CA Life & Health Pre-Licensing

© LyteSpeed Communications

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LyteSpeedLearning California Insurance Pre-Licensing Course 13th Edition

California Life & Health

52-Hour Insurance Prelicensing Manual


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S T U D E N T B O O K

CALIFORNIA

LIFE & HEALTH INSURANCE

PRE-LICENSING

© LyteSpeed Communications All rights reserved

17401 Ventura Blvd., Ste. # A-35

Encino, California 91316

Phone 800.220.3923 • 818.905.5123 Fax 818.905.6460

www.LyteSpeed.net


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California Life & Health Insurance Pre-licensing Manual


All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any storage and retrieval system, without the written permission of LyteSpeed Communications, except where permitted by law.

LyteSpeed Communications

17401 Ventura Blvd. #A-35 Encino, CA 91316

LyteSpeed Communications

Acknowledgements

Contributors Donal Griffith

Mary Kananen Michael Strickler Nancy Strickler

Editor

Wendy Cortez


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Before you begin….. The purpose of this 52-hour course is to provide aspiring insurance professionals with an introduction and basic understanding of the history, purpose and function of Life and Health Insurance, basic life and insurance concepts, terminology and products and the ethical standards and behavior that are expected and required by law from every licensed Life and Health agent and insurer.

This course consists of twenty interrelated chapters that cover basic life and health insurance concepts and principles, contract law, the requirements and responsibilities of those who transact life and insurance and the various ways insurance is regulated in California. Separate chapters also provide an overview of life and health insurance products.

Collectively, the information presented in this program provides the prospective Life Agent with all the information he or she will need to successfully complete the Life Agent pre-licensing examination.

Once a person obtains their Life and Health Agent License, he or she will have a tremendous opportunity to service the public in the purchase of life and health insurance and annuity products.


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Getting Started The insurance profession can be a very rewarding career, but first you must successfully pass the Life and Health agent exam. With this training manual along with the help of your instructor, you will do just that! Not only will this manual assist you with your exam, it will also serve you well as a reference manual in servicing your clients. Important items:

x It would be beneficial for you to read and study the text material ahead

of the scheduled class time. x Get involved in the class. Ask questions (no question is a stupid

question). x Spend time reading and understanding the glossary terms. x Be on time for class and listen to the instructor.

About this Course

Educational Objectives (EOs) are produced by the California Department of Insurance and are found at the front of this course directly following the table of contents. Each EO has been referenced to the exact location in the text where you can find the material that meets each objective. The state exam is derived from these educational objectives. Use the EOs as a study tool. Be Positive, open minded and ready to learn. Best wishes to you, Michael Strickler LyteSpeed Communications Publisher

INSURANCE BASICS AND CONTRACT LAW CHAPTER 1


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1 Insurance Basics and Contract Law INSURANCE is a social device for spreading chance of financial loss among a large number of people. Transfer of risk is the basic principle of all insurance. When buying insurance, a person shares risk with a group of other people, thus reducing the individual’s potential for complete financial ruin. The insurer (also called the insurance company) receives a small amount of consideration (money), known as the premium from each of the larger number of people buying insurance. Individuals realize a small loss (premium payment) in exchange for protection against a large unknown loss. These premiums are pooled (loss reserve) to cover loss payments and expenses. When losses occur, they are spread among a large number of individuals (the pool of policy holders). The contract (agreement) between the insurer and the insured is a legal document referred to as the POLICY. The insurer promises to pay, providing the insured has paid the premium, if a loss occurs. The insured must provide proof of loss and submit a claim. When a claim is made by the insured it is a demand for payment of the insurance benefit for the named insured in the policy.

1.1 Loss, Perils and Hazards A LOSS is the unexpected reduction or disappearance of something of value. Principal types of losses are the loss of property, financial loss (money) or those losses associated with legal liability.

1.1.1 Loss Exposure LOSS EXPOSURE is the potential for incurring a loss. People buy insurance because of the possibilities of a LOSS.

1.1.2 Peril A PERIL is the immediate specific event or danger that causes a loss. Fires, thefts, acts of nature; there are as many perils as there are losses.

1.1.3 Hazard A HAZARD will increase the likelihood or severity of loss as a result of a peril. Hazards are risk situations that may lead to the possibility of loss.

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There are four primary types of hazards: Physical Hazards Can be detected by any of a person’s five senses: Bad brakes on a car, poor health, gas leaks or potholes in a driveway are physical hazards. Moral Hazards Occur when an applicant lies or is dishonest. False statements on an application, prior fraudulent claims, addictions and/or illegal activity can create moral hazards. Morale Hazards Morale hazards will occur when a person is indifferent to the consequences of his/her actions. Speeding and drunk driving are morale hazards. Legal Hazards Come from court actions that increase the likelihood or size of a loss. They are usually associated with liability insurance. Lawsuits are the most obvious form of legal hazard. Discrimination is a common cause for legal hazard in the insurance industry.

1.2 Risk RISK is the uncertainty of loss. Risk management is present whenever there is a choice to be made about how to reduce the chance of the loss. There are two types of risk:

PURE RISK is the chance of loss only with no chance of gain or profit. Death, sickness, and the likelihood of needing medical care are examples of pure risk. SPECULATIVE RISK involves a chance of loss and also a chance of gain. Examples include investing in the stock market or purchasing a lottery ticket.

NOTE: Only pure risks are insurable.

1.2.1 Methods of Managing Risk The following are the five most common methods of managing pure risks for insurers and individuals:

Sharing Potential insureds may reduce their need for insurance coverage by sharing risks with others in their same situation. Farmers can share the cost and risks associated with selling their products by combining their product and overhead into one cooperative place to market goods. An insured may also share part of the risk with a health insurance company in the form of higher policy deductibles and coinsurances.



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An insurer may share all or part of a risk with other insurance companies. A total loss could still occur, but the entire group would share the loss exposure. This is a form of reinsurance and the primary insurance company is the one that transfers its loss exposure to another insurer.

Transfer Transferring a risk involves spreading an individual’s risk across a group of people. The most common method for an insured or business to transfer risk is to purchase an insurance policy. In essence, the insurance company combines large numbers of people who each pay a relatively small amount into a group so that the combined premiums will cover the large losses that may be incurred by individuals. Avoidance Avoidance means bypassing any situation that creates a possibility of loss. This isn’t very practical in many situations. Trying to avoid the danger of an automobile accident by avoiding automobiles entirely won’t work well in today’s society. Some risks carry too much loss exposure for insurers, so they “avoid” them by declining to issue a policy. Reduction Reduction is more feasible than avoiding a risk entirely. By reducing the likelihood or the severity of the loss exposure, the risk becomes smaller. For instance, exercising and healthy diets can reduce the chance of heart disease. Self-Insurance or Retention Instead of buying insurance, some people retain the risk and consequences of loss themselves. This is often used when the chance of loss is very slim (being trampled by an elephant) or the cost of the loss is very small (the loss of the pens on the instructor’s desk).

1.2.2 Ideally Insurable Risk An IDEALLY INSURABLE RISK is one that presents only a chance of loss with no potential for gain. The risk of a loss must then be:

Uncertain In property and casualty insurance, the uncertainty is not when but if. In life insurance, the uncertainty is not if but when. Accidental This refers to an unforeseen and unplanned event. Due to Chance This refers to totally random acts or events.



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1.2.3 Insurable Events (CIC 250) INSURABLE EVENTS are events that may be subject to insurance. From a legal standpoint, any contingent or unknown event, past or future, may be insured against (except for lotteries, gambling or civil damage awards against unlicensed persons). However, for insurance to be legal, the policy owner must have an insurable interest in the event, property or person insured.

1.2.4 Insurable Interest INSURABLE INTEREST refers to the fact that a policy owner must have a financial or beneficial interest in the person or property being insured. In a life insurance policy, the policyowner must have an insurable interest in the life of the insured at the time of application, but not necessarily at the time of loss. The beneficiary of a policy does not need to have an insurable interest at any time. The person purchasing the insurance must prove that they qualify for the benefit (meaning insurable interest); the person receiving the funds or benefit does not. INSURABLE INTEREST is the inherent or acquired right one has to be indemnified (restored to the condition one was in before the loss), in the event of a loss to an event, a person, or property.

NOTE: There must be a direct relationship between the insured and the policy owner. Contingent (third party) interests are not insurable.

Insurable interest has three components:

x Legitimate financial interest: x A business partnership, someone who provides financial support for

another or a bank that lends someone money, are examples of financial relationships that could hold an insurable interest

x Potential for economic hardship

In property and casualty insurance, insurable interest is measured by the dollar value at risk. It must exist at the time the insurance takes effect and when the loss occurs but need not exist in the meantime.

In life insurance, insurable interest is identified in two different ways:

1. Financial Relationship -If there is a distinct financial relationship, there is an insurable interest (business partnerships, bank loans, etc)

2. Strong Love and Affection generated by blood or marriage. Spouses can insure each other, children can insure their parents, and parents can insure their children.

1.2.5 The Law of Large Numbers The LAW OF LARGE NUMBERS is based upon a statistical principle that the larger the database of information used in an analysis, the more accurately one can predict outcomes. Insurance deals with the probability of loss. The law of



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large numbers is applied to risks associated with the perils that might occur over a large number of insured entities of similar type, over a long period of time within a large group. Simply stated, the law of large numbers could be defined as:

“The larger the number of individuals in a group, the more accurately

one can predict outcomes in the group over time.”

Loss Exposure LOSS EXPOSURE is the potential for incurring a loss. The amount of loss exposure is a major guideline for determining the cost of insurance. Insurance agents must be able to identify and analyze loss exposures and evaluate ways they can be addressed. This often involves reducing or avoiding risks to minimize exposures and reduce policy costs. However, care must be taken to be sure that premium savings do not eliminate the effectiveness of the policy. Loss exposure can refer to exposure to Property Loss, Liability Loss and Human Personal Loss. Profitable Distribution of Risk SPREAD OF RISK or “the profitable distributions of exposures” is the way insurance companies manage and attempt to distribute risks in a profitable way. The insurance company must charge the appropriate premiums to cover its costs and to pay all claims.

Mortality By collecting statistics over a long period of time, actuaries can predict the number of deaths that will occur across a sizeable group of people during a given period of time. The larger and more homogeneous the group being studied, the more certain the predictions will be. Mortality Tables MORTALITY TABLES are the insurer’s application of mortality statistics and the law of large numbers. That predicts how many persons per 1,000 in a given age group will die in a given year. These tables are used to calculate insurance rates that cover insurer expenses and ensure a return on the insurer’s investment. Accurate premium charges are dependent upon accurate mortality tables.

Morbidity Used in Health and Disability Insurance underwriting, MORBIDITY deals with the frequency of illnesses, sickness or disabilities that occur in a given group over a defined period of time. As in life insurance, the law of large numbers is applied to gain valid statistics that allow the insurer to predict losses, calculate expenses and charge adequate premiums.



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1.3 Operating Channels The following four channels are critical areas of operation for most insurance companies:

1.3.1 Marketing/Sales MARKETING departments keep insurers current, regarding new strategies and market trends that can help companies reach clients and prospects. After the strategy is defined, a marketing plan is developed and submitted for approval by Department of Insurance before program implementation.

1.3.2 Underwriting The job of the UNDERWRITING department is to facilitate a profitable distribution of the company’s risk exposure within the underwriting guidelines set forth by the insurer.

1.3.3 Claims The CLAIMS department must settle or deny claims from insureds fairly, accurately and in a timely manner. This department is critical in the survival of every insurer.

1.3.4 Actuarial ACTUARIAL departments consist of professional statisticians who:

x Determine the premiums insurers charge for their insurance products x Track the expenses of the insurers x Advise the company regarding profit and loss scenarios

1.4 Contract Law All insurance policies are legal contracts. As such, they are subject to the general law of contracts. A contract is a binding legal agreement that creates an obligation which courts will enforce. Parties Subject To a Contract The parties subject to an insurance contract may be an insurer and any person capable of making a contract (subject to restrictions of the Insurance Code). Elements of a Contract By law, a valid contract must contain the following four essential elements:

x Consideration x Legal purpose x Agreement (an offer & acceptance or mutual consent) x Competent parties

Valuable Consideration The exchange of value on which a contract is based. Consideration is usually the premium and the statements in the application.



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VALUABLE CONSIDERATION must be exchanged between the parties to an insurance contract. From the insured, it is the FIRST PREMIUM PAYMENT and the HONEST ANSWERS TO THE QUESTIONS ON THE APPLICATION (sometimes referred to as a “Statement of Good Health”). From the insurer, it is the PROMISE TO PAY the benefit stated in the contract. Consideration in other contracts may be:

x Money x An act or service x A promise x Giving up of a legal right

Valid Legal Purpose The contract must not violate any laws or be detrimental to the public good. Agreement (Mutual Consent/Assent) An OFFER is made to the insurer when an applicant submits an application. By evaluating the way the applicant answers the questions on the application, the insurer can develop a preliminary estimate of the amount of the risk it is being asked to take. The insurer responds either with an ACCEPTANCE of the offer, or a rejection. This process is often referred to as MUTUAL CONSENT/ASSENT.

Competent Parties (Legal Capacity) The parties to the contract must be COMPETENT for the contract to be enforceable. This means they must not be:

x A MINOR, defined by the California Insurance Code as someone less than 16 years of age, based upon the nearest birthday. If a person is an emancipated minor, deemed by the court they are considered an adult.

x INTOXICATED. The applicant must be free from the influence of alcohol and drugs (legal or otherwise).

x MENTALLY INCOMPETENT. The applicant must be of sound mind and able to rationalize.

Required Policy Specifications All insurance contracts must specify:

x The parties between whom the contract is made. x The property or life being insured. x The interest of the insured/owner in the property insured (if he or she is

not the absolute owner of the property). x The risks insured against. x The period during which the insurance is to continue. x A statement of the premium or, if the exact premium can only be

determined upon termination of the contract, a statement of the basis and rates upon which the final premium is to be determined and paid.



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NOTE: This list does not include financial ratings, claims payment ratings or any of the marketing materials used in the presentation. (This information is not required to be specified in the insurance policy.)

1.4.1 Special Characteristics of the Insurance Contract In insurance, a CONTRACT is an agreement, by which an insurer agrees, for a consideration, to provide benefits, reimburse losses or provide services for an insured. The insurance policy is the written statement that outlines the terms of the contract. Insurance contracts differ from other types of contracts in that they are:

Contracts of Adhesion Insurance policies are “take it or leave it” contracts written by insurers. This means there are no negotiations between the insurer and prospective insured. By accepting a contract, an insured agrees with the terms and must adhere to them. Therefore, if the contract is written in an ambiguous way, the law will usually side with the insured because he or she did not write the contract and had no control of the content.

Conditional Contracts Each party has CONDITIONS that must be met. Insured individuals must show proof of a loss (and, at times, insurable interest) before insurers will pay a claim. Aleatory Unlike most other contracts, an equal value is not exchanged between the parties. The actual performance of the contract depends on the occurrence of an uncertain event. A policyowner may pay premiums for years and never receive a benefit. Likewise, an insurance company may receive a single monthly premium and be obliged to pay the entire death benefit. Unilateral Only the insurer makes an enforceable promise. The only party with the option to cancel is the policyowner. Insurance contracts remain in force as long as the insured pays the premium.

Personal Contracts An insurance policy is a PERSONAL CONTRACT between the insurer and the insured and cannot be transferred from one party to another without the express written permission of the insurer. (Life insurance contracts, some types of cargo or transport insurance contracts and marine coverage are exceptions to this rule.) Utmost Good Faith All parties are entitled to rely on each other to be honest and to in no way attempt to misrepresent, disguise, deceive or conceal any information, pertinent or material, to the contract.



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Indemnity An important aspect of determining insurance needs is that it should be designed to make the policyholder whole again – not to enrich or create a profit. This is sometimes referred to as the “principle of indemnification.” Indemnification restores a person, in whole or in part, to the condition that existed prior to the loss, with no opportunity for gain or profit.

1.4.2 Contract Terminology It is also important to understand the following terms when reading or writing an insurance contract:

Fraud FRAUD is defined as a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment, an intentional and deliberate act for unlawful gain or profit. The penalty for defrauding an insurance company is imprisonment for two, three, or five years, and/or by fine of up to $150,000 or twice the value of the fraud, whichever is greater.

Concealment CONCEALMENT is neglecting to communicate or failure to disclose facts that are known (or should be known) and are material to a contract. Intentional or unintentional concealment entitles the injured party, insurer or insured, to rescind the contract. Information that need not be communicated includes: x Information that is known x Information that should be known x Information that the other party waives x Information that is not material to the risk

Warranty (Expressed / Implied) A WARRANTY is a statement that is guaranteed to be true. A warranty may be express or implied.

A statement “contained” in the contract, relating to the risk, person or thing insured is an express warranty. Implied warranties are “included but not specifically stated” in the contract. The agent/broker and carrier must adhere to the following warranty conditions in conducting the business of insurance: x Warranties may relate to the past, present or future. x Unless the policy states that the violation of a specific provision will void

the policy, the breach of an immaterial provision does not void the policy. x A particular wording is not necessary to form a warranty. x Violation of a material warranty or provision, on the part of either party, will

entitle the other to rescind. x An express warranty, made at or before the execution of a policy, must

either be contained in the policy or in another instrument signed by the insured party. If another instrument contains the information, the instrument must be referenced in the policy and made part thereof.



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x When the performance of a future warranty becomes unlawful or impossible, the omission to fulfill the warranty does not void the policy.

x A policy statement that there is an intention to do or not do something, which materially affects the risk, is a warranty that such act or omission will take place.

A warranty breach, without fraud, merely exonerates an insurer from the time that it occurs. Where the warranty is broken in its inception, it prevents the policy from attaching to the risk.

Materiality MATERIAL INFORMATION is information that would influence a party’s assessment of a proposed contract. In insurance, materiality is determined by three questions: x Are the facts important enough to influence the decision? x Do they affect or influence insurability or the risks involved? x Does the information create any disadvantages to either party entering

into the contract?

The MATERIALITY of a given concealment or representation determines its importance.

Representations REPRESENTATIONS are oral or written statements made to the best of one’s knowledge and belief. A representation is false when the facts fail to correspond with the assertions and stipulations. If a representation is false in a material point, the injured party (insurer or insured) is entitled to rescind the contract. All answers to questions on applications are deemed to be representations. A representation may be altered or withdrawn before the insurance is effective but not afterward.

Misrepresentations When a representation is found to be untrue it is called a MISREPRESENTATION. It is illegal for anyone who transacts insurance to cause or allow misrepresentations of: x Policy terms x Benefits or privileges x Future dividends payable under the policy

Waiver and Estoppel A WAIVER is the act of waiving or excluding a right that is known to exist.

An ESTOPPEL is the legal right an insured has if an insurer persuades him or her to violate a contract condition and then voids the contract because the contract has been violated.



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Right of Rescission (Free Look Period) A life insurance policy shall contain specific notification that the insured may return the policy to the insurer (or the selling agent) within the time stated in the body of the policy for cancellation, if he or she is not satisfied with the contract for any reason.

This time period must be no less than ten (10) days (under age 60), thirty (30) days (over age 60), (20 days if a replacement is involved). Such a delivery by the insured shall void the policy as if it had never been issued and all premiums and fees paid shall be refunded to the insured party. The insurer has 30 days from receipt of the notification to submit full reimbursement to the client.

The free look period begins when the policy is actually received by the policy owner. Insurers often require the policy owner to sign an “Acknowledgement of Delivery Receipt” at the time of policy delivery.

1.5 Tort Law A TORT is a legal wrong other than breach of contract or crime. An entire body of law, tort law, is devoted to the subject of LEGAL LIABILITY. Variations exist because each state determines its own law of torts but the different systems also have many similarities.

There are three areas of torts that may be the subject of liability insurance. There are:

x Intentional acts or omissions of employees x Cases of negligence x Cases of strict or absolute liability

Errors & Omissions Insurance Professional liability insurance comes in two forms and covers most instances of agent liability under tort law.

