Understanding Insurance: Coverage, Exclusions, and Clauses - Prof. Jennifer Atkinson, Study notes of Introduction to Business Management

Download Understanding Insurance: Coverage, Exclusions, and Clauses - Prof. Jennifer Atkinson and more Study notes Introduction to Business Management in PDF only on Docsity! We can know that someone in this class will get injured in the next month but we don't know who it is. So for that person, we're going to pay 100 each and that person can use that to pay the hospital. If she/he needs more, then all of us pitches in again.  Pooling: The sharing of total losses among a group ○ Insurers accomplish this by combining a group of objects situated so that the aggregate losses become predictable within narrow limits  We still have the loss, but we reduced our financial consequences. We reduce our risks because we reduce our financial consequences. Risk reduction: A decrease in the total amount of uncertainty present in a particular situation ○ Insurance involves not only risk transfer but also pooling and risk reduction • Usually through the payment of an insurance premium○ Overall risk for the group is reduced, and losses that result are pooled • Insureds transfer various risks to the group and exchange a potentially large uncertain loss for a relatively smaller certain payment (the premium) • Nature of Insurance• Pays for the loss Financial Intermediation○ Insurance policy is a contract. ISO Forms - for general policys. Manuscripts From - Contract specuallized written for a certan purpose Contractual Relationship○ Two Main Elements• A lot of times once something happens, you have no idea what to do. So insurance company will come and try to help you out. Their best interest is keeping you from a large loss.  "render services connected with the risk" “Pooling of fortuitous losses by a transfer of risk to insurers who agree to indemnify insureds for such losses, to provide o ther pecuniary benefits on their occurrence, or to render services connected with the risk” ○ Is the insurance company provoding the insurance The underwriter works for this Insurer○ The one who is buying the policy. This person is transfering the risk. Insured○ Definition• Meaning of Insurance• Pooling of Lossesa. Fortuitous = fancy word for unforseen. You didn't know it was going to happen.1) Payment of Fortuitous Lossesb. But essentially, you still have some other payments. For example, the time and effort of getting your car fixed.a) Someone else is paying for it. 1) Risk Transferc. What insurance is trying to do. It is trying to make you whole again. It's trying to make you the same as pre -loss condition.1) So after you get into a car accident - indemfincation is making your car like the way it was before the accident. 2) Indemnificationd. Basic Characteristics of Insurance Definition• Meaning of Insurance• The Law of Large Numbersa) So we're essentially reducing uncertainty and thus lowering risk,b) The more we have, that is similar, the better we can predict things.1) Large Number of Homogeneous Unitsa. General Requirement• Requirements of an Insurable Risk• 5 - Insurance As a Risk Management Technique: Principle Sunday, February 13, 2011 11:08 PM RMIN4000 Page 1 So we're essentially reducing uncertainty and thus lowering risk,b) So if you purposley wreck your car, insurance wont pay for it.1) So you cannot see it coming - so if you can plan for it, its not really covered.2) Fortuitous, Accidental and Unintentional Lossesb. When did this happen and how much does this loss cost?a) The loss has to be determinable and measurable.1) Determinable and Measurable Lossesc. What have you lost? And who decides what has been lost?1) Some thing are easy like a car accident but things like asbestos in the walls is a bit more hardera) Really hard to figure out.2) So we have to make sure we diversify our lossesa) Like a nuclear bomb. b) It's better if we don’t have a loss that effects our entire insurance company. We don't want one event wiping out all of our money. 1) Non-Catastrophic Lossesd. Can we figure out what the chance is for that loss to occur (goes back to law of large numbers)1) You also need like previous events of this loss. 2) Calculable Chance of Losse. You can have the best coverage, but if its too expensive no one will buy it.1) Economically Feasible Premium f. Insurance is for low frequency and high severity. ○ Other key elements in determining whether a risk is insurable include (1) The Large Loss Principal and (2) the Probability of loss not too high • Do these risks meet the requisites of insurability?