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Chapter 11

Other Insurance

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Chapter Goals

Determine when insurance should be used. Describe the role property and liability insurance has

in managing potential losses in real property and legal liability.

Indicate how personal insurance can reduce losses in human exposures.

Explain how significant the federal and state government are in limiting risks.

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When Is Insurance Suitable?

Insurance can be attractive when infrequent but severe losses that can cause hardship to you are present.

Hardship means the losses can have a material impact on the household's overall financial condition or current cash resources (severity).

Insuring against all losses is extremely costly and therefore inefficient.

When losses happen very often (high frequency), insurance companies end up adding on their overhead costs to the losses.

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When Is Insurance Suitable?, cont.

Loss frequency and severity:

High Severity

Low Severity

High Frequency

Retention Retention

Low Frequency Purchase Insurance Retention

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Risk Management and Insurance Terms

Business Risk: A risk taken for potential reward. Pure risk: A risk that carries no financial reward. Uncertainty: No knowledge of outcomes. Risk: The exact outcome is unknown but the probabilities

of alternative outcomes are known. Perils: Exposures to the risk of loss. Hazards: Exposure to increased probability of peril.

– Physical hazard: A deficiency in physical property that increases the possibility of loss.

– Moral hazard: Hazard that arises from actions taken by the insured person which increase the possibility of loss.

– Morale hazard: Hazard that arises from a person behaving negligently because he or she has insurance coverage.

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Risk Management and Insurance Terms, cont.

If insurance companies had perfect information, they could place clients in risk classes based on probabilities of losses at the beginning of the business relationship and provide less expensive policies for the average client.

But due to asymmetric information, insurance applicants know more about themselves and their probability of future actions than their company does.

Under adverse selection the customer base drawn to an insurance product may differ and be less attractive than that of the population as a whole.

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Risk Management and Insurance Terms, cont.

To minimize costs, the industry has instituted the following practices:

– Insurable interest: You can only insure against loss of items that you yourself would suffer a loss on, should they be damaged or eliminated entirely.

– Indemnity: Your maximum reimbursement in the event of loss of an asset you own is the value of the item.

– Screening and segregation of applicants: Involves separating people based on their risk categories.

– Deductibles: The insurance company reimburses individuals’ claims only for the amount above an established minimum.

– Coinsurance: The policyholder pays a certain percentage of the outlay along with the insurance company; often this is subject to an overall cap on payments by the holder.

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Risk Management and Insurance Terms, cont.

Coinsurance can take the following forms:– Exclusions: Eliminating certain conditions from insurance

company payout when a new contract is drawn up. – Waiting periods: Before reimbursements are allowed.– Prespecified Limits: Establishes the amount the insurance

company is willing to pay contractually. – Experience-Based Alteration in Policy Costs: Charges rates to

policy holders based on their loss experience after they have become clients.

– Use of Group Policies: can reduce adverse selection. Monitoring costs for moral and morale hazards are covered,

at least in part, by the business itself. Employees may be more straightforward with their employer. Reduced processing and marketing costs.

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Risk Management and Insurance Terms, cont.

Mutual insurance companies: Owned by the policyholders.

Stockholder-owned insurance companies: Run for the benefit of the stockholders.

The actions of stockholder-owned companies in their attempt to maximize profits may conflict with the interests of policyholders.

Stockholder-owned company actions in attempting to maximize profits for their owners may conflict with the interests of policyholders.

Recently, several large insurance companies have switched from mutual to stockholder status.

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Needs Analysis

Some of the many factors that enter into household insurance decision making include:

– General Characteristics: The term “need” has to do with whether the household believes purchasing the insurance is essential.

– Tolerance for Risk: Households with low tolerances for risk will be more attracted to insurance.

– Personal Likelihood of Occurrence: When a person believes he or she is at more risk for a negative occurrence than the population at large, and the insurance cost has not been raised for that increased occurrence, they are more likely to take out insurance.

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Types of Insurance Coverage

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Property Insurance

Homeowners insurance covers both real property and personal property related to the home are covered.