ERRORS AND OMISSIONS insurance covers the insured for any loss due to an error or oversight on his/her part. All California agents and those who transact insurance business are required to obtain E&O coverage before they conduct business. Many captive agents have coverage through their insurance companies. E&O insurance will pay a third party a settlement if that person suffers a loss because the agent was negligent. The type of negligence that is covered is the kind we could all be guilty of if we are not diligent in the process of assisting the insured in getting insurance. Errors and omissions insurance will not pay if the agent is criminally negligent or guilty of gross negligence.

There are no standardized policies, and E&O insurance usually carries a high deductible.

Malpractice MALPRACTICE insurance is similar to Errors and Omissions with regard to negligence but will also cover for any bodily injury caused by the insured in the performance of their duties. This is not available to insurance agents but is found in the medical field.

PRODUCERS, LICENSING, INSURERS, AND UNDERWRITING CHAPTER 2


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2 Producers, Licensing, Insurers & Underwriting 2.1 Producers

A PRODUCER is an agent, broker, or solicitor who generates insurance policies. The actions and statements of a producer can help or hinder an insured’s security and financial well-being. For that reason, every producer must accept legal, ethical and moral responsibility for the clients and the companies they represent. The California Insurance Code recognizes the following types of insurance producers:

2.1.1 Legal Relationships AGENTS represent companies to clients. BROKERS represent clients to companies. Insurance agents enter into a contract to represent an insurer, and under agency law:

x Their actions are the actions of the company. x Their knowledge is the knowledge of the company. x Receipt of money by the agent is receipt of money by the company.

2.1.2 Agent vs. Broker vs. Solicitor The authority of agents and brokers comes as a result of the licenses they receive. Agents and brokers who are licensed by the California Department of Insurance may only transact within the borders of California and are restricted to transact only with companies that are admitted to do business in California.

An agent operates under the authority of his/her contract with an insurance company to which he is appointed.

A broker operates under the authority granted to him by his client through a written contract.

A solicitor operates under the authority granted to him by an appointing agent or broker. An insurance solicitor is a natural person employed to aid an insurance agent/broker in transacting insurance, other than life insurance.

There is no such license as a “life solicitor.” Also, there is no such thing as an “Accident and Health Solicitor.”

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A broker represents the client, not the insurance company.



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NOTE: Insurance companies will only pay commissions to licensed agents. Brokers are paid by the client with whom they have a contract. Solicitors are paid by the agent/broker for whom they are doing business.

2.1.3 Life Agent A LIFE AGENT is a person authorized, by and for a life / health insurer to transact life insurance, fixed annuities, and health/ disability income insurance.

2.1.4 Life-Only Agent A LIFE ONLY AGENT is a person authorized by, and for, a life insurer to transact life insurance and fixed annuities. The Life-Only agent has a legal relationship to the insurer or insurance agency principal that he or she works for. The underwriting information of the applicant needs to be presented to the insurer or agency principal. The Life – Only agent also has a responsibility to solicitate, field underwrite, and submit applications and premiums all in a timely manner. In regards to the insured, the Life –Only agent has the responsibility to stay in contact with the insured and make periodic reviews of their coverage and answer all pertinent questions.

2.1.5 Life-Limited to the Payment of Funeral and Burial Expenses Effective January 1, 2007, the California Insurance Code (CIC) states that an applicant for a life agent license who is limited by the terms of a written agreement with an insurer to transact only specific life insurance policies or annuities having an initial face amount of fifteen thousand dollars ($15,000) or less that are designated for the payment of funeral and burial expenses, shall be required to take an examination of sufficient scope developed to test their knowledge of topics relevant to the type of policies that they are restricted to sell and to satisfy the Insurance Commissioner that an applicant has sufficient knowledge of insurance and insurance laws to transact the type of policies they are restricted to sell.

2.1.6 Life and Disability Analyst A LIFE AND DISABILITY ANALYST is a person who, for a fee, advises an insured, a beneficiary, or anyone having an interest in a life or disability insurance contract of his or her rights under the contract. An analyst must meet the following requirements:

x May not be an employee of an insurer. x Must reside in California. x Must be at least 18 years old. x Must have knowledge of life and disability insurance. x Must have a good reputation. x Must pass the Life and Disability Insurance Analyst exam.

A life and disability analyst CANNOT charge a fee for soliciting or servicing insurance contracts written by the analyst or contracts for which the licensee receives compensation (commission) from the insurer. If an analyst is also



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licensed as a life and disability agent, a written statement must disclose this information and state that the individual receives commissions for the sale of products.

Analysts may not receive any fee unless it is based on a written agreement, signed in advance of the sale, by the party being charged. This agreement must state:

x That policy information and services may be obtained directly from the insurer without cost.

x The service is being performed for a fee. x The amount of the fee.

The licensed analyst must retain a copy of each agreement for three years.

Note that a life or life-only agent differs from a life and disability analyst in several key points:

x An agent represents an insurance company and markets insurance policies, while an analyst represents a policyowner and analyzes an existing policy.

x An agent is paid by the insurance company under the agency contract, while an analyst is paid by the policyowner under the written agreement signed in advance.

2.1.7 Insurance Agent An INSURANCE AGENT is the person authorized by and for an insurer to transact all classes of insurance other than life, disability and health insurance. This includes all types of property and casualty which may be sold by a property and casualty licensee – a person authorized to act as an insurance agent, broker or solicitor.

2.1.8 Insurance Broker Under California law, an INSURANCE BROKER is a person who transacts insurance – other than life, disability and health insurance – with, but not on behalf of, the insurance company for compensation and on behalf of another person.

Brokers are independent contractors who review the insurance needs of their clients and then “shop” the marketplace for the coverage that best suits those needs. Unlike agents, brokers do not represent insurance companies; instead, they represent clients or insureds. Every insurance application submitted by an insurance broker shall show that he/she is acting as an insurance broker.

Brokers work for commission and fees, usually in the property and casualty field and always based on a written agreement signed by the party being charged. There are some very large firms, known as “brokerage houses”, which operate nationwide and represent commercial clients.



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If a person is licensed to act as a broker/agent, he or she shall be deemed to be acting as an agent in all transactions with insurers for whom a NOTICE OF APPOINTMENT of that licensee as its agent has been filed with the Commissioner and is then in force. (See 2.5.2 Filing of Appointment).

There is no such license as a life broker or health broker.

2.1.9 Accident and Health Agent An Accident and Health agent is a person authorized by and for a disability insurer to transact accident and health insurance.

2.2 Fiduciary Duties When underwriting insurance, all producers act in a FIDUCIARY CAPACITY, or a position of financial trust. An excellent example of fulfilling one’s fiduciary responsibility is to promptly submit all premiums to the insurer.

Responsibilities Fiduciary responsibility refers to a person’s accountability for monies that they hold that belong to someone else.

Life and life-only agents act as a fiduciary with their clients and the companies they represent. As such, they are expected to:

x Be prudent and ethical. x Remit all funds received to the appropriate insurer. Any person who

uses or diverts those funds for personal use has committed a crime of theft and may be punished under the laws of California.

x Maintain fiduciary funds on California business at all times in a trustee bank account or depository in an amount at least equal to premiums and return premiums, net commission received and remaining unpaid amounts to persons that are entitled to such funds. These funds must be separate from all other accounts and no other funds may be commingled. Any alternate method of handling funds must be described in a written agreement, authorized by every person that is entitled to the funds. Any agent may deduct amounts due for unpaid premiums on the same policy from amounts due an insured.

2.3 Marketing

2.3.1 Agency Marketing Purposes, Duties & Authorities An AGENCY is a relationship in which one person is authorized to represent and act for another person or corporation. The three agency systems used in insurance are:

Independent Agency An INDEPENDENT AGENT is a person who enters into agency agreements as a contractor and represents more than one company at a time. The agent is allowed to search the market for the company and products that best fit their client’s needs. The agent is not controlled by any one company, owns the



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records of the policies sold and pays the cost of doing business out of commissions.

Exclusive Agency An EXCLUSIVE AGENT, also known as a “captive” or “career” agent, represents a single insurer and submits business only to that company unless that company rejects its “right of first refusal.” Controlling companies usually provide exclusive agents with training, expense allowances, a minimum salary and benefits. Exclusive agents do not own the records of the policies sold.

Managing General Agent A MANAGING GENERAL AGENT is a licensed property and casualty broker/agent or life agent, who, as a person, firm, partnership, corporation or association: x Has a written management contract and appointment on file with the

Commissioner with one or more admitted insurers. x Produces and underwrites gross direct written premium, equal to or more

than 5% of the policyholder surplus, as reported in the insurer’s last annual statement and either: (A) adjusts or pays claims in excess of an amount determined by the Commissioner or (B) negotiates and binds ceding reinsurance on behalf of the insurer.

2.3.2 Direct Response Marketing DIRECT RESPONSE (WRITING) COMPANIES use employees to solicit and sell insurance. These agents usually receive a salary, or a salary plus commission. A direct writing company has complete control and ownership of its policies and renewals.

2.3.3 Home Service Marketing (Industrial Life) INDUSTRIAL LIFE Insurance was developed in the early 1900s to give minimum coverage to blue collar and factory workers. Coverage is usually low ($1,000 to a maximum of $10,000) and is intended to cover funeral expenses. Coverage is also often available for families (from birth to age 65 or 70) and there are no suicide or loan provisions. Industrial life insurance is often more expensive than other life policies because:

x Underwriting guidelines are more lenient. There is usually no medical exam required.

x Those who carry this type of insurance are often higher-than-average risks x These policies are usually sold via the mail or internet. x Premiums are collected by the agent at frequent intervals, at least monthly

or weekly, so the insurance company’s administrative costs are higher: The requirement that premiums be collected in person is the reason this is frequently called “home service” marketing.



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2.4 Types of Agent Authority It is important for anyone involved in the insurance business to understand the meaning and difference between the following types of authority associated with producers.

2.4.1 Express Authority Is granted to the agent under a written contract. Only the specific items written in the contract are considered express authority.

2.4.2 Implied Authority Is not specifically stated, but granted based on other statements in the contract. The ability to print and use business cards or signage is an implied authority.

2.4.3 Apparent Authority Is not granted to the agent, but appears to exist due to the agent’s actions. Insurance companies are not bound by apparent authority. An agent accepting a late premium without filing for a reinstatement is an example of “apparent authority.”

2.4.4 Rights under Agency Law The authority of insurance agents is contained in a contract between the agent and the principal. Under this authority, the agent, and the insurance company are considered to be one in the same (“the principal”) and are governed by “agency law.” There are four major rules that are part of this relationship:

x The agent legally represents the principal. x Contracts made by the agent are contracts of the principal. x Payment made to the agent is considered to be payment made to the

principal. x Agent knowledge is assumed to be principal knowledge. The agent is

legally, morally and ethically required to disclose any material information discussed or acquired during the application process to the insurer.

2.5 Licensing

2.5.1 Code Specifications for Application & License Upon filing an application for license, the Commissioner may make an investigation and may require the filing of supplementary documents, affidavits and statements as may be necessary to obtain the full disclosure of information needed to determine whether all prerequisites have been met, and if the applicant is otherwise eligible, the Commissioner may issue a permanent license. The Commissioner may also deny an application if the applicant has:

x Committed a felony as shown by a final judgment of conviction. x Committed a misdemeanor denounced by any law regulating insurance

as shown by final judgment of conviction.

The principal is the individual or corporation whose performance is guaranteed in the insurance policy.



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x Had a previous application for a license denied for cause within the five-year period prior to filing the current application.

x Had a previous application for a license suspended or revoked for cause within the five-year period prior to filing the current application.

x Federal Law -Under Title 18 Section 1033, prohibits anyone who has been convicted of a felony involving dishonesty or a breach of trust from conducting the business of insurance, unless they have first obtained the permission of the Insurance Commissioner. Punishment for a violation of this law can be a fine or imprisonment for not more than 10 years.

Note: Conviction includes having been found guilty by a judge or jury or the filing of a plea of guilty or nolo contendere (no contest). A plea of no contest is considered to be a guilty plea by the California Insurance Department.

2.5.2 Filing of Notice of Appointment Every life-only and or and accident and health licensee who is acting in an agent capacity for an insurance company must have a NOTICE OF APPOINTMENT on file with the Department of Insurance. The Notice of Appointment must be executed by the agent’s insurer, or by an authorized representative thereof, and must be admitted to transact one or more classes of insurance covered under the appointee’s license. The authority to transact insurance under an appointment by an agent or broker becomes effective as of the date the Notice is signed. By filing a NOTICE OF APPOINTMENT, the submitting person or organization is declaring that:

x The licensee is of good reputation. x The licensee is worthy of the sought appointment.

Appointments remain in force until a license expires, terminates or is cancelled. An appointment may also be terminated at any time by the agent or the insurance company by filing the appropriate paperwork with the California Department of Insurance.

2.5.2.1 Solicitation by Life Agent Prior to Appointment A licensed life agent may present a proposal for insurance to a prospective insured on behalf of an insurer and/or submit an application to an insurer without an appointment so long as the insurer submits a Notice of Appointment to the Commissioner within 14 days of receipt of the application.

All licenses issued to natural persons (individuals) terminate upon the death of the individual.



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Note: A Life Agent who is not appointed to a specific insurer may not present a proposal or submit an application to an insurer that requires all agents to represent that insurer or group only.

2.5.3 Inactive License A license becomes inactive when the licensee has no current appointments. An appointment acknowledges to the California Department of Insurance that the licensee has an agency contract with a given insurance company. The holder of an INACTIVE LICENSE may not transact insurance authorized under that license. If renewal fees are paid and continuing education requirements have been fulfilled in a timely manner, the license will remain valid and may be reactivated or renewed at any time prior to its expiration by filing of a new appointment or bond.

2.5.4 Suspension or Revocation of License The Commissioner may suspend or revoke any permanent license for any of the same grounds for which an application for license may be denied.

2.5.5 Termination of License Anyone holding an insurance license may cancel it at any time by simply submitting it to the Commissioner or, if the license is being held by the licensee’s employer, providing written notice to the Commissioner. An organization is no longer eligible to hold a license if:

x A partnership dissolves or changes in structure. x An association is terminated. x A corporation is dissolved.

A continuing partnership may continue to operate for 30 days after registering a change in membership, paying the required fee and furnishing a bond, so long as one person continues to act as the agency or broker.



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2.5.6 Insurance Pre-licensing Education Requirements In the chart below are listed the requirements for each California Licensing exam. The Pre licensing education can either be completed in a classroom or online.

License Type

Pre-licensing Education Required

Lines of Authority

Number of exam questions

Exam Time

Life/ Accident & Health Agent (Life Only & Accident &Health )

12 hr code 40 life 52 total

Life, Health, Annuities, Disability Income Long Term Care

150 3 Hours

Life Only 12 hr code 20 life 32 total

Life ,Annuities NO Long Term Care

75 1 ½ Hours

Accident & Health

12 hr code 20 Health 32 total

Health , Disability, Long Term Care

75 1 ½ Hours

Property/Casualty Agent/Broker

12 hr code 40 Property &Casualty 52 total

Everything but LIFE and HEALTH Products

150 3 Hours

Property Agent/Broker

12 hr code 20 Property 32 total

BOP, Comm. Pkg, Comm. coverage, Crop, H/O,D/F, EQ, Flood, Inland Marine, Livestock, Personal Lines

75 1 ½ Hours

Casualty Agent/Broker

12 hr code 20 Casualty 32 total

Auto, EPLI, CGL, Umbrella, WC, Professional Liability

75 1 ½ Hours

Personal Lines 12 hr code 20 hr Per Lines 32 total

Auto, Home Owners, umbrella

90 2 Hours

Limited Lines Auto Only

12 hr code 20 Auto 32 total

Auto Only

60 1 ½ Hours

Commercial Lines Only as an add on to PL to upgrade to a full P/C

20 Commercial 20 total

Commercial Lines Workers Comp

60 1 ½ Hours

Life - Limited to the Payment of Funeral Burial expense

None

Life policies up to $15,000 in Value

90 2 Hours

Note: The 12-hour Code & Ethics portion of the Pre Licensing does not have to be repeated if the candidate is applying for either license as a second license.



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Note the agent must have completed the 12 hour code course prior to obtaining the first license.

2.5.7 Continuing Education (CE) Requirements All licensees must complete continuing education requirements on an ongoing basis. Continuing Education is not an option. All agents/brokers must participate or their license will be deemed inactive and they will be unable to write business. Specific continuing education requirements are listed in the chart below.

License Type CE hrs Required

CE Requirement

Life Agent (Life Only & Accident &Health )

24 24/ per 2year License term

Life Only 24 24/ per 2 year License term

Accident & Health 24 24/ per 2 year License term

Property & Casualty Agent / Broker

24 24/ per 2 year License term

Property Agent / Broker 24 24/ per 2 year License term

Casualty Agent / Broker 24 24/ per 2 year License term

Personal Lines 24 24 / per 2 year License term

Limited Lines Auto Only 20 20/ per 2 yr license term

Commercial Lines 0

None There is no Stand alone Commercial License This can only be added on to a PL to upgrade to P&C license

Life – Limited to the Payment of Funeral & Burial expense

0 None

Failure to Renew a License on Time Any person failing to Pay the renewal fees on time and / or meet the continuing education requirement shall have his or her license automatically terminated. All company Appointments also expire when the license expires. The process to reactivate a terminated license is costly and time-consuming. In order to reactivate a terminated license, the licensee must pay the renewal fee and the



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50% penalty fee, complete the required continuing education. Additionally, the licensee must submit new action notices to re-establish company appointments.

Note: The total number of CE hours required each 2 year renewal period is per license number, you may hold more that one license but only are issued a single license number.

2.5.8 Mandatory Continuing Education courses Ethics Education All agent/brokers (Life, Life Only, Accident/Health, and Property/Casualty) must satisfactorily complete four hours of ethics continuing education every 2 year license term. Licenses will not be renewed until this requirement has been met. The Ethics requirement for Personal Lines or Auto Only agents is 2 hrs of Ethics each 2 yr renewal term. Annuity Education Life agents and Life-Only agents who sell annuity products must satisfactorily complete an initial 8 hr hours of training in an approved annuity course. In each subsequent renewal period an additional 4 hr course must be completed. This mandated course must have a completion date that falls with in the dates of the renewal period for which they are being applied.

Long Term Care Education Life Agents and Accident/Health Agents selling Long-term Care (LTC) or California Partnership for Long-term Care policies must complete 8 hours of education in CA Long Term Care each year for the first 4 yrs of licensure. After 2 renewal periods (4 yrs) this requirement is reduced to 8 hrs of LTC education each 2 yr renewal period. The requirement for the California Partnership is 8 hours of CA Partnership education each 2 year renewal period. Homeowners Valuation Training Property & Casualty and Personal Lines agents/ brokers who transact Homeowners insurance are required to complete a mandatory one time, 3 hour Homeowners valuation course specific to the standards and training for estimating the replacement value on homeowners' insurance. This course must be completed before transacting any Homeowners insurance.



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Note: All of these mandatory courses are part of, not in addition to, the regular required CE hours. The only course that is mandatory to keep your License in force is the Mandatory Ethics. If you DO NOT sell annuities, Long Term Care or Partnership products you are not required to complete those courses.

2.5.9 Filing License Renewal Application Agents / brokers must renew their license every two years, the appropriate fees must be paid and continuing education must be completed by midnight on the date of expiration that shows on their license As of July 1, 2009 the California Department of Insurance will ONLY be sending out renewal notices to agents/brokers by email. It is Important that each producer have a current email address on file with the CDI. Renewal fees will need to be paid online on the CDI’s web site at www.insurance.ca.gov . Once an agent/broker has completed their Continuing Education (and the CE hours have been posted to their DOI record) and paid their renewal fees and the Agent/Broker may log on to www.insurance.ca.gov and print out their newly renewed license. The CDI will not mail you a paper license. An agent/broker may continue to transact business as long as the Continuing Education has been completed and the renewal fees paid on time for a period of 60 days.

2.6 Transacting Insurance The Insurance Code considers any of the following activities “transacting” insurance:

x Solicitation – Advertise or promote an insurance product within the general marketplace. Includes referrals, media placement, telephone and door-to-door sales campaigns

x Negotiations that take place before a contract is written- Discussions regarding the terms and conditions of an insurance product being offered to a potential client. Includes the presentation of benefits, premiums, deductibles and the general nature of the coverage to be offered by the insurer. The presentation of an “offer”.

x Execution of a contract of insurance- The insurer through the agent provides contractual documents for the review of the client. If satisfactory, the client accepts the documents and acknowledges acceptance by signature.

x Transaction of matters subsequent to and arising out of a contract of insurance- Subsequent to acceptance, the insurer provides the insured with copies of executed documents, summary of benefits, directories and contact information regarding such information as filing claims, amendments to coverage, premium payments and cancellation/reinstatement policies.

