Module 4 - Insurance Basics and Property Insurance

Question 1

According to Maslow’s heirarchy of human needs, where does insurance coverage fall?

Answer 1

The first tier and should be taken care of before other goals, such as retirement funding, can be addressed

Question 2

Insurance management

Answer 2

The process of deciding how much and what kind of insurance to buy

Question 3

Risk Management

Answer 3

Deciding how to deal with broader forms of risk and determining which risks are insurable and which are uninsurable

• Risk management includes insurance management and goes beyond to include more than insurable risks

Question 4

List basic types of personal risk

Answer 4

Income Loss

Catastrophic Losses

Question 5

What are two types of disability insurance?

Answer 5

1) Short-term: generally provide coverage up to age 65

2) Long-term:

Question 6

Describe areas of income loss (personal risk)

Answer 6

• loss of employment: (uninsurable) can cause debt accumulation if not properly planned for with emergency fund
• disability: (insurable) short-term & long-term
• death: (insurable) concerns regarding adequate coverage
• divorce: (uninsurable) could cause significant financial distress. living within or beneath your means and building cash reserves may help immensely if planned for

Question 7

Describe potential areas of catastrophic loss

Answer 7

Medical expenses
Environmental disaster - fire, flood, earthquake
Stolen car / vandalized home
Negligence

Question 8

What are four components to negligence that an injured person must prove in order to collect damages

Answer 8

• existence of a legal duty (to protect others from harm)
• failure to perform a legal duty
• actual damage is caused
• proximate cause is established (proximate cause is the unbroken series of events between the negligent act and the damage)

Question 9

What are specific legal defenses an individual can claim when accused of negligence?

Answer 9

• Contributory negligence: if the injured person contributed in any way to the injury, he cannot collect damages
• Comparative negligence: amount of damages awarded is reduced to the degree by which the injured party was at fault
• Assumption of risk: a person understands and realizes the danger of a particular activity and is barred from collected damages in the event of an injury caused by another person (ex - skydiving / skiing)
• Last clear chance: if a person sees the potential for an accident or injury and doesn’t alter actions to avoid injury, they can’t collect damages from an injury “caused” by that other person

Question 10

When faced with a limited insurance budget, what should you insure first?

Answer 10

Insure against possible large (catastrophic) losses, even if their occurrence may seem unlikely.

Insuring against smaller losses can be done if there is money left after insuring against the larger losses.

It is the large uninsured loss, not a small loss, that cause financial hardship or ruin.

Question 11

List examples of insurance being used to protect against potential catastrophic losses

Answer 11

Homeowners insurance
Long-term disability insurance
Health insurance
Umbrella liability insurance

Question 12

What are four essential techniques for managing risk?

Answer 12

• Risk avoidance
• Risk reduction
• Risk retention
• Risk transfer

Question 13

Define Risk Avoidance

Answer 13

Finding a way around facing a risk - example: if you don’t want to get hurt while skydiving, don’t skydive.

Risk control - you are controlling how you handle risk

Question 14

Define Risk Reduction

Answer 14

Involves either decreasing the change that a loss will occur or doing something so that if a loss does occur, its severity is not as great

Risk control - you are controlling how you handle risk

Question 15

Define Risk Retention

Answer 15

Keeping the risk for yourself - if a loss occurs, you suffer the loss in the form of physical injury, property damage, or legal liability

Risk financing - you are financing by paying out of your own pocket

Question 16

Define Risk Transfer

Answer 16

When you transfer risk through insurance

Risk financing - you are financing by paying insurance premiums

Question 17

What are four essential techniques for managing risk?

Answer 17

• Risk avoidance
• Risk reduction
• Risk retention
• Risk transfer

Question 18

What are three rules of risk management, according to Robert Mehr & Bob Hedges in “Risk Management in the Business Enterprise”

Answer 18

1) Don’t risk more than you can afford to lose
- how much loss can you afford to retain without negative consequences (if home burns, loss is huge / if a window breaks, it’s not a problem)

2) Consider the odds
- if a given loss is certain to occur, the cost of insurance likely will be the amount of the loss + admin costs. (if you leave an expensive bike outside, it is likely to get stolen / insurance isn’t worth it so bring it inside, low odds of it being stolen)

3) Don’t risk a lot for a little
- consider a house worth $250,000 compared to a $1,000 insurance policy. not having insurance is risking a lot for a little

Question 19

Define Risk

Answer 19

A condition in which it is possible that a loss may occur.