Real property: Dwellings and other structures that are affixed to land.

Personal property: Assets that are not affixed to the land and therefore are usually portable.

Originally the individual risks involved with the home were separately insured; now they are usually combined in a single policy.

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Property Insurance, cont.

Types of policies:

Name Type Dwelling Type Coverage

HO1 Homeowner Basic coverage HO2 Homeowner Broad coverage HO3 Homeowner Special coverage HO4 Tenant Contents broad form HO5 Homeowner Comprehensive coverage HO6 Condominium and Cooperative Unit owner’s form HO8 Homeowner Modified Coverage

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Property Insurance, cont.

Contract terms: Property insurance contracts generally have structured terms. Coverage Type Explanation

A The dwelling and other property attached to it such as a garage.

B Structures not attached to the dwelling.

C Personal property.

D Outlays for expenses when damage does not allow occupation.

E Personal liability, which includes the cost of litigation and the proceeds of the suit.

F Medical payments to injured parties.

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Property Insurance, cont.

Amount of Coverage:– Actual cash value approach uses replacement cost but takes into

account depreciation.– Replacement cost method does not deduct depreciation.– When you coinsure part of the cost in the event of loss, the policy

states what percentage of replacement cost you are required to maintain to receive full payment from the insurer. If you are below that figure you will absorb part of the loss according to the following formula:

Where:

Insurance Reimbursement

Amount of Insurance in Force

Amount of Insurance Required

Amount of Loss

Amount of Insurance Required

Coinsurance Percentage Replacement Cost

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Property Insurance, cont.

Earthquake insurance may be available through a rider to the policy. Flood insurance is supervised and underwritten by HUD.

Title insurance reimburses you for loss in the event the title you received is defective in whole or part.

Personal property is often included under a policy but with significant limits on coverage available.

A floater covers the named items wherever they may be located.

Payments as reimbursement for property losses are not taxable. Property losses are tax deductible to the extent they exceed $100 per occurrence and 10 percent of your adjusted gross income for the year.

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Automobile Insurance

The emphasis for automobile insurance has been broadened over the past fifty years from protecting yourself and your property to also paying for suits from third parties.

The automobile policy is separated into six sections: bodily injury liability, medical payments, property damage, collision, uninsured motorist coverage, and the comprehensive section.

Bodily injury liability covers injury to others caused by you and injury to you and members of your family when driving someone else’s automobile.

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Automobile Insurance, cont.

Medical payments reimburse you for injuries to the driver and passengers within your car.

Property damage covers damage you or a designated driver in your car makes to someone else’s property.

Collision covers damage to your car whether through impacting another automobile or by the vehicle turning over.

Uninsured motorist coverage reimburses you for uninsured, underinsured, and hit-and-run drivers who cause losses to you.

Comprehensive insurance covers auto-related losses that arise from theft or damage to your property, but not those that come from another automobile.

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Automobile Insurance, cont.

The price of automobile coverage depends factors such as the type of the car; the age of drivers and their previous accident and driving violations record.

Your rate can be changed to reflect your incidence of accidents during the time you are covered by the company.

No-fault insurance does not assign blame for an accident, and each person is paid for damages by his or her own insurance carrier.

The no-fault approach is intended to reduce litigation expenses and help protect third parties.

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Liability Insurance

Liability insurance (third-party coverage) protects you personally against having to pay for a variety of potential losses to others.

Third-party liabilities occur through personal injuries and property damage to others caused by you. Such liabilities extend to your home and you and other family members and to personal operations as they pertain to exposures to others.

Third-party coverage stands in contrast to losses to you or to your property directly, which is sometimes called first-party coverage.

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Umbrella Insurance

Umbrella insurance (excess liability insurance): A broadly diversified grouping of property and liability coverages in addition to liability coverage under existing home owners and automobile insurance policies.

Umbrella insurance generally does not pay until the limits of coverage in the primary insurance policy are reached.

In today’s litigious society with large awards being made, umbrella insurance can reduce your exposure to catastrophic losses.