It is important to note that the activities listed above constitute the definition of “transacting insurance”. An individual or entity acting in any of these capacities must

http://www.insurance.ca.gov/

http://www.insurance.ca.gov/



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hold a valid California insurance license authorizing the person or entity to act in such capacity.

2.7 Insurers An INSURER is an insurance company. An insurer is sometimes referred to as a CARRIER. Carriers may be admitted insurers (authorized to transact business in California) or non-admitted insurers (not authorized to transact business in California). Insurers may be a person, an association, an organization, a business trust, a partnership, a limited liability company or corporation. REINSURANCE is used when an insurance company is asked to take a risk that is greater than its RETENTION LIMIT (the amount of risk an insurer would normally accept on a given contract). Companies reinsure risks that are in excess of the retention limit in one of two ways:

Treaty An agreement where the insurer (“the ceding company”) transfers all excess risk up to the limits of the agreement to a reinsurance company Reinsurance (“re-insurer”). Facultative When an insurance company has no agreements, or has used them all, facultative reinsurance can assume the excess risk and facilitate the issuing of the policy.

For either option, the ceding company transfers the risk to the reinsurance company but retains the responsibility of paying any losses to the insured. In this way, the reinsurance company is invisible to the client. The insured’s premium is shared between the insurance company (ceding) and the reinsurance company (reinsurer).

2.7.1 Admitted Insurers These insurance companies are approved or entitled to transact insurance in the State of California because the insurer has complied with the law and satisfied all the conditions required to transact insurance.

2.7.2 Non-Admitted Insurers These insurance companies are not entitled to transact insurance in the State of California. This may be because they fail to comply or because the insurer is unable to meet financial or business practices requirements, etc. However, non-admitted carriers may transact insurance in California in any one of the following ways:

x A citizen, with respect to that citizen’s own property. x A surplus lines broker. x A special lines surplus lines broker.

A SURPLUS LINES broker may only be used if no admitted carrier will accept the risk. Penalties for violating these laws include the penalty for the

Surplus Lines only applies to Property and Casualty insurance.



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misdemeanor plus a fine of up to $500 ($100/month or portion of a month during which the violation occurs). It should be noted that the insurer is not subject to the financial solvency regulation and enforcement that is applied to admitted insurers. In addition, such insurers do not participate in any of the insurance guarantee funds created by California law. Therefore, these funds will not pay your claims or protect your assets if the insurer becomes insolvent and is unable to make payments as promised.

2.7.3 Domicile of Insurers Insurer’s domiciles are determined by where they are incorporated.

Domestic Insurance companies with their home office in the State of California. Foreign Insurance companies with their home office in another state. Alien Insurers Insurance companies with their home office in another country.

2.7.4 Categories of Insurers Generally speaking, most insurers fall into one of the following classifications:

Stock Company An incorporated firm owned by stockholders (shareholders). The insurance policies are issued through the corporation. Stock companies usually issue non-participating (non-par) policies that do not pay policy dividends. Mutual Company Is owned by policyholders who contribute capital through the purchase of policies. The policyholders vote for a board of directors that directs the affairs of the company. Mutual companies usually issue policies that allow policyholders to share in any divisible surplus through the payment of dividends. The insurance code does contain provisions whereby a mutual company may be converted into an incorporated stock company – a process called demutualization. Lloyd’s of London Consists of groups of individuals who form syndicates to insure hard to place risks. Lloyd’s is not an insurance company. If a loss occurs, each individual in the syndicate is personally liable for his share of the loss.



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Reciprocal Company Is an unincorporated group run by an attorney-in-fact. Members are called subscribers. Each member subscriber shares the risk for all fellow subscribers. The minimum number of members is 25. Reciprocal companies are also referred to as inter-insurers. Fraternal Benefit Society Is an incorporated society, order, or supreme lodge that is formed and operated solely on behalf of the membership. Fraternals are nonprofit, religious, charitable or benevolent organizations and issue no capital stock. They have a representative form of government and a ritualistic work order. Fraternals issue par policies and must meet requirements that are similar to, although not identical, to those that guide other types of insurers. Fraternals issue assessable policies (allowed to charge additional premium).

NOTE: Every insurer will only provide coverage up to a certain “retention limit.” A retention limit is defined as the maximum amount of risk an insurance company will accept.

2.8 The Insurance Application The INSURANCE APPLICATION is a form on which a prospective insured answers questions asked by the insurer. Underwriters use the information gathered on the application to determine whether to accept, modify or decline the risk. Both Life and Health insurance applications are generally divided into three parts. Parts I (General Information) and II (Non-medical Information) eventually become part of the insurance contract. Part III (the Agent Statement) does not.

NOTE: Endorsing Part I & II by attaching them to the policy legally binds the insured to the statements he or she has made in the application.

2.8.1 Applications An APPLICATION is the document that a prospective policyholder completes to provide underwriting information to the insurance company. The insurance agency and its licensed agents are authorized to solicit and submit policy applications for the company(s) they represent.

2.8.2 Participants in the Application Process In addition to the insurer and agent, as many as five other individuals may participate in the insurance application process. These are the:

Insured Person covered by the policy. Policy Owner A person, organization or entity that owns and controls the rights, options and benefits of a policy. (The policy owner must approve policy changes in writing).



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Beneficiary Person named to receive the benefits of the policy upon the death of the insured. Applicant The individual or organization that fills out the application and provides information to the insurer. Premium payor The party responsible for paying the premium.

NOTE: The insured and policy owner, however, are often two different people. The insured, owner, applicant and premium payor may be one person or four different people.

2.8.3 Part I: General Information This section asks for general information about the insured(s) and the type of policy being applied for. Specific questions include requests for:

x Name(s) x Address x Age x Sex x Date of Birth x Marital Status x Occupation x Income x Type of policy being requested x Face amount of policy x Beneficiary and contingent beneficiaries (names and relationship) x Other insurance coverage carried with the same or other insurers x Applications pending with other insurers x Policy Ownership information

2.8.4 Part II: Non-medical Information Since there is no physical exam, specific information is gathered regarding the applicant’s past and present medical condition, including:

x Hospitalizations x Illnesses x Surgeries x Doctor visits x Tests x Medications x Substance use and/or abuse x Height x Weight



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x Level of fitness x Participation in hazardous sports or activities x Chronic or ongoing conditions that could result in an immediate claim or

very high claim within a very short period of time

Depending on the applicant’s response to these questions, and the insurer’s underwriting guidelines, a medical exam or tests may be requested before the evaluation is completed.

2.8.5 Part III: Agent Statement and Other Information In this section, the agent provides personal observations of the applicant, including:

x Personal relationships x Length of time agent knew applicant x The applicant’s financial condition, character and background x Purpose of insurance and whether or not replacement is involved x Any other information the agent thinks the underwriter should know

2.8.6 Application Signatures The completed application must be signed by the insured, the policy owner (if not the insured) and the insurer’s agent. Changes after information has been entered must be crossed out with a single line, edited and initialed by both the applicant and agent. No alterations may be made on a written application by anyone other than the applicant without his or her written permission.

2.8.7 Effective Date of Coverage for Insured/Applicants The EFFECTIVE DATE OF COVERAGE is the date on which the protection of an insurance policy or bond goes into effect. All life agents and all property and casualty broker/agents shall provide applicants, at the time of application or receipt of premium, the effective date of coverage (if known). There must also be disclosure of any circumstances under which coverage will be effective if there exist conditions precedent to coverage. This applies only to personal lines of insurance.

2.8.7.1 Conditional Binding Receipt (Conditional Receipt) The CONDITIONAL RECEIPT provides that, if a premium is paid, policy coverage will be in force from the date of the application or medical exam, so long as the insurer would have approved coverage. For Life and Health Insurance policies, a conditional receipt is not valid until it is delivered to the insured and the premium is paid. (There is no such thing as a “Life Binder”)

2.8.7.2 Binder/Covering Notes A BINDER is a temporary coverage agreement executed by the agent or insurance company (usually the company) and delivered by the agent. This document puts the insurance in force until the premium is paid and is good



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until the insurer issues a policy or declines coverage. Only agents, not brokers, are granted binding authority. A binder is frequently referred to as temporary term insurance, since it will guarantee coverage for a short period of time, usually 60 to 90 days. The commission may suspend or revoke a license of any agent issuing or purporting to issue any binder of a type for which the agent lacks authority.

2.9 Underwriting

2.9.1 Company Underwriting All insurance companies have their own guidelines for deciding who is insurable and who is not. COMPANY UNDERWRITERS review each application to determine whether or not the applicant meets the insurer’s “normal” standards. The purpose of underwriting is to rate the amount of risk the company will incur. Risks may be:

x Class rated – compared to the risk determined for a similar group of insured people.

x Experience rated – based on the insured’s past experience. x Based on the underwriter’s experience and judgment.

An insurance UNDERWRITER is a technician trained in the process of evaluating risks to determine if they fall within the insurers underwriting guidelines. The major underwriting considerations are lifestyle and demographics, such as:

x Age x Gender x Location x Occupation and income x Physical condition x Personal habits and avocations x Moral and morale hazards x Financial status x Carrier history

2.9.2 Obtaining Reliable Information To be effective, underwriters need current and reliable information. For life insurance, gaining this information may require:

x A review of the application. x DMV records. x A review of consumer credit reports that may include information about the

applicant’s background and reputation. x A medical examination. x Attending physician’s statements. x Medical Information Bureau information. x Responses to questionnaires. x Telephone interviews with the applicant.



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2.9.3 Premium Determination There are three major components to an insurance policy premium:

x Mortality x Interest x Expenses

Mortality is based on the likelihood of death assigned by the actuarial department for each class of insureds. A class is typically based on age and sex. Interest is a credit to the total premium cost. It is based on the anticipated earnings that the insurance company will receive from investing the insured’s annual premium. Expense or loading factors cover the insurer’s overhead costs. This includes all that costs of putting the policy “on the books,” the cost of commissions, potential reinsurance requirements, etc. The combination of these factors is used to determine a rate. The price of insurance for each unit of exposure is called the rate and is used to calculate the premium. A unit of exposure in life insurance is generally $1,000.

2.9.4 Adverse Selection & Spread of Risk ADVERSE SELECTION is the tendency of those who are most in need of insurance to apply. Underwriting protects insurers from “adverse selection” by eliminating high-risk applicants. (Terminally ill people are more likely to want life insurance than healthy people.) People who live in flood areas will want flood insurance more than those who live in “safer” areas.

2.9.5 Field Underwriting The screening process that every agent uses when evaluating and qualifying prospects is called FIELD UNDERWRITING. The basic information that the insurance company needs to begin underwriting is gathered in the field by the agents during the application process.

2.9.6 Pre-selection/Post-selection PRE-SELECTION is the process undertaken by field underwriters (agents) to target those prospects that are most likely to provide the insurer with low risk clients. This generally begins prior to the actual application. POST-SELECTION takes place in the insurance office, when company underwriters review and rate the applicant pre-selected by the agent. The goal of both pre and post-selection is to accurately rate the risk before the policy is issued, rather than “post-claim.”

2.9.7 Post-Claim Underwriting POST-CLAIM UNDERWRITING is the rescission, cancellation or limiting of a policy or group certificate because the insurer did not complete underwriting



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and/or answer all reasonable questions before the policy was written. It is illegal for any insurer to engage in post-claim underwriting for any type of insurance.

2.9.8 Classifying Risks After all essential underwriting information is gathered and analyzed, applicants are assigned one of the following risk classifications so appropriate rates (or denial of application) may be assigned:

Preferred Risk Applicant is above the standard health and moral guidelines. Standard Risk Applicant falls within normal underwriting guidelines. Sub-Standard Risk Applicant falls below normal guidelines (usually due to poor health, occupation or dangerous hobbies).

NOTE: A substandard risk classification may still be insured at times with special exclusions or increased rates.

2.9.9 Declined Applications On occasion, some applicants maybe declined from the insurer due to underwriting guidelines. The reason maybe health, moral, morale, or occupational hazard. When this occurs the applicant receives a full refund of their premium.

2.9.10 Other Evaluation Sources for Life/ Health Insurance Risks The following other sources are often used by underwriters to determine whether or not a prospect is insurable:

Medical Exams An examination administered by a physician, paramedical or nurse can provide professional validation of the applicant’s general condition. (In some cases, this exam may also include specific diagnostic tests). Attending Physicians’ Statements Insurers often request statements from physicians who have previously treated the applicant. These reports include detailed information about the purpose of visits, test results, diagnosis and treatment recommended. The Medical Information Bureau (MIB) The MIB is a centralized computer agency that maintains detailed medical histories of applicants who have applied for life, health or disability insurance with MIB member insurers (histories include information provided when applicants applied for coverage from other insurers). Each insurer reports



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medical impairments found during the underwriting process to the MIB. This information is provided in code form to: x Protect confidentiality x Prevent fraud x Protect current policyholders against adverse selection by insurers

Insurers cannot refuse to insure an applicant solely on the information provided by the MIB.

2.10 Group vs. Individual Underwriting Since group life insurance is written on a “group basis,” the underwriting process is different from individual insurance. Specifically, there is usually minimal or no evidence of insurability required. There is no individual medical underwriting for group insurance and no medical question on the group enrollment form. Instead, group underwriters are concerned with criteria that relate to the group as a whole, such as:

x Adverse selection. x Size of the group. x Nature of the group. x Financial stability of the group. x Number and frequency of new entrants to the group.

Although medical underwriting is not required, group life plans still usually require evidence of insurability for any employee who wants to join a contributory group (where employees pay part of the premium) after the initial time of eligibility.

2.11 The Fair Credit Reporting Act Because of the confidential nature of much of the information collected by insurance companies, there is a need to protect the public from misuse of this information. The Fair Credit Reporting Act requires insurers to notify the insured parties when consumer reports are requested regarding them.

2.12 Discrimination in Underwriting The California Insurance Code prohibits the following discriminatory practices:

Ethnic Identification Applications or insurance investigation reports may not identify or ask for the applicant’s race, color, religion, national origin or ancestry. Questions asking for the applicant’s birthplace are permitted, so long as the question is used to identify and not discriminate against the applicant. Insurers may not reject an application, refuse to issue a policy, or cancel a policy on the basis of marital status, sex, race, color, religion, national origin or ancestry. These criteria do not contribute to a condition or risk that may require a higher rate or premium.



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HIV & AIDS Risks There are established standards for underwriting life insurance regarding potential victims of HIV and AIDS. These include:

x Mandatory standards for assessing risks to determine insurability. x Requirements for maintaining confidentiality of information. x Required written consent before testing.

Insurers may not use sexual orientation, marital status, living arrangements, occupation, gender, beneficiary designation, zip codes or other territorial classification to determine whether to test for HIV. The civil penalty for violating these mandates is $1,000 to $5,000.

Genetic Disability Traits Insurers may not refuse to issue or renew a life or disability policy because a person carries a gene associated with a hereditary disability that has caused no adverse effect on the carrier. Group policies may not require a higher premium or require a rebate from an insured with a genetic disability that is different than the rate required of other insured members of that group.

No insurer may construct a policy that requires the insured to accept anything less than the full value of the policy if a claim is filed. Insurers may not set a lower commission fee for agents or brokers who write policies for individuals with genetic disability traits. Physical or Mental Impairment Physical or mental impairment includes physical, sensory or mental limitation that impairs an individual’s ability to perform major life activities. Life insurers may not refuse to insure, limit coverage or charge a different rate for physically or mentally impaired individuals, except when based on sound actuarial principles or related to actual or reasonable anticipated experience. Blindness Individual or group life insurers may not refuse to insure, limit coverage or charge a different rate based on an applicant’s blindness or partial blindness.

LIFE INSURANCE CHAPTER 3


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3 Life Insurance 3.1 Introduction to Life Insurance

Life Insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the death of the insured. In return, the policy owner agrees to pay a premium at regular intervals or in a lump sum. The life insurance contract pays the benefit (policy face amount) to the beneficiary in a lump sum or the proceeds can be paid out to the beneficiary in a stated period of time or a stated amount.

3.2 The Insurance Policy The written instrument in which a contract of insurance is set forth is the policy. An INSURANCE POLICY is the agreement (contract) between two parties, the insured and the insurer that, for consideration, the insurer will pay a claim providing that a loss occurs during the term of the contract. All conditions and policy limits are stated in the contract and must be agreed to prior to coverage being in force. The limit of liability of any policy is the maximum amount the policy will pay in the event of a claim.

3.3 Types of Insurance The products commonly sold by the various types of insurers fall into one of the following four classes:

Life Insurance Any type of insurance policy that guarantees a specified individual (beneficiary) a sum of money to be paid on the death of an insured is life insurance. The major difference between life insurance and all other insurance is that it provides protection for an event that is sure to happen. The only uncertainty is when, how and where the covered event will happen. Annuities are considered to be a form of life insurance, rather than a class of their own. Annuities are investment products, sold by insurance companies to provide fixed or variable payments, either immediate or in the future, for a specific number of years or for the life of the recipient. Annuities are usually set up to pay individuals after retirement or when they can no longer earn a satisfactory income. There are no “Standard Life Policies”, unlike Property/Casualty insurance.

Chapter

3



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Health/Disability Insurance This class covers any type of insurance that provides protection against financial loss or medical expenses caused by an illness or injury.

Property Insurance This class of insurance protects the insured from losses incurred when property is stolen, damaged or destroyed by an insured peril. Damage to land is specifically excluded. Buildings and other structures, personal property, building contents, equipment, inventory or stock may be covered by property insurance.

Casualty Insurance Casualty insurance is usually packaged with property insurance and covers the liability of a person, organization or business for negligent acts or omissions that cause bodily harm or property damage to a third party. Financial Risk Management The two primary purposes for the purchase of life insurance include:

The Financial Consequences of Dying Protection against loss of income is the main reason to buy life insurance. Common financial considerations include:

x Cost of final illness or injury. x Home mortgage and debts. x Need for continuing family income to maintain a standard of living. x Funeral expenses. x Estate taxes. x Educational funding for children. x Retirement income for surviving spouse.

The financial impact caused by the death of a breadwinner can be huge. Life insurance will protect against dying too soon.

The Financial Consequences of Living In addition to paying death benefits, life insurance can provide “living benefits” that offset some of the risks that come with living a long time. Cash values may be available to borrow, and some policies create income for retirement.

For people with young children, mortgages and other debts, life insurance can provide cash to replace the lost income of a deceased breadwinner. For older people with lower debt and higher investments and savings, the need for life insurance decreases drastically. This concept, referred to as THE LAW OF DIMINISHING RESPONSIBILITY, is important when determining what type of insurance to purchase.

PURE (term) insurance provides only a death benefit.



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CASH VALUE (permanent) insurance provides a death benefit and living benefits.

Estate Planning Life insurance creates an immediate ESTATE. The benefits it provides gives the deceased a fully funded estate that transfers to the beneficiary and, at the same time, helps preserve the value of an existing estate. ESTATE PLANNING is the process of planning, before someone dies, how his/her estate will be preserved.

3.4 Determining Life Insurance Needs: The Personal Financial Planning

The goal of an effective personal finance plan is to provide enough insurance to cover the client’s needs at a premium he or she can afford. This requires an honest analysis of a prospect’s:

x Present and anticipated needs. x Reasons for buying insurance. x Unique circumstances. x Future goals. x Available and anticipated resources.

Life insurance professionals must always remember that the needs of the client must come first. Determining those needs is not an exact science and there is no such thing as “one size fits all.” Indemnity An important aspect of determining insurance needs is that it should be designed to make the policyholder whole again – not to enrich or create a profit. This is sometimes referred to as the “principle of indemnification.” How Much Life Insurance to Purchase The purpose of most individual life insurance is to:

x Replace lost income x Protect assets x Minimize estate taxes

Because insurance is not an exact science, there is no single way to determine how much insurance anyone will need. There are, however, several methods that agents use to evaluate needs and recommend appropriate products.