Question 20

Describe the differences between Speculative Risk and Pure Risk

Answer 20

With Pure Risk - you assume that things will continue as expected, barring any unforeseen loss. Either no loss will occur or a loss will occur. There is loss or no loss, but never gain.

With Speculative Risk - when there is a chance that either a loss or a gain will occur (ex - investing in the stock market)

Question 21

What are the four types of Pure Risk

Answer 21

1) Personal Risk - the risk that we might become unable to earn income, resulting in a loss of income and / or assets.
2) Property Risk - the possibility that we may lose some of our property (real or personal) due to damage, destruction or theft.
3) Liability Risk - as we move through life, we interact with others. there is a chance that we could accidentally cause a loss to another person.
4) Failure of Others - there is a risk that we may suffer a loss because of another person’s action or inaction.

Question 22

Describe and define Peril, Moral Hazard, Morale Hazard

Answer 22

• Peril is the cause of loss; whereas a Hazard is something that increases the chance of loss. If a house fire is the risk, fire is the peril, and a pile of oily rags left in the garage is a hazard.
  1) Peril - a cause of loss (fire, hurricane, explosion, heart attack, or cancer). insurance policies insure against losses from perils
  2) Moral Hazard - Exists when people are dishonest (ex - an employee stealing or an insured person lying on a claim. This type of hazard is the primary source of insurance fraud.
  3) Morale Hazard - Exists when people or institutions are careless or have the attitude that “the insurance company will pay for it, so don’t worry about limiting costs”. (ex - you have insurance on your car so don’t drive carefully because insurance will pay for any damage that might occur). Attitude of “eh - that’s what insurance is for”

Question 23

How does the insurance industry use the term “risk”

Answer 23

Risk is used to describe the person or property that is insured.

Question 24

Define the term “underwriting”

Answer 24

The process of determining whether a risk is acceptable and at what price, if at all. When a policy is issued, the risk is considered “underwritten” - it has been accepted by the insurance company and has been transferred from the insured to the company.

Question 25

Describe “insurable risk”

Answer 25

From the insurance company’s POV, insurable risk must meet four requirements

1) the law of large numbers must apply (there must be a large enough number of simpler exposure units)
2) the loss must be accidental or fortuitous (not intentional)
3) the loss must be definite and measurable
4) the loss must NOT be catastrophic

Question 26

Describe the insurable risk requirement “the law of large numbers”

Answer 26

Is based on the idea that if you have enough similar risks (eg - houses) you can predict what the losses will be for the entire group. As the number of “risks” increases, the ability to predict losses becomes more accurate.

Question 27

Describe the insurable risk requirement “must be accidental or fortuitous”

Answer 27

You can’t insure against things over which you have no control or which are certain to happen.

To further this end, insurance companies exclude coverage for losses incurred because of intentional acts of the policy owner. You can’t burn down your own home.

Death is fortuitous because the timing is always unknown, making it “occurring unexpectedly or by chance”

Question 28

Describe the insurable risk requirement “must be definite and measurable”

Answer 28

Means that the insurance company must be able to tell that a loss occurred and can place a dollar amount on the loss.

Question 29

Describe the insurable risk requirement “must not be catastrophic”

Answer 29

Meaning it can’t be a catastrophic loss to the insurance company. (eg - thousands of homes burning down or a hurricane destroying thousands of homes)

Most insurance companies can’t survive having 10% - 15% of their insured risks suffer a total loss simultaneously.

Question 30

What are the legal requirements for an insurance contract to be considered valid?

Answer 30

1) They must deal with a legal activity or legal object to be enforceable
2) They must consist of an offer and an acceptance
3) They must provide for some sort of consideration (eg - payment or performance)

Question 31

Define “insurable interest”

Answer 31

Is of paramount importance with insurance.

Question 32

Define “insurable interest”

Answer 32

Is of paramount importance with insurance.

1) With life insurance - the purchaser & beneficiary of a life insurance policy must have an insurable interest in the insured when the policy is first purchased. (you can’t take a life insurance policy out on a stranger)
2) With property insurance - the insurable interest must exist at the time of the claim. (you have to own the property when it burns down / know the person who died)

Question 33

What are the legal requirements for an insurance contract to be considered valid?

