendar-year deductible (ie: $250 or more).
2nd - The insurance carrier pays a calendar-year coinsurance (normally 80%), and the insured pays a remainder (normally 20%) f the next medical expenses.
3rd: After a client pays his/her portion of the stop-loss limits (breakpoint), the company pays 100%
Deductible definition
Most deductibles are fixed dollar amounts that apply separately to each person. Some carriers apply a limit to the number of deductibles a family may have to satisfy (limit of three). Each family member pay an individual deductible.
Medicare does not cover
Foot care, dental care, glass hearing aids, most immunizations except one flu shot per year
Emergency care outside the U.S. (except for Canada, Mexico, caribbean, u.s. territory waters)
Components of HMO
Capitation: a monthly fee is paid to the provider. in return, the individual receives virtually all the medical care required during the year.
Gatekeeper: Care is managed by a primary physician who is responsible for determining what care is received and when the individual should be referred to specialists.
Managed Care Plans
HMO: provider pays monthly fee regardless of service rendered (capitation)
out-of-network care not covered at all
PPO: provider pays for actual services rendered
Out-of-netowrk partially covered (usually 70%)
Point of service (POS) plans:
hybrid arrangement combining aspect of an HMO,PPO, and a comprehensive major medical plan
COBRA Coverage Requirements
MUST HAVE 20 FULL/PART-TIME EMPLOYEES
Coverage must be offered to: terminated employees and dependent continuation period up to 18 mo (voluntary or involuntary termination change from full time to part time), spouses and other dependents continuation period up to 36 mo (EE death, divorce, legal separation, or eligibility for Medicare), Children of employees continuation period-up to 36 months (loss of depended status (marriage) reaching dependency age limit specified by plan
HIPAA
prevents job lock
no pre-existing condition exclusion if an employee was covered by the prior employer’s health plan for 12 months or more and less than 63 days elapsed since he/she lost coverage under the prior employer’s plan.
Health SAving Account (HSA)
must have an HDHP to qualify to open an account
distributions tax-free if used for health care
contributions not spent are carried forward in the owners name and are portable
unused assets become property of named beneficiary upon death
distributions for non-medical ordinary income taxable plus 10% penalty if under 65.
both employers and employee can contribute
note over the counter drugs do not qualify for 2011 going forward.
Health Reimbursement Arrangements = HRA
Solely employer-funded
REimburses employees for substantiated medical expenses up to a maximum dollar amount per coverage period
Definitions of Disabiltiy
Owner Occupation - Best definition for insured
Modified any occupation
Split definition - own then modified
any occupation (social security definition)
loss of income
Disability Income - Policy Continuance Provisions
noncancellable “noncan”: continuous term policy guaranteeing the insured’s right to maintain the policy at the stated premium
Guaranteed renewable: continuous right to maintain the policy but the insurer may increase the premium by class of insureds
Elimination Period waiting period
acts like a deductible
the longer then waiting period, the lower the premium
older policies written for 30 days
current policies written for 90 days
Taxation of disability policies taxation of premiums and benefits
the individual owns the contract and pay the premium. 1) premiums are not deductible, 2) benefits are tax free tot he employee
The employee owns the contract and the employer pays the entire premium under a bonus arrangement like section 162 disability ins. Premiums are deductible by the employer as a bonus, benefits are tax free t the employee
The employee own the contract, and the emplyer pay the entire premium under a salary continuation plan. 1) the premiums are deductible by the employer 2) benefits are taxable to the employee
Partnership / S Corp Shareholders Taxation Rules
Can deduct the premiums paid for coverage for a partner or a greater than 2% shareholder of an S Corporation as a deductible business expenses
The deduction is based on the premium cost being included in the taxable income of the partner/shareholder as conduit income
Proceeds are excludable from taxable income because the partner/shareholder pays premium with after-tax money.
Riders
Disability waiver of premium - whole life, universal, and variable universal life
Guaranteed purchases option (guaranteed insurability opiton)
Accidental death
Medicare Limitations - Qualify for Skilled Nursing Facility
Patient admission conditions
Condition must require skilled nursing
hospitalized at least three days in a row
admitted within a short time from leaving the hospital
care is for condition previously cared for in hospital
professional certifies admission
Permanent Life Insurance - Low Risk Tolerance
Insurance company controls investment return
Assets part of general account
1) whole life
2) Universal life
Permanent Life Insurance High RiskTolerance
Client Controls Investment Return
Assets part of separate account
1) Variable Life
2) Variable Universal Life
Whole Life Insurance Advantages vs. Disadvantages
Advantages: Provides permanent protection, level premium, combines savings (cash value) with protection
Disadvantages: Must be paid for lifetime (or limited-pay), Higer than term at the beginning, not flexible to meet changing needs (limited to nonforfeiture options)
Contract Provisions
Automatic premium loan grace period incontestable clause reinstatement clause misstatement of age clause suicide clause
Dividend Options
CRAPO Cash Reduced paid up Accumulate with interest Paid-up additions One-year term/5th dividend
Nonforfeiture Options
Cash
Paid up reduced Amount
Extended term
Settlement Options
Cash Pure life/single life Refund Period certain Specified income/period Interest only
Viaticication vs. Life Settlements
Viatication: payments refers to the sale of a terminally ill person’s life insurance policy to a business firm that specializes in such transactions
Life Settlement: describes a transaction involving an insured who is not terminally or chronically ill and is generally over age 65
Modified Endowment Contract - MEC
entered into after June 21 1988
fails to meet the “seven pay test” (includes all single premium policies)
distributions/withdrawals are taxed LIFO (interest-first rule)
distributions under 59 1/2 also subject to 10% federal penalty (if not disabled)
death benefit is tax-free
“MEC” Grandfather Life Insurance Rules
If the death benefit increases by $150,000 or less and the insured has guaranteed insurability (no proof of insurability), the policy will NOT lose its grandfathered (non MEC) status.