Needs Approach When using this method, the agent helps the family determine their financial needs and objectives and weighs these against their existing resources (income and assets) to discover the most appropriate policy for the situation. Typical questions an agent might ask when using this method include:



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x What if the proposed insured dies suddenly? x What if death involves a prolonged illness? x What if there are large medical bills? x How many children are involved and what are their ages? x Do any children have special needs? x Can the surviving spouse work? (What is his or her earning potential?). x How will the survivors pay for childcare? x Is other insurance in force? x What about social security? x Are there personal savings, assets and other investments? x Children’s education

The Human Life Value Approach This approach focuses solely on the prospect’s earning potential based on age, present annual salary, present annual expenses and multiplying the results by the number of years the prospect expects to work before retirement. The drawbacks to this method are the fact that it does not adjust for increases in wages, standard of living, changes in family structure or alternative sources of income.

3.5 Types and Classes of Life Insurance There are two basic categories of life insurance: Temporary Temporary insurance (or TERM INSURANCE) is pure insurance that provides a death benefit only if the insured dies during the term of the contract. If the insured lives to the end of the term, the policy will expire with no further value, although most term policies can be renewed. The premium generally remains the same (level) during the policy term. The death benefit may be level or increasing (goes up over time) or decreasing (goes down over time). Typically, term insurance policies are written for 1, 5, 10, 15, 20 or 30 years. One year renewable term insurance policies are common on health insurance benefits. The premium increases each year as the person ages. Permanent Permanent insurance (or CASH VALUE INSURANCE) usually provides a death benefit for the insured’s whole life (or age 100). It also has a cash value that may grow on a tax-deferred basis. The various forms of permanent insurance include whole life, endowments, limited pay life, universal life, variable life and variable universal life.



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Classes & Types of Life Insurance All life insurance policies fall into one of four classes: Ordinary (Individual), Group, or Industrial (Home Service Insurance). In addition, credit life insurance, as debtor protection insurance, is worthy of special mention.

3.5.1 Ordinary Life Insurance Most life insurance policies written in the United States today fit into the class of ordinary insurance. The class includes whole life, endowments and term life that are purchased on an individual basis. The following is true for all ordinary life insurance policies:

x They are written for a face amount of $1,000 or more, although most insurers require at least $10,000 to cover underwriting costs and ensure profits.

x Premiums are paid directly to the insuring company on a pre-approved annual, semi-annual, quarterly or monthly basis. The frequency of premium payments is known as MODE OF PAYMENT.

x Policies are underwritten on an individual basis, based on the insured’s age, sex, past and present health, occupation, lifestyle and other relevant underwriting criteria.

3.5.2 Group Life Insurance Group life policies often provide coverage to individuals who could not otherwise afford it. A business, association, organization or civic group generally pays premiums. These polices are usually sold on an annual one-year term (ART) basis.

3.5.3 Industrial Life (Home Service) Insurance INDUSTRIAL OR HOME SERVICE LIFE coverage is usually low ($1,000 to a maximum of $10,000) and is intended to cover funeral expenses. Coverage is also often available for families (from birth to age 65 or 70) and there are no suicide or loan provisions. Industrial life insurance is often more expensive than other life policies because:


x Those who carry this type of insurance are often higher-than-average risks.

x Premiums are collected by the agent at frequent intervals, at least monthly or weekly, so the insurance company’s administrative costs are higher. The requirement that premiums be collected in person is the reason this is frequently called “home service” marketing.

3.5.4 Credit Life Insurance A CREDIT LIFE policy insures the lives of debtors for the benefit of a creditor. It may be written on an individual or group basis, usually as decreasing term insurance that is tied to the purchase being financed. Credit life premium payments are often added to the installment loan payments and financed along



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with the item being purchased. Coverage terminates if the debt is paid, transferred, refinanced or becomes significantly overdue.

3.6 Term Insurance TERM INSURANCE is temporary insurance because it provides coverage for a designated period of time. At the end of this period, if it is not renewed, it will expire. Term insurance policies are usually written for 1 to 30 years, carry no cash value and will only pay the death benefit if the insured dies while the policy is in force. Initial premiums for term insurance will be lower for shorter-term policies. Since premiums only cover mortality, the risk becomes higher each time the policy is renewed. As mentioned above, insurers compensate for this by increasing the premium, reducing the death benefit or terminating the policy. Term insurance premiums are typically guaranteed at initial level; that is, the premiums are guaranteed not to change during the policy period. Occasionally, there will be an initial premium and then a maximum premium. This generally occurs only when the term of the policy extends past a certain age. At that age, the insurance company will raise the premium charges. Term insurance may be issued as a separate policy to cover all needs or to meet specific need, such as debt reduction or mortgage protection, or as a rider attached to a permanent policy. A rider is used to cover a specific need related to or part of a policy or insurance package. Many term policies are issued as either guaranteed renewable or convertible. Many are both.

RENEWABLE TERM INSURANCE policies give the policyholder the right to renew the policy without providing proof that the insured is still insurable. This is referred to as “the right to renew without evidence of insurability.” Premiums for renewable policies are calculated at the insured’s ATTAINED AGE and go up to reflect increasing age and the greater risk of health issues. Most policies set limits on how many times the policy may be renewed based on the insured’s age at the time the policyholder exercises the renewal option. For example, a 20-year renewable term policy will most likely not be renewed if the insured has reached age 80 at the end of the term. CONVERTIBLE policies allow the owner to convert the term policy to some type of cash value policy, usually whole life. While this right can be exercised without providing evidence of insurability, the policy must be converted prior to the end of the term. If it is not converted by the end of a term, the client may renew the policy and convert after the renewal is completed.

Typically, term policies are structured in one of the following ways:



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3.6.1 Level Term LEVEL TERM policies charge a higher premium than is required to cover the risk of death in earlier years of the policy and set a portion of it aside for later years. Premium payments remain the same (level) for a specified period of time, but will increase on policy renewal.

The following examples illustrate the concept of a level term policy. Let’s start by comparing two similar level term policies; Both Premium and death benefit remain constant throughout the term of the policy.

3.6.2 Decreasing Term In a DECREASING TERM policy, the premium remains level for the term of the policy but the face amount decreases to zero, at which time the policy ends. This type of coverage is commonly used to pay off outstanding debts. Mortgage protection insurance is usually written as a form of decreasing term. The following chart provides an example of a decreasing term policy.

3.6.3 Increasing Term INCREASING TERM insurance, sometimes called a COST OF LIVING RIDER, is the opposite of decreasing term. The face amount (death benefit) starts at a stated amount that increases over a stated time. Typically, the policy is renewable each year. The premiums, however, increase each year as they are based on the attained age of the insured party.

20 Year Level Term Policy $500,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Years

Both Premium and Death Benefit remain constant throughout the term of the policy

$1,000 $1,500

$ 500

$250,000

$500,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Years

Death Benefit decreases with time until the end of the policy. The Premium remains constant, but coverage decreases.

30 Year Decreasing Term Policy



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There are many situations where increasing term insurance may be the appropriate choice.

x Temporary need for substantial protection for student or business loans with an indeterminate payoff period.

x Return of Premium Rider Increasing term might be added as a RETURN OF PREMIUM rider to an individual policy to provide an amount of money equal to the premium paid for the individual policy if the insured should die during the term of the rider. It can also be used to increase the death benefit of an existing life insurance policy.

The following diagram illustrates the features of an Increasing Term Policy:

In the chart above the premium remains constant, the coverage increases over time. These types of policies are not used very often in today’s market.

3.6.4 Annual Renewable Term (ART) This term coverage is one of the least expensive policies on the market, a good purchase if the insured needs a large amount of coverage on a short term basis, with the initial premium very affordable. (Group life insurance is usually Annual Increasing Term Insurance). Now the downside, as the years progress so does the premium, each year. Eventually the premium increases to a large amount, thus allowing few options:

x Convert to another type of coverage (usually a whole life policy). x The insured lapses the policy and leaving no coverage enforce.

3.7 Characteristics of Term Insurance The primary characteristics of term insurance are:

x The lowest premium cost for a specific amount of coverage for a given period of time.

x Simple, easy to understand conditions. x It is a temporary contract. Protection is only provided during the term. x The premium will increase at renewal. x There is no cash or loan value. x It may not be renewable or available beyond a certain age.

30 Year Increasing Term Policy

$250,000

$500,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Years

Death Benefit increases with time until the end of the policy.



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3.8 Term Life Insurance: Disclosures in Senior Advertising Advertisements for term life insurance directed to individuals 55 years or older shall:

x Distinguish basic life insurance from supplemental benefits. x Disclose any limitations, exceptions or reductions affecting such benefit. x Disclose any condition affecting continuing insurability, including age or a

designated time period. x Disclose any change in benefits or premiums resulting from clients’

attained age, policy duration or any other factor. x If benefits decrease with age or policy duration, while premiums remain

relatively constant, this fact must be prominently displayed in any advertisements promoting the product.

x Any television or radio advertisement for term life insurance, directed at people 55 and older, must contain a statement that policy benefits and limitations should be carefully examined before purchase.

x The Commissioner, by regulation, may adopt a term life insurance monetary value index to be contained in all advertisements directed at individuals 55 years or older – and in all policies and contracts for such insurance. If adopted, such monetary index will be developed with the assumption that it is the insured’s desire to retain coverage for at least 10 years.

x The Commissioner, upon receipt of information demonstrating that an insurer has violated any of these requirements, may suspend their Certificate of Authority to transact insurance in California.

3.9 Whole Life Insurance WHOLE LIFE insurance provides permanent protection for one’s entire “span of life”. This type of policy will guarantee payment of the face amount (death benefit) if the insured should die at any time from inception of the contract until the insured reaches age 100 (assuming all premiums are paid). Policy will endow at age 100 (pay the face amount). Whole life insurance comes in several forms, all of which share the following characteristics:

x The premium remains at a level fixed amount for the entire premium-paying period.

x The death benefit is a fixed amount. x The interest paid to the owner is set at a fixed rate for the life of the

contract.

With traditional (or straight) whole life, premiums are paid and coverage is provided from the date the policy is issued until death or age 100, so long as all premiums are paid. The following example illustrates straight Whole Life insurance.



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3.9.1 Limited Payment Whole Life LIMITED PAYMENT WHOLE LIFE insurance requires premiums to be paid for a limited period of time. Level premiums are paid for a specified number of years (10, 15, 20) or to a specific age (55, 65, 70 etc.), at which time the policy will be paid up or fully funded.

The shorter premium-paying period will make payments higher because the policy will be paid for in a shorter period of time. Because of the higher premium, the “limited pay” policy will create cash values sooner than traditional or “straight” Whole Life. Like all Whole Life policies, Limited Payment policies are designed to mature and endow at age 100.

3.9.2 Single Premium Whole Life SINGLE PREMIUM WHOLE LIFE is paid in full with one premium at the beginning of the contract. As with other limited pay life policies, once the amount of premium that is required to fully fund the contract is paid no further premiums are necessary. The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) created restrictions and limitations on the amount of premiums paid proportionate to the Death Benefit. As a result of TAMRA, all Single Premium policies purchased since June 21, 1988 are prohibited from offering tax-free loans and all are classified as Modified Endowment Contracts or MECs.

3.9.3 Modified Endowment Contracts (MECs) MODIFIED ENDOWMENT CONTRACTS (MECs) are policies that are “paid up” or “fully funded” in fewer than seven payments or seven years. It is a term that also applies to any life insurance policy where the cumulative premiums paid over the first seven years (7 pay test) at any time exceed the total of the net level premiums that would have been paid in over the same period. When this happens, the living benefits (loans, collateralizing, etc.) of the cash value of policies will be treated differently under the federal tax code. The cash value that accumulates in all other life insurance policies is tax deferred. The accounting principle known as FIRST IN/FIRST OUT, or FIFO, is

$500,000

Age 100

Insurer's Risk

Cash Value = Face Value at age 100 when the policy matures and endows at 100%

Cash Value % Tax Deferred



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used in determining any taxation of distributions. Any money withdrawn from the contract will not be taxed until the amount of money equal to the premiums paid has been withdrawn. This is referred to as WITHDRAW TO BASIS.

In a MEC, the accounting principle is LAST IN/FIRST OUT, or LIFO. This means that if a policy is classified as a MEC, all withdrawals, including loans, will be taxed as current income until all policy earnings have been taxed.

In addition to the income tax ramifications, any withdrawal of cash value prior to age 59½ results in a 10% premature withdrawal penalty by the federal government and a 2½% penalty by the state. If there is any possibility that a client might want to tap the cash value of their policy while they are alive, it is not a good idea to allow the policy to become a MEC. It is the responsibility of the insurer to notify the owner if any policy exceeds this “seven pay test”. It is the responsibility of the agent to understand the law and its implications and to provide the client with an adequate explanation of the ramifications of various policy options.

3.9.4 Endowments ENDOWMENTS are the most expensive type of life insurance. While a whole life policy can be described as a death benefit that includes a savings account, an endowment is more like a savings account that includes a death benefit. The primary purpose of whole life insurance is to provide a death benefit. Cash accumulation is secondary.

An endowment’s primary purpose is to provide a specific sum of money at some specific future date. Therefore, its primary goal is the accumulation of cash. However, if the insured dies before that amount has been reached, the death benefit will provide the funds. This type of policy is a good way to help families save for a child’s education, because if the breadwinner dies too soon the death benefit will be paid to the designated family beneficiary.

Endowments pay benefits in one of two ways:

EITHER As a death benefit at any time during the endowment period to a named beneficiary. OR As a living benefit to the policy owner/insured at endowment if the insured lives to the end of the endowment period.

The premiums, rate of return, and death benefit of an endowment remain level throughout the term of the contract, just as in whole life insurance.



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$50,000 Endowment -- 18 Years

$50,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Years

Insurer's Risk

Cash Value = Face Value at the end of 18 years when the policy matures and endows at 100%

Cash Value% Tax Deferred

3.10 Adjustable Life Insurance Within certain limitations, ADJUSTABLE LIFE Insurance policies give the policy owner the flexibility to choose both a premium and death benefit. As the individual’s needs change, both aspects of the policy can be adjusted up or down. This eliminates the cost and need for multiple policies. Within limits based on age, gender and insurer minimums, the insured may choose the initial premium and death benefit. Depending on the level of the premium in relation to the death benefit, the policy will be written as:

Term Insurance Insured chooses lower premium and higher death benefit. Whole Life Insured chooses higher premium and lower death benefit.

If choosing the term insurance option, premiums are typically guaranteed at initial level; that is, the premiums are guaranteed not to change during the policy period. In order to convert the policy to whole life, there will be an initial premium and then a maximum premium. Only if the decision is made to adapt the policy to a whole life policy will the maximum premium be enforced A unique aspect of this type of policy is the fact that by changing the face amount or premium the insured can move from term to whole life insurance without adding, dropping or exchanging policies; hence the name Adjustable Life. Changes can typically be made as often as once a month on the policy anniversary date, although increases in the death benefit that increase the insurer’s risk will force the insured to meet the same evidence of insurability required for the purchase of a new policy.

Another key benefit of adjustable life is that it gives the insured the option of building higher or lower cash values. A low premium for a specific death benefit will produce little cash value and a shorter protection period (term insurance). A higher premium for the same death benefit will produce higher cash value, a longer protection period and shorter premium payment period (whole life insurance).



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3.11 Universal Life Insurance (Interest sensitive and flexible Policy’s)

With the rising interest rates in the early 1980s and the emergence of other investment opportunities, companies began to offer insurance policies with rates of return that were more in line with the market conditions and interest rates. The death benefits and premiums were also made to be flexible to meet the changing needs of the client.

UNIVERSAL LIFE was one of the first “flexible” policies. This type of insurance is comprised of two parts: pure insurance and a cash-value account that earns interest. The premium payment and death benefit amounts can vary and are chosen by the insured, so long as they meet insurer minimums.

One component of a universal life policy consists of pure life insurance and is the actual life insurance component of the policy. The second component consists of cash value, which consists of the premium contribution minus the cost of the pure life component.

Universal life should not be thought of as a combination of benefits and features borrowed from other types of policies. It is a unique product in its own right and can be defined as a life insurance policy with a flexible premium and adjustable death benefit that accumulates cash values. It falls under the cash value or permanent life umbrella and formally separates the life insurance portion from the cash value portion of the policy.

Flexible Payment Schedule Universal life policies, after the first year of the contract, typically offer the flexibility of not having to make regular premium payments. With certain limitations, the policyholder can schedule payments on a “stop and go” basis and/or make unscheduled premiums whenever the policyholder desires; if there is a large enough cash value. If you decide not to pay premiums, the insurance company simply deducts the cost of maintaining the insurance from the cash value portion of the policy. Premium Amount The premium can range (depending on circumstances) from as low as zero to some predetermined maximum (so as not to create a MEC). Generally, a target premium is set based on the amount the policyholder needs to pay to keep the policy in effect until age 100. It should be noted that the introduction of flexible payment schedules has opened the gateway for a growing number of new plans with many premium variations, rather than the classic guaranteed level premium. Some companies, for example, now offer choices of graduated premium options. Thus, the clients who want to pay a guaranteed minimum premium (sometimes called a modified premium) in the first few years of their policy may opt for a plan where the premium may increase after a



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specific time period but never more than a guaranteed maximum. The purchaser, of course, has to be made aware that early affordability means that cash values won’t accumulate as fast. This, in turn, results in modified cash value tables. Current Interest Rate The interest rate is also a flexible feature. Policies pay a credit of interest at the current interest rate to the cash value account. The current rate is usually guaranteed for one year at a time and consists of:

x A minimum guaranteed rate for the life of the contract, plus x Excess interest earned by the insurer.

Current interest rate, then, is equal to guaranteed interest plus excess interest. Accordingly, with a universal life policy there is the potential to offer the insured party a greater investment returns if the insurance company’s investments increase at a higher rate. In addition, the interest earned inside a universal life policy grows on a tax-deferred basis and can be accessed without taxation by making policy loans. Death Benefit A policyholder may increase the death benefit without buying another policy, although he/she may have to prove insurability. In addition, the policyholder may reduce the death benefit.

Internal Mechanisms An interesting aspect of universal life insurance is its “unbundled” design that makes it possible to allocate specific portions of each premium dollar to either the protection part of the policy (mortality), or to insurer expense loading (commissions, acquisition costs, underwriting and administrative costs.), or to a savings “side fund” that earns a current interest rate. The policyholder has access to these funds through loans, partial surrender or withdrawal, so long as funds are left to pay the cost of pure insurance and expenses. Earned interest and annual payments, which may be made on a flexible basis, are credited to a policy fund. A charge is then made against the fund to pay the cost of the desired insurance coverage at the current rate for pure insurance. This approach keeps the policy in force, so long as there is sufficient cash value to meet monthly expenses, even if the policy owner skips or stops making payments. Loans, Surrenders and Withdrawals Policy loans are often available in universal life contracts, as they are in any other permanent life policy that builds cash value. Partial withdrawals are another way of obtaining money from the cash value account. In using this procedure, the policyholder incurs a service charge. When partial withdrawals are paid back, the funds are treated as a new premium payment and subject to expense charges.



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A universal life policy may be surrendered for its cash value at the request of the policyholder. However, a surrender charge will normally be assessed for this service.

When and if the cash value drops to zero, the contract coverage will expire after a thirty days’ notice.

3.11.1 Universal Life Death Benefit Options The universal life death benefit may be structured in two ways:

Option A: A Level Death Benefit The policyholder chooses a level death benefit when the policy is taken out, which equals the cash value plus remaining pure insurance (decreasing term plus increasing cash value). The longer the policy is in effect, the greater the proportion of the death benefit that is made up of accumulated cash value. Over the same time period, there is a steady decrease in the pure insurance portion.

If the cash value approaches the death benefit before the policy matures, an additional amount of pure insurance, called a “risk corridor”, is created to offset the increasing cash value. This is because guidelines in the Internal Revenue Code limit the amount of pure risk that can be replaced by accumulated cash value. As there must always be an amount of pure risk included in the universal life policy, when the cash value approaches the face amount, the death benefit must increase, so as to provide the additional amount of risk.

Option B: An Increasing Death Benefit The death benefit equals the sum of the original face amount of pure insurance plus the cash value account (level term plus increasing cash value). The death benefit increases as the cash value increases and provides the policyholder with a type of level term policy plus a savings fund. With this type of policy, it is important to remember, however, that the federal tax code prohibits the cash value of life insurance from being disproportionately larger than the term insurance premium.