Answer 33

1) They must deal with a legal activity or legal object to be enforceable
2) They must consist of an offer and an acceptance
3) They must provide for some sort of consideration (eg - payment or performance)

Every contract is a promise to do or provide something from one party in return for a promise to do or provide something from the other party. The parties to a contract agree to do something in exchange for some form of consideration (an act or payment for an act)

Question 34

Define “insurable interest”

Answer 34

Is of paramount importance with insurance.

1) With life insurance - the purchaser & beneficiary of a life insurance policy must have an insurable interest in the insured when the policy is first purchased. (you can’t take a life insurance policy out on a stranger)
2) With property insurance - the insurable interest must exist at the time of the claim. (you have to own the property when it burns down / know the person who died)

Question 35

Are insurance policies considered unilateral or bilateral contracts?

Answer 35

Unilateral - because only the insurance company’s promise to pay if a covered loss occurs is legally binding. The insured pays a monthly premium, but that is not an enforceable promise.

Unilateral - contracts where only one party to the contract makes a promise (eg - if you paint the fence by Tues, I will pay you $75)

Bilateral - contracts under which both parties have made enforceable promises (eg - I promise to paint the fence by Tues, and you promise to pay me $75)

Question 36

Define “indemnity” as it relates to insurance contracts

Answer 36

When a person suffers a loss, they should be “made whole”. Policy owners shouldn’t profit from a loss, they should merely be reimbursed for the loss.

Subrogation clause - your insurance company gets paid back before you get any more money. (eg - if you get into a car accident, your insurance will pay for the repairs, then the other person’s insurance company will also pay some amount. your insurance company will be reimbursed first before you receive any $$)

Question 37

What are the sections of an insurance policy?

Answer 37

1) Declarations
2) Insuring agreement
3) Exclusions
4) Conditions

Question 38

What are the sections of an insurance policy?

Answer 38

1) Declarations - statements of the policy owner
2) Insuring agreement - identifies what is insured, for what amount, and under what conditions
3) Exclusions - states what is NOT covered
4) Conditions - explains what has to happen for the insurance company to be obligated to make a payment
5) Riders and endorsements - (not standard) decrease or increase coverage, provide for additional coverage, or otherwise modify the policy

• Riders: (typically used with life and health policies)
  (eg - accidental death benefit pays an additional amount if you die in an accident)
• Endorsements: (typically used with property and liability policies)

Question 39

Insurance companies are generally one of two main types of companies?

Answer 39

1) Mutual Company - owned solely by its policy holders (no stock holders). At the end of a policy period, policy holders may be entitled to a refund of premium if the companies expenses were less than anticipated. This dividend is NOT taxable as income unless the refund exceeds the cumulative premiums paid.
- State Farm & USAA

2) Stock Company - publicly traded company owned by stock holders, who may or may not have a policy with the insurance company but can still own stock. Dividends will be taxed just like a dividend from any other corp.
- Geico & Allstate

Question 40

What are two main types of life insurance policies? (How are the profits shared)

Answer 40

1) Participating policies: the policyholders are paid the dividend since they are the owners of the company.
- Mutual companies are not allowed to sell nonparticipating policies.

2) Nonparticipating policies: Dividends are paid out of company profits and only paid to the firms’ stockholders, not the policyholders.
- Sold only by stock companies
- Stock companies may also sell participating policies where payment of dividends is shared between stockholders and policyholders.

Question 41

What is the difference between and agent and a broker?

Answer 41

Agents are legal representatives of the insurance company, and their first allegiance is the the insurance company, NOT the client.

• The agent is considered to BE the company and has power to “bind coverage”. This means when an agent tells you that you’re covered, the insurance company is legally obligated even if you have an accident 10 minutes later. The agent IS the company
• Accountability: if an agent neglects to tell the insurance company pertinent information about you and the company issues a policy, they are legally bound to meet the policy requirements even if it later finds that you wouldn’t normally qualify.

Brokers represent the buyer, and their first allegiance is the the client. They use various insurance companies to obtain policies for their clients, but they are not employees of the insurance company.