• Requisite Risk of Flood Risk of Tornado Risk of Bankruptcy Large Number of Similar Exposures Yes Yes Yes Fortuitous, Accidental & Unintentional Maybe (you can be a flood zone) Yes Maybe Determinable & Measurable Yes Yes Maybe Not Subject to Large Scale Catastrophe No Maybe No Calculable Yes Yes No Economically Feasible Premium Depends on Location Usually No • Example of Requisites of Insurable Interests• Underwriter works for insurance company and makes decesions like how much to charge and what risks to take.• Underwriting is the process of selecting and classifying applicants for insurance. (Note this is from the perspective of the Insurer.) • For Example: If you were an Underwriter, would you provide Essential Actor Insurance for Charlie Sheen at the same rate as you would provide the same coverage to Dakota Fanning?  Underwriters must guard against this. ○ Essentially, it's like going into a fat people club and advertising your buffet - you'll go bankrupt.○ Your selling life insurance. The average life expectancy is 76 so its more likley that people who are closer to that age is more attracted.  Averese selection is making sure you attract just not only old folks but also young kids too. So you have to diversify your customer base.○ Adverse Selection: The tendency for higher than average risks to seek insurance at standard rates. • Underwriting & Adverse Selection• Speculative risk is a choice. It becomes pure risk when you can't control it. Gambling creates new, speculative risk. Insurance is a technique for managing a pure risk that is already present. New Speculative vs Exisiting Pure:○ In Gambling a winner comes at the expense of a loser. In Insurance, both parties have an interest in protecting the exposure from loss. Winners & Losers:○ Insurance contracts seek to restore what the Insured has lost. ○ Insurance vs. Gambling: • Insurance Compared….• RMIN4000 Page 2 insurance company and increace value. Valued Policy Laws: Varies from state to state. Requires Insurers to pay the face amount of the policy for specified perils, regardless of the ACV. (NOT WILL BE ON TEST) • Replacement Cost Valuation: Agreement between Insured and Insurer that damages / replacement will be paid at market prices without deducting for depreciation. • Examples of Insurable Interests – Ownership, Mortgages, Leaseholders, Creditors, Dependents, Employers.  You must have some financial consequence if the loss occurs.  So you can't insuare your neighbor's shitty son's car. Because that's essentially gambling.  So in terms of property - lets say you sold your car and forgot to cancel your insurance. If the new owner gets into a wreck, the insurance won't pay you because you have no pricinical of insurable interest.  So for life insurance, most people buy it for themselves, but let's say you have a couple of kids and an ex-husband - you can take life insurance on him.  The Insured must be in a position to lose financially if a covered loss occurs.○ Prevents Gambling Reduces Moral & Morale Hazards Supports Determinable and Measurable Loss Why is this Principle necessary?○ Principle of Insurable Interest• IV. Fundamental Legal Principles – Insurable Interest• For covered insurance claims, the Insured forfeits their right to collect from a negligent third party. That right now belongs to the Insurer. ○ Why is this necessary?○ Principle of Subrogation• So someone hits your car. You talk with your insurance company, and they pay you. This means then you can't collect money from the liable party. ○ So let's say you bro in law hits your car, you cannot just say don't worry about it. You can't give up the insurance company's right to subrogation. ○ For hold-harmless agreements, you have to tell your insurance company ahead of time - and they will incporate that in your policyl Wavier of Subrogation ○ Reinforces the principle of indemnity - can only collect once• Holds rates/premiums below what they would otherwise be• Places burden of the loss on those responsible (i.e. negligence)• IV. Fundamental Legal Principles Principle of Subrogation• Suit Injury If insurance did not exist○ Insurer subrogates against negligent party If insurance does exist○ Principle of Subrogation• IV. Fundamental Legal Principles - Subrogation• Aspects & Implications:• Fundamental Legal Principles Principle of Subrogation• RMIN4000 Page 5 Subrogation does not exist where the principle of indemnity does not apply - life insurance○ Subrogation is ALWAYS waived for AN INSURED○ If an insured violates or destroys insurer’s subrogation rights, insured may forfeit collection rights under the contract ○ The insurer is entitled to subrogation dollars only after insured has collected fully for the loss ○ The insurer may waive its rights to subrogate. To protect certain entities/ individuals from subrogation, the Insured must obtain a waiver of subrogation from the Insurer prior to the loss. (usually as an endorsement to the policy) ○ Aspects & Implications:• Principle of Utmost Good Faith• You go online for renter's insurance and you tell him about your history, they give you a quote but they really haven't checked your history yet.  