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Umbrella Insurance, cont.

Umbrella insurance generally has a minimum coverage of $1 million and rises in increments of $1 million.

The scope of umbrella coverage is often greater than that of comprehensive personal liability insurance.

Umbrella insurance may be offered by your auto insurer or your homeowner insurer, giving you broader coverage and higher limits than in the normal automobile policy or homeowner’s policy.

Normally, an umbrella policy requires certain basic coverage to qualify for its usage.

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Health Insurance

Health insurance provides direct payment or reimburses you for medical expenses in connection with illness or accident.

The majority of individuals and their families receive their medical coverage through the workplace or the government.

The structure of the healthcare industry has changed significantly in recent decades as large corporations and others sought ways of reducing their expenses as their cost of coverage rose.

This led to a change from the individual doctor to the group practice, the rise of HMOs, and more emphasis on decision making by the insurance company.

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Health Insurance, cont.

Types of providers: – Blue Cross Blue Shield: A traditional provider that has been

given nonprofit status by individual states. – Health Maintenance Organizations (HMOs): Provide a full

range of medical services for a flat fee. – Point of Service Systems (POS): Patients can choose either

POS or non POS healthcare providers. – Preferred Provider Organizations (PPO): PPOs use primary

care physicians but they are not used as gatekeepers whose approval is needed in order to be reimbursed for additional services.

– Individual Contracts: May separately cover hospitalization, surgery, and ongoing medical expenditure or cover all in the form of a major medical policy.

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Health Insurance, cont.

All three types of medical coverage include:– A basic medical expense policy for doctors. – Nonsurgical costs whether in or out of the hospital. – A basic hospital policy for hospital costs such as room, board

and ancillary services. – A basic surgical policy to pay for the surgeon’s costs, whether

in or out of the hospital. Major medical policies:

– Can provide broad coverage and are used for expensive care. – Usually have deductible and participation requirements. – Generally have high maximum payments allowed. May be the

sole coverage a person has or, in some cases, may provide additional coverage.

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Health Insurance, cont.

For those who select individual policies or who are given a choice, some features in which policies differ include:

– Deductible copayment and coinsurance clauses.– Ease with which you can be approved for services.– Inclusion of such things as prescription drug costs.– Exclusions.– Stated lifetime limits.– Benchmarks for reimbursement levels.– Ability to interact with a skilled employee representative and

receive an appropriate response to questions about coverage and disputed reimbursement allowances.

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Disability Insurance

Disability insurance provides cash flows to compensate you when you are unable to work due to an accident or illness.

Private insurance:– Short-term disability policies provide income for illnesses for

up to a few years.– Long-term disability covers longer periods most commonly

ranging from 10 years and usually up to ages 65 or 70.

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Disability Insurance, cont.

Important features that differentiate private long-term disability policies include:

Definition of Disability: – The strongest definition of disability is own occupation, where

payments are made when you are unable to work in your existing occupation.

– A broader definition would have payment begin when you are unable to work at any occupation that you are qualified for based on your education experience and training.

– The more restrictive the definition the better because it can allow payments to begin even though you can work in another occupation.

Elimination Period: the time before disability payments begin, which is often three to six months.

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Disability Insurance, cont.

Residual Benefit: A partial payment when you have returned to your job but with a shorter work week and reduced income.

Preexisting Condition: May state that it will not pay out benefits for illnesses or injury that occurred within a period of time before the policy was taken out or may be stated in the policy as permanently excluded from reimbursement.

Rehabilitation Benefit: Some policies will reimburse you for outlays that help to rehabilitate you and may serve to bring you back into the workforce more quickly.

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Disability Insurance, cont.

Cost-of-Living Rider: Can adjust the amount of the initial payment and or the ongoing payment once disabled for the effects of inflation.

Due to insurance company concerns about potential worker incentives to profit from illnesses most coverage of disability policies is limited to 60 percent to 70 percent of income.

Disability income is taxable if the policy was paid for by the company and is tax free if the policy was paid for by the policyholder with aftertax money.