Options C: Return of Premium This option is not offered by all insurers. The basis for this option is it pays the death benefit and returns all premiums that were paid to the beneficiary as a result of the insured’s death.

3.12 Variable Life Insurance VARIABLE LIFE Insurance is similar to other forms of whole life, except that the cash value of the policy can grow through equity-based investments chosen by the policyholder. The profits and losses from these investments become part of the policy’s death benefit, causing its value to change with their performance. The value will not, however, fall below a minimum amount. Typical variable fund investments include:

x Stocks & Bonds x Government securities x Money market accounts



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Typically, a separate account holds the assets for a variable life policy. The assets can then be channeled into a number of different investment funds, within the policy, that are called sub-accounts. The policyholder has the ability to move cash value among the different investment vehicles to create an asset allocation strategy.

Death Benefit With most variable life policies, the death benefit can increase or decrease, based on the return on investment. In other words, since the value of the underlying securities can fluctuate, the death benefit will reflect these changes in value. Therefore, if the value of the separate account goes up – so does the death benefit. Conversely, a decline in the death benefit value will follow a drop in investment performance. However, the death benefit will never fall below the guaranteed minimum. There is, however, no guaranteed cash value.

Premiums Traditional variable life insurance policies provide for a fixed premium. New products, such as variable universal life, allow for flexible premiums.

Licensing of Agents Because of the types of investments made by variable life insurance policies, it is considered a security and falls under both state and federal regulations. Both the state insurance departments and the federal Securities and Exchange Commission (SEC) provide these regulations. Agents who sell variable life insurance must have a life agent or life-only agent license as well as a Financial Industry Regulatory Authority (FINRA, formerly National Association of Securities Dealers, NASD) registered representative license or general securities representative license. A prospectus outlining the contract, the investment accounts used and the risk involved must be provided to prospects whenever the agent discusses specific Variable Life Insurance policies. Other marketing materials must have the approval of the agent’s broker/dealer and of the FINRA.

3.12.1 Variable Universal Life VARIABLE UNIVERSAL LIFE (VUL) is a unique type of policy that combines Variable and Universal Life Insurance into a package that offers:

x Flexible premium payments, adjustable death benefits and two death benefit options (universal life).

x Investment options with funds held in separate accounts and investment performance can affect the death benefit (variable life).

The benefits of this type of plan lie in increased policy control and higher income potential.



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3.13 Special Needs Policies In addition to the basic types of policies outlined above, there are numerous “special needs” policies and riders to policies available to fit almost any situation. Several common special needs policies include:

Mortgage Redemption Insurance MORTGAGE REDEMPTION (also called CREDIT LIFE) policies are written as a variation on decreasing term insurance to cover the outstanding balance of a mortgage, loan or other debts if the insured dies before his or her debt is paid off. The face amount of this type of policy decreases as the debt is paid so the protection always equals the amount owed. Family Income Insurance FAMILY INCOME INSURANCE is especially designed for families with young children. This type of policy combines whole life with decreasing term insurance to provide a beneficiary with a monthly income (and the base face amount of the policy if the insured dies) during a specified period of time. Family Maintenance Insurance FAMILY MAINTENANCE is a type of policy, which is similar to the family income policy, except that it combines whole life with level term insurance. This means that, in addition to a monthly income for a specified period of time, the beneficiary may receive the full-face amount of the whole life policy upon death, at any time during the income pay period or at the end of the income period. If the insured dies at the end of a selected period, only the face amount of the policy is paid.

Family Protection Package The FAMILY PROTECTION PACKAGE is a policy that offers coverage for an entire family into one policy. The typical package combines some type of insurance for the breadwinner with term riders for all other members of the family. Unique features of this policy include the fact that:

x Children can convert their term to individual insurance when they reach maturity.

x A spouse covered by a term policy can convert to individual insurance without providing evidence of insurability.

Joint Life JOINT LIFE contracts provide protection for two or more named insured parties. Usually written for two people as whole life rather than term insurance, this type of policy typically pays death benefits when the first insured dies (called a FIRST-TO-DIE policy). When this occurs, the survivor may purchase individual insurance without evidence of insurability. While joint life policies are most popular with two income couples, they are also often used in business situations to guarantee funds to continue a business, provide buy-



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out capital for purchasing a business from an owner or partner’s heirs, or providing cash to cover estate taxes. Premiums for joint life contracts are usually less than premiums for two separate policies, although the underwriting requirements are the same. Last Survivor Life Also called SURVIVORSHIP LIFE or SECOND-TO-DIE insurance. LAST SURVIVOR LIFE is a variation of the joint life policy that:

x Pays upon the second death instead of the first. x Pays to beneficiary of the last to die, rather than beneficiary of the first to

die. x Face value usually more than $1,000,000.

This type of policy is usually used when there could be a large estate tax liability on the death of the second spouse.

Policies Linked to Indexes The face amounts of indexed-linked policies are tied to the Consumer Price Index to help an insured keep up with inflation and an increased cost-of-living. To keep this type of policy current and effective, the policyholder is required to either pay higher premiums every time the death benefit goes up or pay a higher (level) premium over the life of the policy. Juvenile Policies This type of policy is purchased for children and usually provides a small amount of coverage to cover funeral and burial expenses, as well as bereavement time. Another benefit of juvenile protection is that it often includes options for the insured to purchase additional coverage, without evidence of insurability, as his or her needs and age changes. Jumping Juvenile Policy Provides a level death benefit from policy issue to a specified age (usually 21) then “jumps” to an increased benefit level, usually five to ten times the original face amount for the duration of the policy. The premium amount will typically remain the same. Payor Benefit Covers the premium payor on a juvenile policy (usually a parent or grand parent). In the event of death or disability to the payor, the insurer will pay the child’s policy premium to a specified age (usually 21 or 25).

3.13.1 Life Settlement Broker Insurance needs, whether individual or business, often require modifications over time, usually due to shifts in the economic climate. One way to accomplish such changes would be through the use of a life settlement financial transaction, in which the owner of a life insurance policy sells it to a third policy - for an amount



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greater than the cash value offered by the life insurance company but for less than the face value. This allows the owner of the policy to receive a portion of the policy’s death benefit while he/she is still alive.

The entity that buys the policy is called a life settlement provider. In addition, there are life settlement brokers who arrange the sale of the policy. Still considered a rapidly growing multi-billion new market, up until now there has been little or no regulatory oversight in California for these types of agreements. However, effective July 1, 2010, those brokering life settlements must meet the requirements of California Insurance Code sections 10113.2. Specifically:

1. Those brokering life settlements in California must be; A. Life agents, who have been licensed for at least one year and have

complied with the California Department of Insurance’s fee and notification requirements.

B. Life agents for less than one year or applicants that do not have a life agent license must complete 15 hours of continuing education related to life settlements and related transactions. They must also complete an application and pay the life settlement broker license fee prior to operating as a broker.

C. A life settlement broker license is not required for attorneys, CPAs and accredited financial planners representing the policy owner and whose compensation is not paid directly or indirectly by the by the life settlement provider.

2. Providers contracting directly with the policy owner for the purchase of an owner’s life insurance policy must be licensed but not the financing entity providing the capital.

3. Viatical settlement brokers or providers, so licensed as of December 31, 2009, are considered to have complied with the requirements for a life settlement

4. Privacy concerns mandate that the insured’s identity, personal financial information and medical information may not be disclosed unless:

A. The owner and insured have provided prior written consent, or in response to an investigation/examination by the California Insurance Commissioner.

B. It is necessary for the sale of life settlement contracts as investments. It is assumed that the applicable laws governing securities are followed and the owner and insured have provided written consent.

C. It is a condition to the transfer of a settled life insurance policy by one provider to another provider. The receiving provider, in turn, agrees to comply with the Insurance Code’s confidentiality provisions.

D. It is necessary to allow the provider or life settlement broker to make contact for purposes of determining the health status of the insured.



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5. Required Disclosures A. At The Time Of Application all of the following applications all of the

following written (12 point type) disclosures must be made to the owner:

i. Tax Implications: Life settlements may have an impact on an owner’s taxes. Unless the life settlement broker has the appropriate certification to advise owners in such matters, he/she is advised to have the owner seek out advice from a qualified tax expert. It should be noted that the money that is received from a life settlement might be forfeited to creditors, personal representatives, and receivers in state or federal court and/or trustees in bankruptcy court.

ii. There may be a loss of life insurance coverage for the policy owner’s spouse, or other family members, if the policy- or any attached riders- cover their lives.

iii. The amount of premium payable iv. Cash values or dividends that are provided for by the policy v. The policy owner’s ability to receive supplemental social

security income, public assistance and public medical services, such as Medi-Cal, may be affected by the life settlement. These possibilities need to be discussed before execution of the life settlement contract.

vi. There may be a loss of existing rights or benefits, conversion rights, waiver of premium benefits and/or additional or accidental death benefits that exist under the policy. The policy owner should be made aware of this, in order that he/she can review policy benefits with the insurer.

vii. The life settlement documents must reflect the date by which funds will be made available to the policy owner.

viii. At the time of Application, the insurer may offer the policy owner other choices. Most common would be accelerated death benefits, loans or the surrender of the policy for its cash value. In most cases, the life settlement will yield a greater payment.

ix. Policy owners entering into life settlement agreements must be warned that a change in ownership of a settled policy may limit the original owner’s ability to buy additional life insurance, as insurers often limit the amount of coverage they will issue on one life.

B. At The Time of Execution of the Contract i. Health Status: After the policy owner has executed the life

settlement contract, the provider may begin calling to check on his/her health status. Owners who do not want to be contacted may appoint an adult person as the contact. The provider must give the policy owner the name, address and phone number of the person who will be conducting the



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health status review. When the life expectancy is less than one year, health status checks must be limited to once every thirty days and, if the owner is expected to live for more than one year, health status checks are limited to one every three months.

ii. Rescission Rights: The California Code provides the policy owner with the right to rescind the life settlement contract to (a) within 30 days of its execution by all parties and the owner has received all disclosures (b) 15 days from the receipt of the owner of all proceeds of the settlement. To cancel the life settlement contract the policy owner must return all monies paid by the, including any premiums the provider may have paid to keep the policy in force. The provider must then transfer the policy back to the original policy owner.

iii. Provider Disclosures: a. Gross purchase price of the policy b. Dollar amount payable to the policy owner c. Dollar amount to be paid to the life settlement broker d. Detailed provider contact information to the involved

parties iv. Broker Disclosures

a. Provide policy owner with a complete description of all offers, counteroffers, acceptances and rejections

b. Fully describe any affiliation between broker and the provider or entity making an offer on a proposed life settlement contract

c. All data pertinent to the anticipated life expectancy of the insured

6. Fiduciary Responsibilities A. A life settlement broker is someone who, working on behalf of a

policy owner for a fee, commission or other valuable consideration, arranges for a life settlement contact with a life settlement provider. The broker is deemed to only represent the owner and not the life settlement provider or insurer. Accordingly, the life settlement broker is considered to have a fiduciary responsibility towards the policy owner. As part of this fiduciary responsibility, the life settlement broker must:

i. Review the transaction with the policy owner and determine if the proposed contract is a suitable and appropriate transaction.

ii. Use due diligence to ‘shop the policy” in a reasonable attempt to obtain multiple offers

iii. Provide full disclosure of broker compensation.



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3.14 Comparing Costs of Life Insurance The Life Insurance Interest Adjusted Cost Comparison Index and the Traditional Net Cost Method (also called SURRENDER INDICES) provide two distinct ways to measure the relative (not out-of-pocket) cost of similar life insurance policies. The results of this comparison over a two-year period must be presented to prospects during the sales presentation. The LIFE INSURANCE INTEREST ADJUSTED COST COMPARISON INDEX gives prospects a score that helps them see how the proposed policy compares to other policies that provide the same type and amount of coverage. A low index score indicates a lower cost than a higher score. The TRADITIONAL NET COST METHOD calculates the cost of a policy by subtracting the accumulated cash value and dividends from the premiums paid for a specified period of time. The problem with this method is that:

x It assumes the policy has been in effect for the same number of years as the calculation.

x Accumulated cash value and dividends are estimates and could be very different from actual figures.

x The calculation doesn’t consider the time value of money (when the premium was actually paid).

While both of these methods provide a general cost comparison, they do not account for the level and value of service provided or the integrity and strength of the insurer. They are also only valid for cash value life insurance policies. These cost indices should be presented to the proposed policyowner during the illustrations. Since they are only appropriate for comparing very similar policies, however, they won’t be effective when replacing a term policy with whole life, or replacing whole life with term.

NOTE: It is important to always have a buyers guide available to give the prospective client.

LIFE INSURANCE PROVISIONS, EXCLUSIONS AND RIDERS CHAPTER 4


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4 Life Insurance Provisions, Exclusions and Riders 4.1 Legal Aspects of a Contract

All insurance policies are legal contracts. As such, they are subject to the general law of contracts. A CONTRACT is a binding legal agreement that creates an obligation, which courts will enforce.

4.1.1 The Life Insurance Contract The LIFE INSURANCE CONTRACT is owned and controlled by an individual or entity. Unlike property and casualty insurance policies, life insurance contracts are not standardized. Provisions in all life insurance contracts allow the owner flexibility as to his or her:

x Rights x Responsibilities x Limitations

Policy owners must have an insurable interest in the insured life through a blood relationship, marriage or business, in order to enter into a life insurance contract.

4.1.2 Policy Owner Rights When someone other than the insured owns the policy, the contract is called a “third party contract.” In a third party contract, the third party (policy owner) retains “all policy rights” so long as the insured is alive. This means the policy owner has the right to:

x Choose and change the beneficiary. x Select and change the mode of payment x Select the settlement option for payment of death benefits. x Cancel the policy. x Exercise any conversion option to exchange a term policy for a whole life

policy. x Select a non-forfeiture provision if a premium is not paid. x Request a policy loan if there is a cash value. x Select a dividend option (if there is one) and receive dividends. x Assign ownership of the policy to another party.

4.2 Standard Provisions of the Life Insurance Contract The following standard elements are found in all life insurance contracts:

Chapter

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4.2.1 Title Page (face page or data page) The first few pages of every life insurance contract include a TITLE PAGE that summarizes the benefits, coverage and limitations. The title page shows the:

x Type of policy (coverage and annual premium). x Identity of the policy owner and the insured (name, age, gender, etc.). x Term of the policy (effective and termination dates) and premium payment

period. x Optional provisions and riders (premium for each).

4.2.2 Insuring Clause/Consideration Clause Usually part of the title page, the INSURING CLAUSE contains the promise to pay (the consideration on the part of the insurer). It provides a statement from the insurer agreeing that:

x In exchange for a premium and the policy owner’s adherence to the terms of the policy, the company will pay the benefits outlined in the policy.

x The insurer will pay the death benefit to the named beneficiary when provided with proof of death.

4.2.3 Conditions This part of the contract outlines the rights and restrictions for both parties involved in the contract.

4.2.4 Entire Contract/Representations Found at the beginning of the policy, this provision states that the entire contract consists of:

x The policy x Provisions x Clauses x Attachments (applications, riders, etc.)

Collectively, these statements are representations that may be used to contest a claim.

4.2.5 Right of Rescission (Free Look Period)

General A life insurance policy shall contain specific notification that the insured may return the policy to the insurer (or the selling agent) within the time stated in the body of the policy for cancellation, if he or she is not satisfied with the contract for any reason. This time period must be no less than ten (10) days or nor more than thirty (30) days, (20 days if a replacement is involved). Such a delivery by the insured shall void the policy as if it had never been issued and all premiums and fees paid shall be refunded to the insured party. The insurer has 30 days from receipt of the notification to submit full reimbursement to the client.



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The free look period begins when the policy is actually received by the policy owner. Insurers often require the policy owner to sign an “Acknowledgement of Delivery Receipt” at the time of policy delivery. Acceptable Methods of Delivery To start the free look period, insurers must deliver the policy to the policy owner through one of the following methods:

x Personal delivery, with a signed delivery receipt. x First Class mail, with a signed delivery receipt. x Registered or Certified Mail. x Other reasonable means as determined by the Commissioner.

If the insurer or its licensed representative does not use one of these methods, the burden of proof to establish when delivery was made will fall on the insurer. A policy will be considered “received” six months after the date of issuance if the policy owner has paid the premium.

4.2.6 Notice Requirements Being Fulfilled by Mail Any notice required by a provision of the code may be delivered by mailing the notice (postage paid), to the person to be notified at his/her residence or principal place of business in this state. An affidavit stating the facts of the mailing from the person who mailed the notice is proof that the notice has been mailed.

4.2.7 Misstatement of Age or Sex This clause states that if an insured’s age or sex is misstated on an application, the insurer has the right to adjust the policy benefits to reflect the true age or sex.

4.2.8 Medical Examinations and Autopsy This provision (available in some states) gives the insurer the right to conduct a medical examination, as often as reasonably required when a claim is pending, or an autopsy- where not forbidden by law.

4.2.9 Modification This clause states that any contract changes or modifications must be:

x Made in writing. x Approved and signed by an officer of the company. x Attached to or endorsed on the policy. x No agent may amend, alter, change, waive provisions or extend the time

of premium payment on a contract.



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NOTE: This does apply to mutually agreeable changes requested by the policy owner.

4.2.10 Incontestability The INCONTESTABILITY CLAUSE states that a company cannot contest the validity of a policy after it has been in force, except for nonpayment of premiums, for a period of time (two years in California). The clause specifically prohibits the insurer from voiding a contract or using it as a defense against a claim against the policyholder or insured for:

x Benefits x Errors x Concealment x Misstatement x Misrepresentation x Fraud

4.2.11 Assignment of Policy Policy owners may usually transfer or “assign” all or part of a policy to another party. To be binding, the assignment should be completed in writing and filed with the insurer. Assignment gives the new owner (assignee) all the rights of policy ownership (including the right to change the beneficiary).

Assignments may either be ABSOLUTE or CONDITIONAL.

Absolute Assignment The complete and irrevocable transfer of policy rights and “incidents of ownership” to another party. Conditional Assignment Also called “partial” or “collateral assignment,” CONDITIONAL ASSIGNMENT is the transfer of a limited and specified amount of benefits or cash value. This type of assignment is often used as security on a debt held by the policy owner or insured.

4.2.12 Policy Loans Life insurance contracts that have a guaranteed cash value must provide an opportunity for the insured or policy owner to take a loan against the cash value

The following provisions set guidelines for this opportunity:

x Loans may be taken after the policy is in force for a specified period of time (usually three years). There are no credit checks or liens on property because the “equity” or “guaranteed cash value” in the policy is the collateral.

x Interest on the amount of loans is charged at a rate specified in the policy and is payable in advance (if the company makes this stipulation).



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x If interest owed is not paid at the end of a policy year, it is added to the original loan principal. Unpaid interest will continue to compound until the loan is paid off.

x Unpaid interest will not void the policy until it exceeds the cash surrender value of the policy. At this point, the insurer may demand:

x Payment of the total due on the loan plus accumulated interest. x Payment of the accumulated interest. x Payment of current year’s loan interest. If payment is not made, the

insurer may void the contract with 30 days written notice. x Before approving a policy loan, an insurer may require payment of unpaid

policy premiums and advance interest on the new and any existing policy loans to the end of the current year.

x Insurers may defer a request for a loan for up to six months, unless the loan is being used to pay premiums due.

x If the insured dies with an outstanding loan balance, the amount is deducted from the death benefit.

4.2.13 Grace Period Once the initial premium has been paid and the policy is in force, there is a period of time after the due date of subsequent premiums (usually 31 days) when the insurance remains in force even if the premium has not been paid. If death occurs during the GRACE PERIOD, the death benefit is paid, but minus the premium due.

4.2.14 Policy Cancellation California law requires that any life insurance policy or annuity contract, including long-term care and Medicare supplement insurance, issued to a person 60 years of age or older must include a written notice and RIGHT-OF-RETURN statement, offering policy cancellation and full refund of paid premiums at any time during the first 30 days after policy issuance. Policy owners under 60 years of age, have a 10-day cancellation period starting from their receipt of the policy.