So that's why we have priciple of utmost good faith - it makes you tell the truth and if you didn't tell the truth, then you can cael your policy  A higher degree of honesty is imposed on both parties of an insurance contract than is imposed on parties of other contracts. ○ It is impractical for an Insurer to investigate all of the Insured’s statements on an insurance application. Therefore, the Insured is relying upon the Insured’s honesty. Likewise, the Insured depends upon the Insurer’s promise to pay in the event of a loss.  Why is this necessary?○ IV. Fundamental Legal Principles – Utmost Good Faith• Three Legal Doctrines support the Principle of Utmost Good Faith: Representations, Concealment & Warranty • Statements made BEFORE a contract starts to induce a party to enter the contract○ Oral or written statements○ Contract can be voided if the representation is FALSE and MATERIAL○ Representations• . Fundamental Legal Principles – Utmost Good Faith• False - not true at the time of the statement○ If you went online and said you had never got a speeding ticket, but had plenty of speed tickets - this is material cause they would have charged you more if you told them the truth.  Material - would the insurer have declined the contract, changed the wording, or priced it differently if the truth were known ○ Material Misrepresentations• Statement of opinions are not sufficient to void the contract• IV. Principle of Utmost Good Faith• Silence when there is an obligation to speak○ Utmost good faith imposes duty to voluntarily divulge material information otherwise insurer can void contract ○ Generally involves an element of deception○ Same as misrepresentation You knew and you knew you should tlel them, but you didn't. ○ Concealment• Did the insured know of a certain fact?○ Was the fact material? Test for Concealment• IV. Principle of Utmost Good Faith• RMIN4000 Page 6 Was the fact material?○ Was the insurer ignorant of the fact?○ You usually have to sign it.  A warranty creates a condition in a contract○ Any breach of warranty, even if not material, will allow the insurer to void the contract (strict interpretation) ○ Warranties• Express – written○ Implied – not written○ Promissory – condition to continue throughout contract period○ Affirmative – exists at contract’s inception; promises nothing about the future○ Combination examples○ Types of Warranties• Your in a high risk area, why should we lower your insurance? You warrend because eyou have alarm system. But you dodn't keep it on, they can deny your claim • IV. Principle of Utmost Good Faith• Commonly referred to as a ‘bad faith claim’○ Used when the insured feels the insurer is not acting in ‘good faith’○ Used to force insurance companies to perform according to the contract○ Breach of Utmost Good Faith• IV. Principle of Utmost Good Faith• RMIN4000 Page 7 Compulsory• Set Level of Benefits• Floor of Protection• Subsidization• Unpredictability of Losses• Conditional Benefits• Contributions Required• Attachment to Labor Force• Minimal Advanced Funding• Reduced reserve requirements○ Lower cost of capital○ Reduced credit risk○ Business and social stability○ Facilitates offering of new products and services○ Loss control activites○ Benefits• Expense loading etc. to insured (paying > actuarially fair premium)○ Fraudulent claims○ Inflating claims○ Costs• Social Benefits & Costs of Insurance6) Define insurance and explain how it differs from other methods of risk transfer• Determine what makes a risk insurable • Identify situations that give rise to insurable interest and explain how this principle supports the principle of indemnity • State how the subrogation process works and how it is useful• List the legal requirements of a contract and describe the distinguishing legal characteristics of insurance contracts • Differentiate between insurance agents and brokers and describe the sources for their authority • Define social insurance and explain the basic principles that underline most social insurance programs • Describe the central costs and values of insurance to society • Section Objectives 7) $250 (insurance company pays 0)□ $1000 (ic pays 500)□ $750 (ic pays 250)□ Every single time you have a loss, you have to pay. So lets say you have a deductable of 500 and you get into three accident. ○ Straght (each & every)• We build up each one)○ 250 (insurance company pays 0)□ Deductable is $1000○ Aggregate • Deductables (nx chapte)• RMIN4000 Page 10 250 (insurance company pays 0)□ 300 (Ic pays 0)□ You only have to pay 1000 a year. 1500 (IC pays 1050) (250+300+1500 - 1000) □ 2000 (IC pays 2000)□ RMIN4000 Page 11 Declaration• Insuring agreement• We exclude them due to unisurable, should be included in the policy, and can be added on to the policy but you have to pay additional premium.  