• Brokers CAN’T bind an insurance company. You may not be instantly insured. Most states effectively change a broker’s status to “agent” once an insurer has been selected for the purposes of issuing and placing coverage.
• Accountability: if a broker neglects to tell the insurance company pertinent information about you and a policy is issued, the company could cancel the policy as long as the incontestable period (gen 2 yrs) has not expired.

Question 42

What do you need to know about insurance agent specialties?

Answer 42

2 distinct professional areas: 1) life and health related coverage 2) property and liability (P&L) / property and casualty (P&C) coverage

P&L coverage can be broken into 1) personal lines (home & auto) and 2) business insurance (commercial lines)

Most agents / brokers work primarily in only one of three areas 1) life and health 2) personal lines P&L 3) commercial P&L

Question 43

Identify each scenario as either a moral hazard or a morale hazard.

1) Sue had been unable to obtain flood insurance on her home near the ocean. She was planning on raising her home up as others had done. However, today she secured flood insurance and decided not to pay for raising her home.
2) Bob’s home is burglarized, and on the claim form he lists a $5,000 computer server, even though he had actually sold the server the week prior

Answer 43

1) Morale

2) Moral

Question 44

Consider the four elements for an insurable risk and insurance agent Sam’s view, and identify which element best exemplifies the scenario:

Sam is considering insurance for a HNW client to cover a painting in their home. The client listed the painting as “priceless”. Which element must be satisfied first?

1) law of large numbers must apply
2) lost must be accidental or fortuitous
3) loss must be definite and measurable
4) loss must not be catastrophic

Answer 44

3) loss must be definite and measurable

Question 45

Consider the four elements for an insurable risk and insurance agent Sam’s view, and identify which element best exemplifies the scenario:

Sam must tell a client that her company can no longer provide insurance in south Florida after the company had extreme losses due to hurricanes in the area. Which element of insurance is her company following?

1) law of large numbers must apply
2) lost must be accidental or fortuitous
3) loss must be definite and measurable
4) loss must not be catastrophic

Answer 45

4) loss must not be catastrophic

Question 46

Consider the four elements for an insurable risk and insurance agent Sam’s view, and identify which element best exemplifies the scenario:

One of Sam’s clients is going hiking in an area that is known to have a lot of snakes. He wishes to obtain snakebite insurance. Which element of insurance should Sam cite to tell him that her company can’t provide snakebite insurance?

1) law of large numbers must apply
2) lost must be accidental or fortuitous
3) loss must be definite and measurable
4) loss must not be catastrophic

Answer 46

1) law of large numbers must apply

Question 47

Consider the four elements for an insurable risk and insurance agent Sam’s view, and identify which element best exemplifies the scenario:

Sam has a new client walk in and request insurance on an old warehouse he just purchased. With some digging, Sam sees that this client has owned several rundown properties, a few of which burned down. Which element of insurance does Sam consider may be be broached in this case?

1) law of large numbers must apply
2) lost must be accidental or fortuitous
3) loss must be definite and measurable
4) loss must not be catastrophic

Answer 47

2) lost must be accidental or fortuitous

Question 48

Coverage C of homeowners insurance covers items in the home.

1) If Coverage C is 30% and the home is insured for $300,000, what is the personal property coverage?
2) What insurance should a homeowner consider if they have a diamond necklace worth $40,000 in their home?
3) After a house is gutted by fire, would Coverage D, loss of use, cover mortgage payments while the home is being rebuilt?

Answer 48

1) Personal property insurance at 30% means that items in the home are covered up to $90,000
2) If personal property is only covered up to $90,000, with jewelry comprising only a portion of that, the $40,000 necklace should be covered by additional insurance, along with any other expensive items.
3) Coverage D, loss of use, would NOT cover mortgage payments while a home is being rebuilt; it would cover the cost of alternate living arrangements while the home is being rebuilt.

Question 49

What insurance coverage would pay for Susan’s medical treatment if she visited her friend Molly, and at Molly’s home, fell, sprained her ankle and required medical treatment?

Answer 49

Coverage F (medical payments to third parties) on a homeowners policy covers medical payments of any third party, with permission to be on the property, who is injured on the premises of your home. This coverage pays their medical bills regardless of fault or negligence.

Question 50

A personal auto policy (PAP) covers the three main categories of auto-related loss: legal liability, injury to the insured or other family members, and damage to or loss of the auto.