4.3 Premiums A PREMIUM is the money paid to an insurer for insurance coverage. The first premium payment is part of the consideration on the part of the policyowner. Most insurers offer the following options:

x Annual payments. x Semi-annual payments. x Quarterly payments. x Monthly payments by mail or through pre-authorized checks that are

automatically debited from the policy owner’s checking account.

MODE OF PAYMENT refers to the frequency of premium payments in each year. Premiums may be paid on an annual, semi-annual, quarterly or monthly basis.



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NOTE: If a premium is paid by any other mode other than annual, typically there is a surcharge; therefore a monthly premium may be higher due to the added surcharge.

Example if Mr. Smith’s annual premium for his life policy is $550.00 and his financial status has changed. He can request a monthly premium but, his premium would not be $45.83 it would be $50.83, this would include a $5.00 per month surcharge.

4.3.1 Unearned Premium Unearned premium is that portion of an advance premium that has not yet been used up for the coverage written. Conversely, earned premium is that portion of an advance premium that expires with the passage of time. When an insurer makes changes to a policy that result in unearned premium, the insurer must refund that premium to the insured according to the following schedule: 25 days For unearned premium created when an insurer endorses, rejects,

declines cancels or surrenders a policy. 15 days If the unearned premium is sent to the agent of record, the agent

must pay interest if the premium is kept after 15 days, unless the insurer is in liquidation or under a conservator.

120 days After policy coverage ends due to cancellation.

If unearned premium is not assigned as security to a premium finance company or is less than $25, it may be applied to policy renewal or other premiums due, so long as written notice is given to the insured within 30 days. If the amount of unearned premium is less than five dollars, no written notice is required. The insured may request a refund of the unearned premium in writing.

Example If in January Mr. Wallace paid the annual premium in full, and now has

requested cancellation of the policy in March of the same year, those first 3 months of the year are considered earned premium. The remaining 9 months of pre paid premium would be unearned premium, and subject to refund to Mr. Wallace.

4.3.2 Lapse & Reinstatement When a premium is not paid by the end of the Grace Period, coverage will end and the policy will LAPSE. The same policy may be REINSTATED during a specific period of time (usually three years) if the policy owner:

x Submits an application for reinstatement. x Proves insurability. x Pays past due premiums plus interest. x Repays any policy loans that were outstanding when the policy lapsed.

The primary benefit of reinstating a lapsed policy, rather than purchasing a new one, is that the premiums stay the same.



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Lapse and reinstatement should not be confused with nonrenewal and renewal of a policy. A lapse may occur because of nonrenewal, but nonrenewal is typically a choice that is made not to continue the policy. Renewal, on the other hand, is dissimilar from reinstatement in that there is no lapse in coverage and insurability need not be proven.

4.3.3 Illustrations In order to protect consumers, it is the intent of the Department of Insurance to establish regulatory standards for illustrations and disclosures as used by insurance companies. The basic rules are as follows:

x Insurers shall notify the Commissioner of any policy forms using illustrations.

x A policy form identified by the insurer as one marketed with illustrations must be so presented to the individual or group that is the subject of the marketing effort.

An approved application should include:

x Name of insurer x Name and business address of producer x Name, age and sex of proposed insured, unless it is an approved

composite illustration x Underwriting or rating classification x Generic name of policy x Death benefit x Dividend option

The insurer and his/her agents shall not:

x Represent the policy as anything other than a life insurance policy. x Use non-guaranteed elements in a misleading manner. x State that the payment of a non-guaranteed element is guaranteed. x Use an illustration that is not in compliance. x Use an illustration that depicts policy performance in a more favorable way

than is produced by the insurer whose policy is being illustrated. x Provide an incomplete illustration. x Represent that policy payments will not be required for each policy year in

order to maintain the illustrated death benefits- unless that is a fact! x Use the term vanishing premium to imply that premiums are paid up, to

describe a plan that uses non-guaranteed elements to pay a portion of future premiums.

x Use an illustration that is not “self-supporting or lapse-supported” Interest rates used to determine illustrated non-guaranteed elements shall not be greater than the earned interest rates.

A basic illustration shall show the date on which it was prepared, have numbered pages and, if the age of the proposed insured is shown – it shall be issue age



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plus the number of years the policy is assumed to be in force. Where applicable, the illustration should show premium outlay, guaranteed death benefits and values available upon surrender. Guaranteed elements should be specifically referred to before corresponding non-guaranteed elements. . The illustration should also show value available upon surrender, policy benefits, riders or options, and definitions of column headings. If an insurer or agent uses a basic illustration and the policy is applied for as illustrated, a copy of that illustration shall be signed and submitted to the insurer at the time of the policy application.

4.4 Beneficiary In life insurance, the BENEFICIARY is the person, or persons, who receive benefits upon the death of an insured. The beneficiary may be:

x An individual x Business or business partner x Trusts x Estate of the Insured x Charity, non-profit organizations or institution

In a life insurance contract, beneficiaries are usually identified as one of the following:

4.4.1 Primary Beneficiary Any person(s), organization(s) or estate entitled to policy benefits upon the death of the insured (must be living, competent and willing).

Revocable Beneficiary A named beneficiary, who the insured or policy owner may change without his or her consent. (This option is subject to community property laws.).

Irrevocable Beneficiary This designation gives the insured or policy owner no power to change the beneficiary, appoint further beneficiaries, assign the policy or borrow against the loan value of the policy without the consent of the beneficiary. The insured or policy owner still remains the policyholder, is entitled to dividends and may select or change the contract’s settlement options. Joint and Survivor Beneficiary Entitles two or more people or organizations to jointly share as beneficiaries of a single policy. May be concurrent or subsequent; the policy must clearly state the amount of benefits each beneficiary will receive.

Class Beneficiary Designation (s)

Irrevocable beneficiaries have a “vested interest” in the policy. Therefore, the policy owner cannot exercise his or her rights of ownership without the beneficiary’s consent.



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This type of classification is used when children or another specific group are to share benefits equally. The most common class designations commonly used for children are:

Per Capita Benefits are paid equally to all surviving individuals. If one or more of the named beneficiaries has died, the benefits are equally divided between the survivors. Per Stirpes Benefits are paid “in line” If the first person who was to receive benefits has died, a child, grandchild or great-grandchild moves up to take his or her place.

4.4.2 Contingent (Secondary) Beneficiary The person(s), organization(s) or estate entitled to:

x Benefits, if the primary beneficiary dies before the insured. x Receive unpaid amounts of the Death Benefit if the insured or policy

owner elected this type of settlement option. x Benefits, if the primary beneficiary cannot qualify for a reason other than

death.

Tertiary Beneficiary The person(s), organization(s) or estate that is third in line to receive benefits after the primary and contingent beneficiary.

4.4.3 Naming and Changing Beneficiaries There are two methods for naming and changing beneficiaries:

Filing (recording) The name or change must be filed with the insurer, in writing, and recorded in the policy. Filing becomes effective when the insured or policy owner signs it. Endorsement This method requires the insured or policy owner to type or attach a beneficiary change to the policy. The policy and a written request for the change must be submitted to the company.



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The wording used to designate a beneficiary must be specific. Standard wording for common types of beneficiaries is outlined on the following page:

TABLE 4.4.3: Standard Wording for Common Types of Beneficiaries

4.4.4 Creditors’ Rights When an insured dies, the contractual relationship between the policy owner and insurer shifts to a relationship between the beneficiary and insurer. This gives the beneficiary the right to sue the insurer if the death benefits are not paid upon presentation of a death certificate. The policy owner’s creditors have no right to any portion of the funds, but the beneficiary does have a right to benefits.

Spendthrift Clause This clause prevents a beneficiary from selling or borrowing against his or her rights to benefits before the death of the insured. It also protects the benefits against claims from the beneficiary’s creditors, so long as the

BENEFICIARY STANDARD WORDING Estate My Estate One beneficiary Jane Doe, wife Two beneficiaries John Doe, father, Ellen Doe, mother, equally or to the survivor

Three or more beneficiaries

John Doe, father, and Ellen Doe, mother, and Bob Doe, son, equally or to the survivor

One beneficiary and one contingent beneficiary

Jane Doe, wife, if living, otherwise Bob Doe, son

One beneficiary and two contingent beneficiaries

Jane Doe, wife, if living, otherwise Bob Doe, son, and Ann Doe, daughter, equally or to the survivor

One beneficiary and three or more contingent beneficiaries

Jane Doe, wife, if living, otherwise Bob Doe, Ann Doe and Andy Doe, children, equally or to the survivors or survivor

Two beneficiaries and one contingent beneficiary

John Doe, father, and Ellen Doe, mother, equally, or to the survivor, or if neither survive, Jane Doe, wife

Two beneficiaries in unequal portions

Three-quarters (¾) of the proceeds to John Doe, father, if living, and one quarter (¼) to Ann Doe, mother, if living, the share of a deceased beneficiary to be paid to the survivor, if any

Trust with individual trustees (for living trusts only)

Larry Doe and Joe Williams, trustees or a successor in trust under (Trust name) established (date of trust agreement)

Trust with corporate trustees (for living trusts only)

ABC Bank & Trust Company, Reading, Pennsylvania, trustee or successor in trust under (Trust name) established (date of trust agreement)

Testamentary trust Trustee of the trust created in the last Will and Testament of the insured, as admitted to probate, but if for any reason The Company is not furnished within ___ days of the death of the insured evidence of the qualifications of such trustee or if said trustee disclaims all right to receive payment, payment shall be made to the policy owner, if living, otherwise to the estate of the policy owner, and such payment in lieu of payment to the said company _______



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insurer holds the funds. After benefits are paid to the beneficiary, creditors can file suit to attach those proceeds.

NOTE: This clause does not apply if the beneficiary is the insured’s estate.

4.4.5 Common Disaster Clause This clause, also called the “Short-term Survivor Clause” or “Survivorship Clause,” protects contingent beneficiaries by presuming that the insured was the last person to die when the insured and primary beneficiary are killed in a common disaster and the order of death cannot be determined. This is an important without this clause the proceeds from the life policy would be paid to the insured’s estate.

4.4.6 Automatic Premium Loan (APL) An APL provision is usually included in cash value policies. It stipulates that when a premium remains unpaid by the end of the grace period, and there is sufficient cash value in the policy to cover the amount, the insurer may withdraw the premium. This amount is a loan against the policy and interest will be charged at the stated amount. If repayment is not made, the loan will accumulate interest until the cash value is gone. At this point, the policy will be voided under the provisions as in policy loans.

4.5 Non-Forfeiture NON-FORFEITURE provisions protect insured individuals from having to forfeit (lose) the cash value of a policy for nonpayment of premiums when the policy has been in force and paid for a certain period of time. The non-forfeiture provision is selected at the time of the application. If no option is selected at the time of the application, the default option is extended term.

Note: Non-forfeiture options are only available on cash value insurance policies. Term insurance has no cash value, thus no non-forfeiture provision.

Cash Surrender Value CASH SURRENDER VALUE is a portion of the excess premiums paid above the mortality costs of a policy. The contract must state that the insurer will pay cash surrender value rather than paid up forfeiture benefits:

x If there is nonpayment after the policy has been in effect for a period of time (usually three years).

x On the written request of the policy owner. x Payment of a cash surrender value will terminate the policy.

Extended Term Insurance If the insured has not selected another non-forfeiture provision and has no outstanding policy loans, the death benefit stays the same. The cash value of the policy is used to purchase single premium term insurance to extend coverage as long as possible. When the term insurance runs out, the policy is terminated.



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Reduced Paid-up Insurance This option reduces the amount of paid-up insurance from the original amount to an amount equal to what the existing cash value of the policy can purchase. This reduced face amount will be in force for the insured’s life or to maturity at age 100. With this option, no further payments are needed to keep the policy in effect. Table of Guaranteed Values The following table must be included in all life insurance policies issued in California. It shows the guaranteed cash surrender and/or loan values, non-forfeiture values, extended term time limits and reduced paid-up insurance amounts for the life of a contract. Any of these options may be used instead of surrendering a policy for its cash value.

TABLE 4.5 Sample Table of Guaranteed & Non-Forfeiture Values

Issue Age: 38 Face Amt: $100,000 12 Mo. Premium: $1,500 End of Policy

Year Guar. Cash Surrender or Loan

Value Reduced Paid-up

Insurance Extended Term

Insurance Years Days

1 $ - $ - 0 0 2 $ - $ - 0 0 3 $725 $ 3,730 3 192 4 $1,745 $9720 7 3 5 $2957 $14,622 9 247 6 $3,950 $19,850 12 216 7 $5,447 $25,266 14 60 8 $6,020 $29,217 15 211 9 $7,713 $32,364 16 303 10 $9,041 $36,444 16 352 11 $10,222 $41,007 17 127 12 $11,631 $44,982 17 317 13 $12,900 $47,830 18 77 14 $14,222 $51,525 18 162 15 $15,937 $53,210 18 212 16 $17,243 $56,833 18 299 17 $18,664 $60,342 18 310 18 $20,131 $62,492 18 332 19 $22,741 $65,412 18 352 20 $24,877 $67,621 18 360 25 $33,224 $76,831 19 29

27 (age 65) $35,221 $78,352 16 88 30 $44,681 $83,677 15 108 35 $52,966 $92,782 13 52

62 (age 100) $100,000 $ - 0 0

4.6 Settlement Options The payment of death benefits can be structured in a number of different ways or “settlement options.” In all cases, funds must be accessible to the beneficiary within 30 days of the insured’s death or interest must be paid. The following settlement options are commonly used to pay life insurance benefits:



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Lump Sum A single cash payment to the beneficiary(s). This is the way most policies are paid if no other option of settlement has been selected. Interest Only A specific rate of interest, as stated in the policy, is paid to the beneficiary at regular intervals while the proceeds are retained by the company and released to the beneficiary or a designated third party at a later date. A minimum rate of interest is guaranteed but payments could be higher.

A policy owner who selects this option may request that:

x Interest only status remains for a specified period of time; then remainder is paid in cash or according to another settlement option.

x Principal is paid to a contingent beneficiary or estate on the death of the beneficiary.

x Withdrawal or another settlement option may be selected at any time.

Fixed Period/Period Certain Installments Also known as “time option” or “installment certain,” this option pays benefits for an elected period of months or years. Payments are designed to eliminate the principal and interest at the end of that period. If the primary beneficiary dies, payments are made to a contingent beneficiary so long as they last. Fixed Amount/Amount Certain Installments Also known as “amount option” or “principal and interest to exhaustion,” this option pays benefits of a specified amount for as long as the payments last. (Payments eliminate the principal and interest at the end of that period.) If the primary beneficiary dies, payments are made to a contingent beneficiary so long as they last. Life Income Also called “straight life” or “pure life” income, this option provides a guaranteed monthly, quarterly, semi-annual or annual payment so long as the beneficiary lives. Benefits are calculated on the beneficiary’s life expectancy at the time payments begin. A disadvantage of this option is that if the beneficiary dies, no refunds or further payments will be made. However, as long as the beneficiary lives, this option will provide the most income.

Cash/Installment Refund Option If the primary beneficiary dies without receiving payments equal to at least the original amount of benefits, payments of the balance due will continue to a second beneficiary. Payments made in a lump sum are called a “cash refund.” Payments made in installments are called “installment refund.”



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Joint and Survivor Option Married couples that use the income for retirement most often select this option as it provides guaranteed life income for two persons. Upon the death of the first, payments continue to the second. Payments are made in installments and the amount is based on the life expectancy of both beneficiaries. Payments may be equal for both recipients or provide a reduced benefit to the last survivor. This approach gives larger payments while both beneficiaries are living because the insurer needs not set as much aside for payments to the last survivor.

Joint Life Settlement This little used option that provides income for two persons until one of them dies, is most often used when there is another source of income that will not begin payments until the first person dies.

4.7 Policy Dividends

Dividends Unlike corporate or stock dividends, life insurance policy dividends are considered “a return of excess premium paid” and are not taxable in the year they are declared. A mutual insurer will issue dividends, typically annually, after they have determined the earned surplus for the company that year. The earned surplus will be divided among the participating policy owners. Exception When the dividend accumulates interest, the interest is taxable (not the dividend). The policy owner may select any of five dividend options: One-Year Term Insurance The dividend is used to purchase term insurance equal to the amount the dividend will purchase. This option is often used when there is a loan against the policy. (In the event of death, the unpaid loan balance plus outstanding interest will be deducted.) Cash A check is sent for the full amount of dividend due. Reduced Premiums Dividends are credited to the policy to offset premiums due.



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Accumulate At Interest The insurer keeps the dividend and pays a specified interest rate that is compounded annually. The insured may withdraw accumulated interest without affecting policy cash values. Interest credited under this option is taxable. Paid Up Additional Insurance The policyholder purchases small amounts of additional insurance using the dividend as a single premium. This option is not usually available with term policies.

4.7.1 Other Options Many insurers have their own dividend options for specific products. In all cases, the actual dividend depends on mortality, interest and expense statistics. If a specific option is not requested, in writing, by the policyholder, the policy will state an option.

NOTE: The following chart provides a comparison of the attributes of non-forfeiture, dividend and settlement options.

Table 4.7.1: Non-forfeiture, Dividend, and Settlement Options

Non-Forfeiture Dividend Settlement Cash Surrender Extended Term - The death benefit remains the same. (most insurance) Reduced Paid-up The death benefit is reduced (longest time)

One Year Term Cash Reduce Premium Accumulate Interest Paid up Additions Mutual Companies

x Participating Policies

x Not Taxable x Refund on Excess

Premium x Cannot be

Guaranteed

Interest Only Fixed Period Fixed Amount Life Options x Straight or Pure Life

(Most Money) x Life With Period

Certain (Whichever is Longer)

x Refund Life (equal) x Lump Sum x Periodic Payment x Joint & Survivor Life

(continues) x Joint Life (stops)

NOTE: It is the duty of the agent and the insurer to inform prospects that dividends are not guaranteed.

4.8 Policy Restrictions & Exclusions Every life insurance policy lists certain risks, either in the policy body or in the attached riders. These risks are not covered because they are considered unusually high or outside the scope of the policy. The most common RESTRICTIONS, or EXCLUSIONS, are the:



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Suicide Provision If the insured commits suicide within two years after the policy is first issued, the insurer is only liable for premiums paid. Aviation Restriction If the insured dies in an airline accident and is serving in any capacity other than that of an airline passenger, the insurer is only liable for premiums paid. War Exclusion If the insured is killed while at war or in the military, the insurer will be liable for either paid premiums or the cash value of the policy, whichever is greater. Hazardous Occupation If the insured is involved in a hazardous occupation, he or she may not be covered. Participation in Hazardous Sports or Hobbies If the insured is involved in a hazardous sport or hobby, he or she may not be covered.

NOTE: Paying an additional premium may sometimes cover insured individuals who are involved in hazardous occupations or sports.

4.9 Optional Provisions and Riders In addition to the various types of life coverage, the following special riders and clauses help protect policyholders and add benefits to cover their unique needs: Waiver of Premium/Waiver of Monthly Deduction Premium is waived if the insured is disabled. Most insurers require a total and permanent disability. The disability must usually have continued for six months, after which the insurer will return the premiums paid during the six month waiting period. Disability Income Insurance that provides payments to replace income when an insured is unable to work because of sickness or injury. Accidental Death Provides payment if death is caused by an accident. (Payment is usually double the face amount). Cost Of Living A rider that increases insurance coverage to keep up with inflation. Living Need Provides access to a portion of the Death Benefit if the insured becomes terminally ill.



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Viatical A contract under which a terminally ill person assigns or transfers ownership or otherwise designates all control of a policy to a company that buys Death Benefits at a discount. A Viatical settlement is an absolute assignment. Amendments are being made to the Viatical Act to regulate Stranger-Originated Life Insurance (STOLI) which are arrangements that attempt to circumvent state insurable interest laws. Policies are taken out by strangers and unscrupulous investment firms for their investment purposes, even though they have no insurable interest. The insurance community is pursuing efforts to regulate these contrived transactions.