Losses, pents, property ○ Exclusions• Conditions• Definitions• Basis of recovery• Clauses limiting the amount of recovery• Major Parts of a Policy• Policy number ○ Address of the insured or insured property ○ Insured’s name ○ Agent’s name ○ Premium amount ○ May contain some underwriting information ○ If policy contains options they will be listed ○ Usually on the first page and provides • Declaration • Normally states what the insurer agrees to do and major conditions under which it so agrees • Statement of what the insurer promises ○ Most crucial part of the agreement • May also find a list of the perils insured against and the definition of the insured • Named perils lists the perils that are covered ○ Except those perils specifically excluded  Open perils states that it is the insurer’s intention to cover risks of accidental loss to the described property ○ Named perils vs open perils • The Insuring Agreement • In life insurance that person may also be called the policyholder  Person or organization that is to receive the benefit of the coverage provided ○ Named insured • Normally receive coverage somewhat less complete than that of the named insured ○ Additional insureds • Defining the Insured • Used to help define and limit the coverage provided by an insurer • With the coverage narrowed by the use of exclusions ○ Policies often have very broad insuring agreements • Typically exclusions are used to restrict coverage of given perils, losses, property, and locations • Exclusions • Practically all insurance policies exclude from coverage certain perils among those factors that can • Excluded Perils • 6 - Insurance as a Risk Management Technique: Policy Provisions Tuesday, February 22, 2011 11:59 PM RMIN4000 Page 12 Normally this is the method used □ Make a cash settlement for the amount of the loss Requires the insured to do everything possible to minimize losses to insured property from the insured peril ○ Preservation of the property • All contracts specify the conditions under which the policy may or may not be terminated ○ But not by the insurer  Generally, life insurance and some health insurance contracts may be terminated by the insured ○ For property and liability insurance, contracts may usually be canceled by either party on specific notice ○ Cancellation • You can't just assign contracts to someone else.○ The transfer of the rights of one party to another, usually by means of a written document ○ The party granting the right  Assignor□ The party to whom the right is granted  Assignee □ Such commission must be specifically granted  Is common to allow the insured to assign personal rights under the contract to another person ○ Such as the right to receive death proceeds to the extent of a debt that existed between the assignor in the assignee  In life insurance, the policy provides that if another person is to be given it any rights under the contract the insurance company must be notified ○ However, contracts provide that assignment of the policy rights will not be valid without the written consent of the issuer  When property is sold, the existing property insurance policy may be transferred to the new owner ○ Assignment • (Replacement cost - Depreaction)• Not to exceed the amount that it would cost to repair or replace the property with material of like kind and quality ○ The insurer sets the actual cash value as the maximum reimbursement ○ Many property policies state that only the actual cash value of the property at the time of loss will be reimbursed • Depreciation refers to actual economic depreciation as opposed to accounting or tax depreciation ○ Interpreted to mean replacement cost at the time of loss less any depreciation• Actual Cash Value • They'll just write a check for you, and you can do whatever you want with it.