Match each of the following six parts with its correct description.

1) coverage for damage to your vehicle
2) general provisions
3) uninsured / underinsured motorist coverage
4) liability coverage
5) duties after an accident or loss
6) medical payments

Answer 50

1) Part D - coverage for damage to your vehicle
2) Part F - general provisions
3) Part C - uninsured / underinsured motorist coverage
4) Part A - liability coverage
5) Part E - duties after an accident or loss
6) Part B - medical payments

Question 51

All homeowners policies include two sections - Section I and Section II - what do they cover?

Answer 51

Section I - property losses

Section II - liability losses

Question 52

What are the three main types of homeowners insurance policies purchased

Answer 52

1) Single family homes (including town homes)
- Provides liability coverage, but requires additional coverage for the dwelling itself, possible other structures, and loss of use. These days, coverage is purchased with replacement cost coverage included, ensuring enough coverage to replace the home if it’s a total loss
- Two main exclusions NOT covered are damage resulting from earth movement and flooding

2) Condominiums
- Has minimal dwelling coverage since the condo association covers the outside structure. The policy would cover the interior space, personal property and loss of use in addition to liability coverage.

3) Renters (tenant)
- Generally includes personal property and loss of use?

Question 53

Summarize the four areas of coverage included in Section I of a homeowners policy

Answer 53

Coverage A - insures the dwelling, including additions or other structures ATTACHED to the building. Includes limited coverage on landscaping around the dwelling

Coverage B - insures other structures (“appurtenant structures”) on the premises of the dwelling, such as unattached garages, fences and sheds
- does NOT include structures being used in business or rental

Coverage A & B will provide an adequate amount of coverage as long as the amount of insurance is AT LEAST 80% of the replacement cost of the home. If this is the case, then the loss will be paid minus the deductible.

• If the coverage is less than 80% of the replacement cost, a partial loss is covered
• (((amount of insurance carried / amount of insurance required) x loss)) - deductible))) = settlement

Coverage C - insures general personal property, as defined within the contract. Limits / exclusions for amount of coverage for jewelry, firearms and furs will apply.

• Basic personal property coverage is a % of the amount of Coverage A.
• You can increase limits on specific coverage (like jewelry) if necessary

Coverage D - provides loss of use coverage, which includes expenses incurred while the dwelling is uninhabitable due to damage caused by a covered peril
- Payments will be made for the length of time used to replace or repair the damage to your dwelling or for resettlement, if necessary.

Additional coverage that may be included with homeowner’s insurance may include: debris removal (if caused by an insured-against peril), reasonable repairs (made to protect the property), fire department service charges, loss assessment (from condo or HOA), collapse from specified perils, glass or safety glazing

Question 54

Years ago, Betsy purchased a house for $100,000 and insured it for that amount. Her deductible is $500. Today, her house is valued at $250,000, but she has not increased her insurance coverage.

A recent hail storm caused enough damage to the roof that it needs major repair. The insurance adjuster has determined the replacement cost for the house is $200,000 (value of land is NOT included in determining replacement cost).

Repair of the 10 year old roof will cost $20,000. How much will the insurance company cover?

Answer 54

80% of the home’s replacement cost is ($200,000 x .80) $160,000 but Betsy only has $100,000 in coverage.

The calculate for the insurance company is

((Amount of insurance carried / Amount of insurance required) x Loss)) - Deductible = Settlement

(100 / 160) = 0.625 (62.5% of the loss will be covered)

$20,000 x 0.625 = $12,500

$12,500 - $500 (deductible) = $12,000

The company will pay for $12,000 of the $20,000 roof repair. Betsy is responsible for paying the remaining $8,000.

If her coverage were at least 80% ($160,000 of coverage), she would only be responsible for paying the $500 deductible.

If the house burned to the ground and the replacement to build was $200,000 and Betsy only had $160,000 of coverage, she would still be required to come up with the remaining $40,000

Question 55

What is an “inland marine policy”?

Answer 55

Used to provide coverage for personal property that is frequently moved from one location to another / for which there is not enough coverage under the homeowners policy.