Guaranteed Insurability This option allows the insured party to buy additional coverage to a specified amount and at prescribed future intervals without proof of insurability. Even if the insured does not exercise one of several options, there is usually a no-lapse option of guaranteed coverage. No- Lapse Guaranteed insurance There is no required payment schedule in Universal Life Insurance, which creates a risk that such policies will lapse because it is difficult to know how much money is required to keep them in force. The no-lapse rider imposes a payment schedule onto the basic universal life policy requiring that certain payments are required and it is these payments that keep the policy from lapsing. Guarantees coverage for a period of time, as set forth in the contract. During that period of time, the insurer has no right to make any change in any provision of the contract other than a change in the premium rate for all insureds in the same class. Long Term Care Rider Option that provides a limited long-term care benefits to the insured Annuity Rider Riders are designed to add value to an annuity contract. Over the last decade, carriers have developed a variety of riders to make annuities more appealing to consumers. It is sometimes said that annuities are the opposite of life insurance. While life insurance creates an immediate estate in the event of premature death, annuities protect against the risk of outliving one’s income. Adding a life insurance rider to an annuity contract might appear to be an illusory benefit, but it is not. There are those professionals who believe an annuity is a ticking tax time bomb and here is why. During the accumulation phase of an annuity, gains are tax-deferred. But at death, beneficiaries are required to deal with the tax liability. In non-qualified annuities, annuity gains are treated as income to the beneficiary and subject to income tax. Hence, a ticking tax time bomb. Life insurance riders were designed by insurance companies to help beneficiaries offset the income tax due on annuity gains. They are especially suitable for seniors who purchase annuities with no



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intent to access the funds, but want the proceeds disbursed to children and grandchildren upon their death. The life insurance rider consists of non-medically underwritten term insurance equal to a percentage of the annuity’s gain, typically 28%. Upon death, the rider pays an additional 28% on the gain crated in the contract during the accumulation phase. Return of Premium Rider This is a popular rider. It allows the insured/policy owner to actually receive the return of their premium that was paid. The insurer invest the premiums over the term of the contract to guarantee that a full refund of premium will be paid in a stated number of years usually 20 or 30 years. The downside to this type of policy is the premium is higher than a non return of premium policy. Something to consider when factoring the prospective clients ability to pay.

ANNUITIES, REPLACEMENT AND TAXATION CHAPTER 5


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5 Annuities, Replacement and Taxation 5.1 Annuities

ANNUITIES provide protection against living too long and outliving ones income. This has become a very real concern as more and more Americans are living long past retirement age and outliving their financial resources. An ANNUITY is a tax deferred savings contract issued by life insurance companies that provides payments to an annuity holder (the annuitant) that begin at a specific date or age. Unlike other life insurance programs that actually create an estate, annuities liquidate the estate by providing an income that can be guaranteed for the annuitant’s life. The annuitant is not always the policyowner, just as in life insurance when the insured is not necessarily the policyowner. Annuities also name a beneficiary in the event that the annuitant does not survive to collect benefits. For the investor, annuities provide a wide range of risk tolerances – fixed interest; equity- based with principal guarantee and full variable annuity products.

Individual Annuities The amount and number of annuity payments are decided by the:

x Age of the annuitant x Gender of the annuitant x Amount of money to be “liquidated” x Rate of return

Younger annuitants will receive smaller checks over a longer period of time, while older annuitants will receive larger checks over a shorter period of time.

Group Annuities

Differ from individual annuities in that the annuity payments are based on: x The life expectancy of the individuals comprising the group. x The length of the period for which payments are guaranteed. x Time elapsing before payments start. x Number of lives on which payments are continued. x Assumed interest rate.

Chapter

5



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Annuity returns are based the annuity tables, by the class of the individual insured. The concept is identical to that of the mortality tables. A life insurance premium will be lower for younger, healthier women because they are likely to live longer. Therefore, annuity payments for younger, healthier women will also be lower, for the same reason. Payments from an annuity account are comprised of principal and interest and are partially taxable. The formula to determine the taxable amount will be discussed under Taxation of Premium and Proceeds.

5.1.1 Classes of Annuity Contracts Annuities are classified in several different ways –by number of lives covered, by method of premium payment, the benefit period and investment security. However, one contract could fall into more than one class.

5.1.2 Number of Lives Covered Individual annuity – One life Joint and survivor annuity – Two or more lives

5.1.3 Method of Premium Payment & When Benefits Begin There are four basic types of annuity premium payment schedules: Single Premium Deferred Annuity (SPDA) A single lump sum premium deposit is made, with payout deferred (on a tax deferred basis) until a future date, usually over twelve months away. Flexible (Installment) Premium Deferred Annuity (FPDA) An initial deposit is made, followed by numerous flexible premium payments with deferred payout. The accumulated cash grows on a tax-deferred basis. Single Premium Immediate Annuity (SPIA) One lump sum payment and periodic paybacks begin for a certain number of years or until the occurrence of a specific event, such as the annuitant’s death. Level Premium Deferred Annuity Equal premium amounts at regular intervals, until the date scheduled for benefit payouts. The cash is accumulated tax-deferred. Other classification types include:

5.1.4 Temporary Life Annuities These contracts are similar to other annuities except that payments are made only for a specified time. Their purpose is usually to provide an income for a short time until another source of income (retirement, social security, etc.) becomes available. If the annuitant dies prior to the end of the specified time, the annuity also ends.



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5.1.5 Retirement Annuities Retirement annuities are deferred contracts that combine an annuity with a decreasing term life insurance rider to provide a double benefit (a death benefit plus any accrued annuity value). Both benefits are paid if the annuitant dies before reaching retirement age, but the term policy is terminated if the annuitant reaches retirement age.

5.1.6 Market Value Adjustment Annuity (MVA) Increases or decreases the accumulation value of the annuity if more than the penalty- free amount is withdrawn or the contract is surrendered in the surrender charge period. At withdrawal, if interest rates are higher, the accumulated value will be adjusted downward and, if lower rates prevail, the accumulation value will be adjusted upward.

5.1.7 Equity Indexed Annuity (EIA) A fixed annuity variation that earns interest linked to an external equity index, such as Standard and Poor’s Composite Stock Price Index.

5.1.8 Disposition of Annuity Proceeds (Settlement Options) Pure or Straight Life Annuity This method guarantees income for life, no matter how long or short a time he or she lives. While the annuitant could live a long time, there is no refund provision, so payments end when the individual dies. If there is still money in the account, it is retained by the insurance company and neither the spouse or heirs receive further distributions. However, if the annuitant payments exhaust the account balance, the insurance company will continue making regular payments until the death of the annuity holder. Life Annuity with Amount Certain Also called GUARANTEED MINIMUM ANNUITY, this option guarantees payout of a specified amount of money or number of payments that will be paid whether the annuitant is alive or dead. In this and other types of annuities, the annuity owner (contract purchaser) names a beneficiary, who receives the money upon the death of the annuity contract owner or annuitant. The annuitant selects the amount of each payment and payout will continue until the balance of the annuity is exhausted.

Annuity with Period Certain The annuitant is entitled to choose a specific length of time for the distribution of the income payments. It is guaranteed to pay a minimum number of months either to the annuitants or beneficiary. A shorter contract period will result in higher monthly income payments. Once the contract period has run its course, the account balance will be at zero.



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Refund Life Annuity As with a straight life annuity, this option entitles the annuitant to receive income for the rest of his/her life. It also guarantees that, if the annuitant dies before receiving payments equivalent to the premiums paid into the account, the annuitant’s designated beneficiary will receive a refund that is at least equal to the purchase price of the annuity or the difference between the purchase price and the amount that has been received at the time of the annuitant’s death. The refund may be taken in installments (installment refund annuity) or as a lump sum (cash refund annuity).

Joint and Joint-Survivor Life A joint life annuity provides a benefit that continues through the joint life of two people but terminates at the first death. A joint/survivor annuity guarantees life income for two persons. Upon the death of the first, payments continue to the second. Payments are made in installments and the amount is based on the life expectancy of both beneficiaries. Payments may be equal for both recipients (joint and survivor) or provide a reduced benefit to the last survivor (joint and one-half; joint and two-thirds). The second approach gives larger payments while both beneficiaries are living because the insurer needs not set as much aside for payments to the last survivor.

5.1.8.1 Payout of Benefits Payment of annuity benefits can be either “fixed” or “variable.” With a fixed payout, the recipient knows exactly how much payment will be received. The disadvantage of this form of payment is that, if the annuitant lives a long time, the payments may not enable him or her to keep up with inflation. Payouts from a variable annuity are based on equity investments and tied to the performance of the stock market. While this product does not provide a guaranteed amount of money like the fixed annuity, it does move with inflation. This can help the annuitant keep up with inflation. If the annuity holder decides not to keep an annuity contract or chooses to take a partial withdrawal, there may surrender charges assessed by the insurer. Typically, if the annuity owner holds the contract for a number of years, there is a gradual elimination of surrender charges.

5.1.9 Variable Annuities VARIABLE ANNUITIES are designed to help protect annuitants against inflation by investing deposited funds into equity-based securities. There are several important differences between a variable and fixed annuity:

x The fixed annuity guarantees a certain amount of money to be paid, while the variable annuity does not.

Married couples that use the income for retirement most often select this option



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x Insurers invest variable annuity premiums into a separate account, instead of the general account used for fixed annuities.

x Instead of a fixed payment, the variable account will fluctuate during both the accumulation period (pay-in) and the annuity period (pay-out).

In a variable annuity, premiums are used (after expenses) to purchase “accumulation units” that are based on the amount being contributed to the annuity. At any given time, the value of the accumulation units is determined by the value of the annuities investment portfolio. When the annuitant retires or requests payment, the total number of accumulated units is converted to “annuity units” (or retirement units) that are valued each month to determine the amount of payment. This approach makes the value of the annuity units change from month to month; however, the number of units remains constant. Like fixed annuities, variables can feature:

x Single or flexible premium. x Immediate or deferred payout. x Individual or joint contracts.

Because variable annuities invest in securities, they are regulated, at the federal level, by the SEC and by various agencies at the state level. Those who sell variable annuities must be licensed as both a life agent and a FINRA (formerly NASD) registered securities representative. Like variable life, variable annuities are often used as a hedge against inflation.

5.1.10 Life Insurance and Annuity Contracts

Presentation of Non-Guaranteed Values Illustrations to Seniors Every insurer and agent offering individual life or annuity contracts to senior citizens, with either pre-printed or non-preprinted illustrations that contain non-guaranteed values, shall disclose on those illustrations the following statement:

“THIS IS AN ILLUSTRATION ONLY. AN ILLUSTRATION IS NOT INTENDED TO PREDICT ACTUAL PERFORMANCE. INTEREST RATES, DIVIDENDS, OR VALUES THAT ARE SET FORTH IN THE ILLUSTRATION ARE NOT GUARANTEED, EXCEPT FOR THOSE ITEMS CLEARLY LABELED AS GUARANTEED.”

This statement must always be presented in such a matter as to be more prominent than the surrounding material (boldface type, different color, underlined, etc.).



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All preprinted illustrations shall contain this notice in 12-point bold print, with at least one-half inch space on all four sides, as part of the document itself or as an attached coversheet. Annuity Recommendations to Senior Consumers The relevant information, which the agent should obtain when presenting an annuity product to a senior consumer, should always include:

1. Occupation and occupational status 2. Marital status 3. Age 4. Number and type of dependents 5. Sources of income 6. Yearly income 7. Consumer’s existing insurance(s) 8. Consumer’s needs and objectives 9. The cost to the consumer and the consumer’s ability to pay for the

proposed transaction or transactions. 10. Source of funds to pay premiums 11. Investment savings 12. Liquid net worth 13. Tax status 14. Need for tax advantages 15. Investment experience of the consumer 16. Consumer concern for preservation of principle 17. Product time horizon 18. Consumer’s awareness of liquidity limitations or surrender charges

The NAIC has identified four criteria that should be evaluated prior to making an annuity recommendation to a senior (60 years or older). This is to ensure that the insurance needs and financial objectives of seniors are appropriately addressed during the presentation.

x The senior’s financial status x The senior’s tax status x The senior’s investment objectives x Other information which may be a consideration regarding the purchase

5.2 Pretext Interviews Some agents, brokers or others who transact insurance resort to acts called PRETEXT INTERVIEWS to gain confidential information about prospects or clients. When conducting a pretext interview, someone attempts to get information by:

x Pretending to be someone they are not x Pretending to be someone other than the person or company they are

representing x Misrepresenting the purpose of the interview x Refusing to identify themselves



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Pretext interviews are illegal, except when an insurer is conducting a claim investigation for suspected criminal activity, fraud, misrepresentation or nondisclosure. They are particularly heinous when used to solicit appointments and sales of inappropriate products to the senior market. Sales to Seniors Any life insurance policy or annuity contract issued to a person 60 years of age or older must include a written notice and “right-of-return” statement, offering policy cancellation and full refund of premiums paid (or the contract account value for variable life and annuities) any time during the first 30 days after policy issuance. During this 30-day period, the premium for a variable annuity must be invested only in fixed-income investments and money market funds unless the client specifically directs that the funds be invested in the mutual funds underlying the variable annuity product. In the latter case, the cancellation shall entitle the policyholder to the refund of the account value.

Disclosures This is a code requirement for insurers. Every individual life insurance policy and annuity contract (other than variable contracts) shall have the following notice, in 12-point bold print, with one inch of space on all sides, prominently displayed on the cover sheet or jacket.

NOTE: Disclosures in the text are shown with 12 point bold print as they are in actual policies.

IMPORTANT

YOU HAVE PURCHASED A LIFE INSURANCE POLICY OR ANNUITY CONTRACT. CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT FOR A FULL REFUND BY RETURNING IT TO THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY. AFTER 30 DAYS, CANCELLATION MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE.

Every individual variable annuity or variable life insurance contract, shall display the following disclosure in 12-point bold print, with one inch of space on all sides, prominently displayed on the cover sheet or jacket.

IMPORTANT

YOU HAVE PURCHASED A VARIABLE ANNUITY CONTRACT (VARIABLE LIFE INSURANCE CONTRACT OR MODIFIED GUARANTEED CONTRACT). CAREFULLY REVIEW IT FOR LIMITATIONS.



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THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT. DURING THAT 30-DAY PERIOD, YOUR MONEY WILL BE PLACED IN A FIXED ACCOUNT OR MONEY–MARKET FUND, UNLESS YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO UNDERLYING THE CONTRACT DURING THE 30-DAY PERIOD. IF YOU DO NOT DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO, AND IF YOU RETURN THE POLICY IN THE 30-DAY PERIOD, YOU WILL BE ENTITILED TO A REFUND OF THE PREMIUM AND POLICY FEES. IF YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO DURING THE 30-DAY PERIOD, AND IF YOU RETURN THE POLICY DURING THAT PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE POLICY’S ACCOUNT VALUE ON THE DAY THE POLICY IS RECEIVED BY THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY, WHICH COULD BE LESS THAN THE PREMIUM YOU PAID FOR THE POLICY. A RETURN OF THE POLICY AFTER 30 DAYS MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE.

NOTE: The 30-day Free Look Period also applies to Long-term Care and Medicare Supplement Policies

5.3 Policy Replacement, Individual Life and Annuity POLICY REPLACEMENT is a transaction in which an insurer proposes a new life insurance policy or annuity because an existing life insurance or annuity will be:

x Lapsed, forfeited or terminated x Converted to other insurance (reduced paid up, extended term, etc.) x Amended to reduce the benefits or terms of enforcement x Reissued with a reduction in cash value x Pledged as collateral for a loan

Replacement laws provide a minimum standard of conduct for the replacement of existing life insurance or annuities. These laws require:

x The presentation of full and clear information x Accuracy x Complete disclosure

Replacement requirements do not apply to:

x Credit life insurance. x Group life or annuities. x Applications submitted to existing insurers when exercising a contract

change or conversion privilege. x An alternate policy. x Situations where the existing and replacing insurer are the same, or

subsidiaries of the same company or control. x Registered (variable life or annuity) contracts, except when a prospectus

or offering brochure is provided.



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5.3.1 Duties of the Agent Regarding Replacement Every agent or broker accepting an application must:

x Obtain, as part of the application, a signed statement from the applicant, stating whether or not there will be replacement of existing insurance.

x Submit a statement to the insurer, revealing whether or not the agent knows if a policy replacement is involved.

If replacement is involved, the agent must provide the applicant with a NOTICE REGARDING THE REPLACEMENT OF LIFE INSURANCE, signed by the agent and applicant. A copy of this notice, which must also be submitted to the insurer along with the application, appears below:

Notice Regarding Replacement

Replacing your Life Insurance policy or annuity? Are you thinking about buying a new Life Insurance policy or an annuity contract and discontinuing or changing an existing one? If you are, your decision could be a good one or a mistake. You will not know for sure unless you make a careful comparison of your existing benefits and the proposed benefits. Make sure you understand the facts. You should ask the company or agent who sold you your existing policy to give you information about it. Hear both sides before you decide. This way, you can be sure you are making a decision that is in your own best interest. We are required by law to notify your existing company that you may be replacing their policy _________________________________ _____________________________ Signature of Applicant Signature of Agent Date ___________

5.3.2 Duties of Insurers Who Use Agents Regarding Replacement As part of each application, insurers must require a statement signed by the agent and applicant that reveals whether or not replacement is involved. If replacement is involved the insurer must:

x Require a list of all the applicant’s existing life insurance policies. x Require the agent to submit the NOTICE REGARDING THE REPLACEMENT OF

LIFE INSURANCE. x Forward a written NOTICE OF REPLACEMENT, contract summary or ledger

statement on the proposed life insurance or annuity to the existing insurer within three business days of receiving the application.

Existing insurers that attempt to stop a policyholder from replacing a life or annuity policy (those who practice conservation) must provide the insured party with a policy summary and account statements for the existing policy or annuity within 20 days of receiving the NOTICE OF REPLACEMENT.



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The successful conservation of a policy is referred to as RETENTION. High retention rates are important to agents, policy owners and insurers. The advantages to the agent and the insurer are clear, in that the commission and premium collection continue. The benefit to the policyowner can be lower premiums due to the lower age at application and no need to prove insurability.

The replacing insurer may also request copies of summaries and statements, to which the existing insurer must respond within 5 working days. The replacing insurer must:

x Keep the NOTICE REGARDING REPLACEMENT and all replacement documents and records for three years.

x Include a written notice in the new policy, stating that the applicant has the right to an unconditional refund of premiums paid within 20 days from the date of policy delivery.

5.3.3 Replacement and Direct Response Sales Insurers who use direct response advertising to sell products must include a NOTICE REGARDING REPLACEMENT when a replacement is involved, even if that insurer does not propose replacement in its advertising.

When replacement is proposed in the insurer’s promotions and a replacement is involved, the insurer must also:

x Request a list from the applicant of all existing life insurance that is to be replaced.

x Forward the NOTICE REGARDING REPLACEMENT to all existing insurers within three working days after receiving the list from the applicant.

5.3.4 Materially Inaccurate Presentations It is illegal for an agent, broker or insurer to use inaccurate claims or comparisons (twisting) when recommending replacement of an existing life insurance policy or annuity.

Any agent, broker or other person (other than an insurer) who is found guilty of making materially inaccurate presentations may be punished by at least a $250 fine for the first violation and $1,000 to $25,000 for repeat violations. Insurers who violate this article may be fined at least $2,500 for the first violation and between $10,000 and $100,000 for repeat violations.

5.4 Taxation Qualified annuities and life insurance policies premiums are paid with pre-taxed dollars, meaning taxes were not withheld from these funds. If funds are withdrawn from qualified plans there are tax ramifications at the time of withdrawal.

Non-Qualified annuities and life insurance policies premiums are paid with after tax dollars, meaning taxes have already been withheld from these funds. If funds are



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withdrawn from a non-qualified plan there maybe tax ramifications (if funds withdrawn exceed the cost base).

Note: Cost Base is money which has already been taxed, used in reference to taxation of investment dollars.

5.4.1 Taxation of Life Insurance Premiums and Proceeds Taxation of life insurance can be complex because of the ways some life products are used, but the following general guidelines usually apply:

5.4.1.1 Proceeds When proceeds are paid in a lump sum, they are not considered income and are not subject to federal or state income tax. They are subject to federal estate tax if:

x They are payable to the insured’s estate. x The insured was the owner of the life insurance policy. x The insured or policy owner transferred the policy to a third party

within three years prior to death. California, like most states, exempts policy proceeds from estate taxes.

5.4.1.2 Installment Settlement Option With installment settlements, where both principal and interest will be paid, the principal is tax-free but the interest is fully taxable as income.