• Allows for recovery with no deductions for depreciation • However, the total reimbursement figure is limited to the cost of repairing, replacing, or rebuilding with similar materials and labor • The insured may not use insurance proceeds for other purposes ○ To collect on replacement cost basis the property must actually be replaced • Replacement Cost • Clauses Limiting Amounts Payable • RMIN4000 Page 15 Virtually all policies have some limits stating the maximum possible payout for losses • Provisions such as deductibles, coinsurance, time limitations, and apportionment clauses may also limit the amount of recovery • Reduce the costs of offering the insurance service ○ Limit the number of small, expensive-to-administer claims ○ Achieve a greater degree of fairness in the rate structure ○ Place an upper limit on the insurer’s obligation on any one policy ○ Generally these types of provisions are used to • Clauses Limiting Amounts Payable • So everything added up to 1 year.○ IN generical, when we have a policy limit = it's an aggregrate limit• In a loss the insurance company will pay the lesser of actual loss or aggregrate limit• May be a specific type of property or one resulting from a specified peril  Restrict payments to a maximum amount on any one type of loss○ Specific dollar limits • Restrict payments on any one group of property items or group of losses from the same peril to some overall maximum ○ Aggregate dollar limits • Usually there is a specific limit of liability for damage to any one person  And an aggregate limit of liability applicable to loss in any one accident  Insurers restrict their liability for losses resulting from bodily injury liability ○ Example of dollar limits• Dollar Limits • A specific dollar amount that will be borne by the insured before the insurer becomes liable for payment • Sometimes causing more administrative expense than the actual amount of payment □ Small losses are expensive to pay  To eliminate small claims ○ To reduce the moral and morale hazards that might otherwise be present ○ Reasons for deductibles • Deductibles • Applies to each loss and is subtracted before any loss payment is made ○ One of the simplest and most effective deductibles ○ Straight deductible • Applies for an entire year ○ At that point, the insurer pays for all losses over the specified amount  The insured absorbs all losses until the deductible level is reached ○ Aggregate deductible • Aggregate deductibles in the health expense insurance industry ○ Calendar-year deductible • The size of the deductible decreases as the size of the loss increases ○ At a given level of loss, the deductible completely disappears ○ Marine insurance  Are for types of properties where we want to eliminate small claims and once we do that, we'll pay for all it. ○ Disappearing deductible • Franchise deductible • RMIN4000 Page 16 Expressed either as a percentage of value or as a dollar amount ○ Once the loss exceeds this amount, the insurer must pay the entire claim  There is no liability on the part of the insurer unless the loss exceeds the amount stated○ If the loss is less than 5% then insured will pay the entire thing out of pocket.□ If the loss is > than 5% insurer will pay the entire thing.□ Lets say our percent is 5%. Example○ Franchise deductible • With a regular insurance eductable, after a certain point - the insurance company compays for everything. This opens the door for morale hazard. • Used in health insurance and property policy.○ So with Coinsuarnce, we're paying the part of the loss with the insurance all the way up til the limit. • Functions much like a straight deductible, expressed as a percentage  Often referred to as the copayment  Health insurance ○ Device used to make the insured bear a portion of every loss only when underinsured  Property insurance ○ Has different meanings in various types of insurance • Coinsurance • They cannot accomplish this unless the insured is willing to protect the whole value of the property  Insurers are supposed to restore their insureds to the positions or situations they had before the loss ○ Than to handle the businesses of those who purchase insurance equal to the full value of the objects  It costs relatively more to insure the businesses of those who are underinsured ○ Underinsurance is undesirable • Usually 80 or 90 percent of the value of the property is the amount required □ In the proportion that the actual insurance carried bears to the amount required under the clause  Typically pro-rates partial losses between the insurer and the insured ○ Places the burden on the insured to keep the amount of insurance equal to or above the amount required by the clause ○ Operation of the coinsurance clause • Table 7-1: Illustrations of the Operation of the Coinsurance Clause • RMIN4000 Page 17