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Disability Insurance, cont.

The Social Security system pays disability income to people who because of illness or accident are unable to work for at least two years, or whose illness will result in death.

There are eligibility requirements including a time frame for previous contributions to the Social Security system, a history of working prior to disability, and a period of six months before payments begin.

Eligibility has become more stringently enforced and is defined as the inability to be gainfully employed in any position in the workforce.

Amounts paid are comparable to what you would have received if you were retired.

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Long-Term Care Insurance

Long-term care insurance reimburses you for expenses incurred when you are unable to perform certain activities of daily living on your own.

You qualify for long-term care payments when you are unable to perform a number of the activities of daily living (or ADLs).

An alternative way of qualifying is through cognitive impairment.

Policies generally have caps on the total amount that will be paid in any period as well as overall limits.

Common policy coverage periods can range from three to six years to a lifetime.

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Government Insurance

Social insurance is insurance provided by governments.

It can be distinguished from public assistance because employers and employees fund social insurance payments directly, generally through mandatory payroll withholding.

The justification for these programs includes absence of adverse selection, and income redistribution, which helps establish a minimum quality of life for all citizens.

The principal government insurance programs are Social Security, worker’s compensation, disability payments, and unemployment insurance.

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Worker’s Compensation

Worker’s compensation provides income to people who are disabled because of work related activities and payments to their families in the event of death.

The system is regulated by individual states, which impose their own requirements.

The majority of the policies are offered by private companies with the states and company self-insurance providing the rest.

Individual businesses are required to participate. Medical care and rehabilitation costs are also covered. Worker’s compensation is no-fault.

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Medicare

Medicare coverage is provided for all people and their family members age 65 or over who are covered by Social Security.

– Part A is given to all and includes hospital care for the first 60 days for a deductible of $912. There is a maximum coinsurance charge of $228 a day for days 61-90 and $456 a day for days 91-150.

– Part B is a supplement that covers doctor’s charges and related expenses. To qualify for the benefit a monthly premium is charged. Only certain expenses are covered and sometimes in limited fashion.

– Effective January 1, 2006, Medicare under Part D has been expanded to offer prescription drug coverage.

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Medicaid

Medicaid is run by individual states and is supported by a combination of federal and individual state funds.

It is intended to cover those people who cannot afford coverage themselves.

Medicaid not only covers those traditionally thought of as disadvantaged, but many younger people or those who otherwise don’t qualify for Medicare.

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Unemployment Insurance

Unemployment insurance provides payments when you have been terminated from your previous job.

It is a benefit organized by the federal government but largely run by the individual states. It is funded by individual businesses.

The benefits amount varies by state and may be a fixed sum or a percentage of your income to a sum.

It generally lasts for 26 weeks, but may be extended in times of high unemployment. You must have had a history of working prior to the application, be interested in obtaining a new job, and not turn down a position that is appropriate for you.

You will not qualify if you were fired for misconduct or are leaving because of a labor dispute.

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Social Security Survivor’s Benefits

Survivor benefits are benefits given to family members when a qualified wage earner dies.

The children each receive 75 percent of what a wage earner would receive at age 65.

Payments to children end at age 18. Elderly parents (over 62) who were supported by the wage earner also each receive the 75 percent payment.

If there is only one dependent, he or she receives 82.5 percent.

The widower’s benefit is 100 percent of the age 65 payment if the spouse was 65 or over. A surviving spouse under age 65 or caring for a child under age 16 receives between 71.5 and 83 percent.

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Chapter Summary

Insurance is most suitable when frequently of loss is low but its severity is high.

Insurance can be separated into property and liability, life and health, and government social insurance.

Property and liability insurance is involved with protection of real and personal property while liability protects you against losses to others.

Property insurance includes home, home’s possessions, auto, liability, and umbrella insurance.

Life and health protects human assets of household members against loss.

Personal insurance includes life, disability, health, long term care. Government insurance includes Worker’s Compensation, Medicare,

Medicaid, unemployment and social security.