• Items can be insured for their FMV, often without a deductible
• Examples: jewelry, electronics, golf and ski equipment, musical instruments, fine art, coin and stamp collections

Question 56

Summarize the two areas of coverage included in Section II of a homeowners policy

Answer 56

Section E - personal liability

• If you, or immediate family members / dependents living with you, incur a legal obligation in a liability settlement (up to policy limits). The policy provides for your defense lawsuit (up to policy limits).
• Any person responsible for the care of your animals or watercraft, any employee or person using a covered vehicle (motorized lawn mower) on an insured location with your consent is also covered.
• Several exclusions apply: intentional injury to another, self-injury, liability from renting your property to others

Section F - medical payments to third parties

• if a third party (with permission) is injured on the premises, this coverage pays for their medical bills regardless of fault or negligence.
• injuries to a third party not on the home premises are payed only if the injury is due to negligence of the homeowner, a family member, an animal owned / being cared for by a member of the family, or a worker hired by the family.

Business and professional activities are not covered, with the exception of odd jobs your children may have.

Question 57

CLUE Personal Property Reports - what do you need to know?

Answer 57

Comprehensive Loss Underwriting Exchange Report

• provides recent claims information on homes, and also on the individuals wanting to purchase homeowners insurance.
• enables insurance companies to access prior claim information in the underwriting and rating process.
• contains up to 7 years of personal property claims

Question 58

What are the four areas of coverage in automobile insurance?

Answer 58

1) Liability
2) Medical Payments
3) Physical Damage
4) Uninsured motorists

Question 59

What does automobile insurance protect?

Answer 59

Protects you against legal liability when your automobile damages another person or another person’s property.

• Coverage may be written as a single limit or “split limit”
• Split limits (eg 25/50/15): the first number is the amount of bodily injury liability coverage, the second number is amount for all people injured in a common accident, the third number is the amount of coverage provided for property damage per accident.

Question 60

What factors are used in determining the cost of auto insurance?

Answer 60

1) age and sex of the driver
2) use of the vehicle
3) type of vehicle
4) the driver’s record
- unofficially, having a good credit score can also impact the cost of premiums.

Question 61

Describe the personal automobile policy (PAP)

Answer 61

Is a package plan that covers 3 main categories of auto-related loss:

1) legal liability
2) injury to the insured or other family members
3) damage to or loss of the automobile

To be covered by a PAP, a vehicle must be owned by an individual (or jointly by spouses) and must be a private passenger vehicle.

The PAP is divided into 6 parts

1) Part A: liability coverage
- contains a single limit of liability that applies to the total covered liability losses arising from an accident, regardless of the # of people injured or the amount of property damage
- covers borrowing / renting a car
- covers anyone using the covered vehicle with permission

2) Part B: medical payments
- pays for medical expenses regardless of personal liability for those inside the covered vehicle

3) Part C: uninsured / underinsured motorist coverage
- protects against those who show financial irresponsibility by paying you the amount that you should have been able to collect from the uninsured motorist.
- protects in the event of a hit and run as long as the uninsured vehicle is does not belong to you or is being used by you or a family member
- protects when the other driver has insurance, but in an amount not adequate to cover your loss.

4) Part D: coverage for damage to the covered vehicle
- provides for direct and accidental loss to your vehicle or any non-owned vehicle you may be using.
- collision coverage is for losses due to a collision between your covered vehicle and another object
- loss other than by collision coverage applies to all non-collision physical losses (glass breakages, hail, larceny, contact with animal)

5) Part E: duties after an accident or loss
- you must provide prompt notice to the insurer of a claim, cooperate in any investigation / settlement / defense, send the insurance company copies of any notices / legal papers related to the claim, submit to a physical exam if claiming injury, submit proof of loss, notify police of hit and run, permit insurer to inspect damage

6) Part F: general provisions
- can include items such as coverage not being provided if there is fraud on the part of the insured (“subrogation clause”)

Question 62

Umbrella Liability Coverage - what do you need to know?

Answer 62

Provides liability coverage with very high upper limits. Designed to provide personal catastrophe liability protection.

Protects the insured against both auto and general liability (up to policy limits). Almost never stands alone, but is coupled with a minimum amount of underlying liability coverage in both homeowners and auto policies (so is in addition to both).

A $1 million dollar policy typically costs around $200 - $300 per year.

Helpful to think of the liability payment that is made from auto or homeowners policy as the deductible to be paid prior to the umbrella policy being called upon.