If the policy increases by ANY amount and the insured must prove insurability, the policy MAy lose its grandfathered (non MEC) status.
Proceeds Taxable due to Transfer for Value
if a policy is transferred from one owner to another for valuable consideration (typically money), the income tax exclusion is lost (like a vatical). The 3 main exceptions to this rule are the following:
a sale or transfer to the insured
a sale or transfer to a partner or partnership in which the insured is a partner
a corporation in which the insured is a shareholder or officer
1035 tax free exchange rules
Life - life - OK
Life - annuity - OK
Annuity Contract - annuity contract - OK
Annuity - LIFE (NO)
Buy sell Stock Redemption vs. Cross Purchase
Stock Redemption: no step-up in cost basis to remaining owner, premium is not deductible, death benefit is income tax-free
Cross-purchase: step-up in basis to remaining owner, premium is not deductible, death benefit is income tax-free
Split-Dollar Insurance EndorRsement Method vs. Collateral aSSignment method
EndoRsement Method:
EmployeR is the owneR
Employee is not a shareholder
Collateral aSSignment Method:
employee is owner
Employee is a Shareholder
Employee aSSigns the policy
Annuity Taxation
investment amount/expected return x#of months = % exclusion
lump sum payouts LIFO - interest first rule
ordinary income plus 10% penalty under 59 1/2
NOTE: Prior to 1982 taxed FIFO (principle first rule)
Flexible Spending Account (FSA)
Medical expense account must be used by march 15th or forfeited to company (use it or lose it)
not subject to income (FICA, FUTA)
Health FSA may not be used to reimburse an employee’s premium paid for other health plan (MSA, HSA, and LTC) .
NOT reimb for LTC
healthcare is unlimited, dependent care FSA is limited to 5000 and must be used by year end
note- over the counter drugs no longer qualify in 2011 or thereafter
Fringe benefits tax-free major ones
healthcare premiums
insurance premiums on non-discriminatory group life policy up to $50,000
Company car for working conditions only
commuter -highway vehicle and transit pass 125/mo
occasional overtime meal money, cab fare, theater ticket or sporting event tickets, discounts on services limited to 20%of selling price charged customers
Fringe Benefits Taxable
Health insurance premiums paid for self-employed, partners, and more than 2% owners of S corporation are taxable income 100% is deductible as an adjustment to income on the front of the 1040. this can include all types of health insurance programs.
Risk - how to deal with it examples
Retention = coinsurance avoidance = take a cab rather than drive transfer = high limit insurance reduction = wearing seatbelt diversification= storing inventory at several locations
HO - 2 vs HO- 3
HO-2 broad form of all coverage
HO-3 open perils for coverages ABD, ho-3 is more comprehensive
HO -3 vs HO-5
contents are covered under open form
Indemnity and insurable interest
Indemnity = being made whole, not making a profit
Insurable interest = proper must be an incentive, life to necessarily to have insurable interest. no claim if property is sold
Which insurance policies are owned by the company?
Key person of the company
Stock purchases agreement
NQ deferred compensation
NOT cross purchase agreement = indiv/owners own it.
Aleatory
a gambling contract - outcome affected by chance, # of dollars given up is unequal
Settlement Options
Cash
Pure Life and Life refund
specific period income
interest only
Parts of the ins contract
Insuring agreement vs. Conditions
Insuring Agreement = the part that spells out the basic PROMISE of the INSURANCE COMPANY
Conditions = This part spells out the detail the DUTIES and RIGHTS of BOTH parties = ex: notice of loss requirement
Problem: 10 year old refrigerator is destroyed in a fire. It originally cost $900. Adj estimated a refrigerator typically lasts 15 years. Therefore it is 2/3s depreciated… insured gets 1/3. 5/15 of 1,200 = $400
original costs are immaterial
Property loss calculation
Insurance Carried / Insurance required X Loss - Deductible = amt paid by insurance
amt required = Replacement cost X coinsurance
A commercial building was constructed a few years ago for $500,000. Today the FMV of the property is $1,000,000. The land is worth $200,000. The property was insured for $700,000 with a 90% coinsurance provision and a $2000 straight deductible. Last week a fire in the building caused 700,000 of covered damages. What will the insurance company pay?
1,000,000 - 200,000 = 800,000 = FMV
90% of 800,000
700,000/720,000 * Loss (700,000) - deductible (2,000) = 678,556