Calculation of the principal and interest portions of each payment is determined by the “annuity rule.” This rule states that the fixed portion of each payment is considered principal and tax-free. The amount of each payment to be exempt is determined by dividing the insured’s investment in the policy by the expected return. The expected return is based on the insured’s life expectancy. See exclusion ration 5.13.

NOTE: An exception to this rule is that a spouse receiving proceeds may exclude up to $5,000 interest income per year.

5.4.1.3 Premiums Personal life insurance premiums are usually considered personal expense and are not tax deductible. When a business buys life insurance for its employees, premiums are considered a necessary business expense and are deductible. However, when a business buys life insurance to “perpetuate a business” (such as in a buy-sell agreement), premiums are considered a capital investment and are not deductible.



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There are four exceptions to these rules: x When the policy is owned by a qualified charity. x When premiums are paid by an ex-spouse and are deductible as

alimony payments. x When premiums are paid by a business creditor for life insurance

used as collateral for a debt. x When premiums are paid by an employer for group life or health

insurance, they are deductible as an employee benefit expense, but only if they meet the following conditions:

x Premiums must represent reasonable compensation for services rendered when added to other employee compensation.

x Premiums must be an ordinary and necessary business expense. x The employer may not be the direct or indirect beneficiary of the

policy.

Cash Surrender Value When a policy owner surrenders a policy for its cash value, the cash value over and above the total premiums paid for the policy is taxable. The amount equal to the premium payments is not taxable. 1035 Exchanges If a policy owner exchanges one life insurance policy for another with the same insured and beneficiary and a gain is realized, it will not be taxable as income. Policy Loans Policy loans are not taxable because they are treated as a debt against the policy. Endowments and Annuities The expected return of the principal paid for an endowment or annuity is not taxable. The excess over the amount that was originally paid in is taxable. The exact amount of taxable income is derived from IRS tax tables. An endowment paid as a lump sum death benefit is not taxable. Funds from a qualified annuity, however, are fully taxable in the year received unless they are rolled over into another qualified product. There could also be additional penalties if the recipient is not at least 59 ½-years old and does not roll the funds over within 60 days. For funds received from an unqualified annuity, only the interest is taxable in the year received.

5.4.2 Taxation of Annuities When annuity payments are made under a settlement (or disposition of proceeds) option, the payments are a combination of both principal and interest. Because the principal is not taxable and the interest is fully taxable, this results in a tax-free return of investment during the benefit payment period and full taxation



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of the balance (as income). If the annuity is qualified, both the principal and interest are fully taxable in the year distribution is received.

The following formula is used to estimate tax for the taxable portion of an annuity payment:

INVESTMENT IN THE CONTRACT EXPECTED RETURN

= EXCLUSION RATIO

5.4.3 Modified Endowment Contracts As mentioned before, MECs are “paid up” or “fully funded” in fewer than seven payments or seven years and the living benefits (loans, collateralizing, etc.) of the cash value of policies will be treated differently under the tax code. Utilizing the living benefits of an MEC will result in similar tax treatment to that of a retirement plan. The cash value that accumulates in all other life insurance policies is tax deferred. The accounting principle used in determining any taxation of distributions is first in, first out (FIFO). Any money withdrawn from the contract will not be taxed until the amount of money equal to the premiums paid has been withdrawn. This is referred to as WITHDRAWAL TO BASIS. In a MEC, the accounting principle is last in, first out (LIFO). This results in some taxation of any cash value because withdrawals or loans are included in the proceeds. In addition to the income tax ramifications, any withdrawal of cash value prior to age 59½ results in a 10% premature withdrawal penalty by the Federal government and a 2½% penalty by the State of California. If there is any possibility that clients might want to tap the cash value of their policy while they are alive, it is not a good idea to allow the policy to become a MEC. It is the responsibility of the insurer to notify the owner if any policy exceeds this “seven pay test.” It is the responsibility of the agent to understand the law and its implications and to provide the client with an adequate explanation of the ramifications of various policy options.

5.4.4 Estate Tax Repeal of 2001 The Economic Growth and Tax Relief Reconciliation Act of 2001 (Estate Tax Repeal) increased exemption amounts and reduced tax rates over time, with a complete repeal of the estate tax in 2010. However, the law reverts in 2011 to what it was prior to the enactment of the Estate Tax Repeal, unless Congress acts prior to 2011. With the new law, the exemption is:

Calendar Year Exemption Amount

2013 $5 million The maximum tax today is 50% of the gross estate. The exception to this maximum is the marital deduction that allows the entire estate to be left to the



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surviving spouse with no tax deduction. Taxes are levied, however, on the death of the surviving spouse. To have insurance excluded from the value of a deceased’s estate, benefits must be paid to someone other than the estate and someone other than the insured must have sole ownership of the policy. If policy ownership is transferred by the insured to another person within the three years prior to the death of the insured, the full amount of benefits are included in the gross estate for tax purposes.

5.4.5 Gift Tax Life insurance can be given as a gift - either as a policy, premium payments or as policy proceeds. While donating gifts to individuals and charities is a good way to reduce estate taxes, it’s important to understand that the federal government has “gift tax” laws to prevent unreasonable deductions. Federal law does, however, allow gift deductions of up to $14,000 per year with no tax to the donor or the recipient. And, a provision in the law known as “gift splitting” allows a husband and wife to treat their individual gift deduction as one-half of the total. This brings their combined deduction to $28,000 per year.

EMPLOYEE BENEFIT PLANS: BUSINESS USE, CHAPTER 6 GROUP LIFE INSURANCE, RETIREMENT PLANS


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6 Employee Benefit Plans: Business Use, Group Life Insurance, Retirement Plans

6.1 Business Uses of Life Insurance Depending upon the way a business is structured, life insurance policies are often used to:

x Fund activities. x Provide interruption insurance that could result after the death of a

principal x Provide employee benefits.

The following pages provide an overview of some of the most common types of coverage:

6.1.1 Life Insurance to Protect a Sole Proprietorship The death of a SOLE PROPRIETOR can throw a business into chaos unless a solid liquidation or take-over plan is in place. Life insurance can provide funding to the deceased’s family after liquidation and protect the value of a business while the ownership changes hands.

6.1.2 Partnership Buy-Sell Agreements A PARTNERSHIP is a legal business agreement between two or more individuals who share in some fixed portion of the profits and losses. The law states that if one partner dies, the partnership will be dissolved. A BUY-SELL AGREEMENT is a legal contract that states that the interest of any deceased partner will be sold to the remaining partners by the surviving spouse or family. The buy-out price or a formula to calculate the price is agreed upon in advance and stated in the agreement. There are two different types of buy-sell agreements: the cross purchase plan and the entity purchase plan. Cross Purchase Plan This type of agreement is usually used by a business with only two or three partners. Each partner purchases, owns, and names himself or herself as the beneficiary on a life insurance policy, naming the other partner as the insured. The amount of the policy reflects each partner’s interest in the

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business, and should be updated as the business grows. In a company with two partners, two policies are necessary. With three partners, six are required. Each partner must have a policy on each other partner in the amount of their share of the business. In the event of the death of one partner, the other partner(s) receive the proceeds of his/her policy, which named the deceased as the insured. Entity Purchase Plan An ENTITY PURCHASE PLAN has the same function as a cross purchase plan but is usually used when there are multiple partners. The partnership, instead of each partner, is the owner and beneficiary of a single life insurance policy covering all partners. The amount of each individual’s benefit will depend on the covered partner’s interest in the business. In the event of the death of a partner, the partnership receives the proceeds of the policy, which can be used to buy out the deceased partner’s interest from the surviving spouse or family.

6.1.3 Key Person Life Insurance In a corporation, a KEY PERSON is defined as an owner, executive or highly skilled employee who contributes significantly to the operation, growth or success of the corporation. If this person dies, the corporation faces a potential hardship and economic loss. Key person life insurance allows a corporation to be the owner, premium payor and beneficiary of a life insurance policy covering a key person. The business controls the policy and can use the death benefit for any purpose deemed important by the corporation. The four most common reasons corporations invest in key-person insurance are: Indemnification Key-person life insurance will compensate the business for financial loss caused by the death of a key person. Reserve Fund Key-person insurance provides an asset that increases in value as the cash value of the insurance policy grows. These assets can be used as a cash reserve fund for the business while the key-person is alive. Business Credit Key-person insurance guarantees that funds will be available to pay off debts if a key individual dies. This enhances the corporation’s credit standing. Tax Benefits The death benefits and cash value accumulation of a key-person life insurance contract are not taxable to the business.



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NOTE: Premiums are not deductible as a business expense.

6.1.4 Deferred Compensation Many companies supplement their employee’s retirement benefits by deferring a portion of their compensation, and the accompanying tax ramifications, until retirement.

Life insurance is a popular way for businesses to defer compensation by owning and paying premiums on a policy for an employee (the insured) on which the business is named as beneficiary. When the named employee retires, the accumulated cash value provides supplemental retirement income. If the employee dies before retirement, the death benefit is paid to the employer who pays the person’s heirs. To qualify for the tax advantage of a deferred compensation plan, there must be a written agreement between the employer and employee that outlines the period of income deferral.

6.1.5 Split Dollar Insurance In this type of insurance contract, the premiums, ownership rights and proceeds are split between two parties (usually an employer and employee, or parent and a child). Split dollar insurance plans are often used in a business situation where the employee has a need for insurance but can’t afford the entire premium. They are not as structured as other plans and need no approval or qualification by the IRS.

Most split dollar policies consist of cash value whole life insurance and term insurance that is purchased with the annual dividends. The cash value of the policy provides a guaranteed return of premium to the employer. The balance proceeds are paid to the beneficiary of the policy. This shared financial interest means the employer is not entitled to the cash value of the policy. The most common use of this type of insurance is:

x As an incentive plan between and employer and employee. x As business-provided insurance for stockholders. x For business partners or co-owners. x Purchase by a parent for a child.

6.2 Group Life & Health Insurance Since group life insurance is written on a “group basis,” the underwriting process is different than that of individual insurance. Specifically, there is usually minimal or no evidence of insurability required. There is no individual medical underwriting for group insurance and no medical question on the group enrollment form. Instead, group underwriters are concerned with criteria that relate to the group as a whole, such as:

x Adverse selection. x Size of the group. x Nature of the group. x Financial stability of the group.



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x Number and frequency of new entrants to the group. Although medical underwriting is not required, group life plans still usually require evidence of insurability for any employee who wants to join a contributory group (where employees pay part of the premium) after the initial time of eligibility.

6.2.1 Group vs. Individual Insurance In addition to the lack of medical underwriting, group insurance has the following advantages over individual policies:

x There are tax benefits in the deductibility of the payment of premiums and the tax-free distribution of benefits of group insurance policies.

x Contributions to retirement plans provide long-term benefits to both employees and the employer.

x Benefits are provided at a much lower cost than if the individual had to purchase them.

x A good group policy promotes loyalty between the employer and the employees.

x Increased loyalty builds morale, teamwork, and productivity because employees do not have the financial (or mental) burden of obtaining and paying for these benefits individually.

x Group insurance provides life insurance, hospital, major medical and disability income benefits to people who could not otherwise afford the insurance, because all or a significant portion of the premium is paid by the employer or sponsoring organization.

x Family members or dependents can be covered under both individual life and group life contracts.

x Group coverage can be tailored to meet the needs of a specific group, both in the types of coverage written and the amounts of coverage, i.e., levels of benefits.

x It is illegal for an employer to be a beneficiary on an employee’s group life insurance policy.

One of the biggest disadvantages of group insurance is that if the insured changes jobs or leaves the group, he or she may not be covered under the group contract and may be faced with the possibility of paying much higher premiums for individual coverage.

NOTE: COBRA, the “Consolidated Omnibus Budget Reconciliation Act of 1985,” extends group health coverage to terminated employees and their families for up to 36 months.

6.2.2 The Master Contract The goal of group insurance is to provide coverage for members of a defined group of people under a MASTER CONTRACT or MASTER POLICY. While individual insurance is a legal contract between the insured and the insurer, group insurance is a contract between the insurer and a “sponsoring organization.”

Some examples of sponsoring organizations are employer-employee groups, trade associations, professional organizations, unions, lodges, fraternities and other special interest groups.



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Underwriters look at the group as a whole, rather than the individual members of the group. The policyholder (sponsoring organization) selects the types and amount of coverage the group will have, determines the insurer, and pays all or a portion of the premium.

Upon enrollment, a CERTIFICATE OF INSURANCE is given to each member of the group to:

x Provide evidence of coverage. x Summarize the plan benefits. x List the terms of coverage and rights.

Premiums Group premiums are based on the entire group. Coverage may be: Contributory Employees (members) pay part of the premium. Non-contributory Employers or the sponsoring organization pay all of the premiums. In order to have a contributory plan, at least 75% of all eligible employees (members) must be insured. For a noncontributory plan, 100% of the eligible employees (members) must be insured.

State and Federal Regulation Most states have standard provisions for group policies. These include:

x Providing individual certificates as evidence of coverage. x A grace period (typically 31 days). x Incontestability (one or two years after policy is effective, two years after

insured’s effective date of coverage). x Entire contract (application must be attached). x Evidence of individual insurability if individual joins plan after enrollment

period. x Requirement that the employer may not be the direct or indirect

beneficiary of the group policy. x Misstatement of age results in premium (and benefits) being adjusted to

correct age. x Facility of payment (allows payment of benefit to close friend or relative if

no beneficiary is named). x Conversion rights, if individual coverage or master plan is terminated.

6.2.3 Certificate of Insurance The document is “evidence of coverage” for an individual covered under a group health insurance plan. It is evidence of the coverage and the certificate, which can range from a wallet card to a “contract-like,” outlines the policy coverage,



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exclusions, deductibles, age limits, notice and proof of loss requirements, the insurer’s right of examination, and conversion privileges.

6.2.4 Group Underwriting Requirements The following requirements are used as guidelines in the underwriting process: Predetermined Coverage Individual coverage must be based on some plan other than individual selection. Most plans are based on occupation classification, number of years of service, or income. Enrollment Percentage Employers and sponsoring organizations are required to meet the guidelines of member participation percentage and premium payments (75% or 100%). Non-Discrimination Requirement A group cannot discriminate in a way that increases the opportunity for adverse selection against the insurance company. They cannot provide different levels of benefits to members of the group who are in the same classification (occupation or income level). Employer Control The employer or sponsoring organization is usually in charge of enrollment, premium payment, benefit selection and all other areas of administration that are not the function of the insurance company. It is also the employer’s responsibility to see that plan administration is handled in a confidential, legal, and objective manner. Insurance Incidental to the Group The group has to have been formed for a purpose other than that of obtaining group insurance benefits. Eligibility The nature and function of the group must fall within the underwriting guidelines of the insurer in order to qualify for benefits. Two of the criteria that are used to determine eligibility are occupation classifications and geographic location. Self-Funded Groups Some corporations are large enough that it is more cost-efficient to pay the medical bills and death benefits than to pay premiums to an insurance company for each employee. This concept is self-funding or self-insuring. In a self-funded circumstance, most companies will contract with an insurance company for a STOP-LOSS agreement. This contract states that after a defined amount of benefits are paid by the company ($1,000,000 or higher), the insurance company will pay the rest of the claims. Premium costs are typically low, due to the high “deductible.”



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Composition of the Group The group must be structured in such a way that there will always be new younger members joining the group and older members leaving (distribution of risk).

In addition to the requirements outlined above, the California Insurance Code states that an insured that is no longer eligible for group insurance must be provided a notice of the right to convert to an individual policy within 15 days before the end of the required 31-day conversion period. If this requirement is not met, the individual will be given an additional period of up to 25 days after the notice is actually given, so long as this period does not extend for more than 60 days after the end of the original 3l-day conversion period.

6.2.5 Eligible Employee Groups To be eligible for group life insurance, an employee group policy must:

x Cover ten or more public or private employees. x Be issued to the employer and paid by the employer or employer and

employee jointly. x Insure all employees or all of any class(s) thereof. Classes are determined

by conditions pertaining to employment. x Have a plan that precludes individual selection on which the amounts of

insurance provided are based. x The employer cannot be the beneficiary of the employee’s life insurance

policy. x Be written for the benefit of persons other than the employer (usually for

the employees or their dependents). x Be offered to all eligible employees and be written to insure not less than

75% of all eligible employees, when written as a contributory plan (The policy will terminate if, subsequent to issuance, the number of insured employees falls below 10 lives or 75% of the number of eligible employees).

NOTE: The selection of coverage is much broader in group insurance than in individual policies.

6.2.5.1 Coverage of dependents If 75% of all insured employees elect dependent coverage, an employee group Life policy may be extended to an insured’s family. The exact amount of coverage available to dependents must be based in a plan that precludes selection and may not be more than 50% of the insurance on the life of the insured employee. Eligible dependents include:

x The insured member’s spouse. x The registered domestic partner to the same extent and subject to

the same terms and condition as provided to an spouse x Unmarried children from birth through 20 years of age. x Unmarried children from birth through 26 years of age if the

dependent child is attending an educational institution.



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x A child 21 years or older who is incapable of self-sustaining employment by reason of mental retardation or physical handicap and chiefly dependent on the employee for support and maintenance.

For a handicapped child over the age of 20, proof of incapacity and dependency must be furnished to the insurer by the employee within 31 days of the child’s attainment of that age, and as subsequently may be required by the insurer but not more frequently than annually after the two-year period following the child’s attainment of the limiting age.

Group insurance premiums covering dependents may be paid: x By the employer. x By the employee. x By the employer and employee jointly.

6.2.6 Incontestability The validity of a group policy shall not be contested, except for nonpayment of premiums, after it has been in force for two years from its date of issue. No statement by an insured employee relating to his or her insurability shall be used in contesting the validity of the insurance after it has been in force for two years during the employee’s lifetime prior to the contest, unless it is contained in a written application, signed by the employee.

6.2.7 War, Military and Aviation Risks An employee group policy may state that the insurer is not liable, or is liable for a reduced amount, for any losses:

x Relating from war or any act of war. x Relating to military or naval service. x Relating to aviation exposures.

The Commissioner may set reasonable rules and regulations relative to the provisions permitted by this section.

6.2.8 Misstatement of Age If the incorrect age is given on a group insurance application, the premium and/or benefit must be equitably adjusted based on the correct age. (For individual insurance, only the benefits are adjusted.).

6.2.9 Conversion Privilege Group health insurance plans usually allow an insured to convert coverage to an individual policy without evidence of insurability. This privilege can be exercised when the insured is no longer eligible for coverage because:

x Employment is terminated (COBRA). x The insured’s “class” is no longer eligible for coverage. x The insured’s dependent child reaches the age at which he or she is no

longer eligible for coverage as a dependent.



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The insured (or dependent) has 31 days from the time of ineligibility to exercise the conversion option without having to provide evidence of insurability. During this time, the individual is still covered under the group plan. Insurers are permitted to evaluate the individual during this time and charge an appropriate premium for the converted insurance. New premiums will be based on an individual rate, rather than a group rate, and will most likely be higher.

6.2.10 Policy Replacement, Group Life, and Disability Any group life or disability policy that provides life insurance, loss of time benefits, specific indemnity during a hospital stay, or hospital, medical or surgical expenses must allow for extension of benefits upon discontinuance of the policy for any employees who became disabled while covered by the policy and who are still disabled.

DISCONTINUANCE is the termination of a policy or coverage by an insurer for an employee unit under a group disability policy, non-profit service contract or self-insured welfare benefit plan. EXTENSION OF BENEFITS means that continued coverage of a specific benefit must be provided after discontinuance for any employee or dependent who was totally disabled on the date of discontinuance. The extension of benefits may be terminated when the employee is no longer disabled or when a succeeding carrier provides benefits. The coverage provided by a succeeding carrier is called REPLACEMENT COVERAGE. Carriers who provide replacement coverage within 60 days must immediately cover all employees and dependents covered under the previous policy on the date of discontinuance at a level of benefits equal to those offered by the discontinued policy. Succeeding carriers are not, however, required to provide benefits for conditions that caused an employees or dependent’s total disability.

6.2.11 Blanket Life Insurance BLANKET LIFE INSURANCE is written for groups whose membership changes frequently (students, camp attendees, members of volunteer groups, etc.). It can also be used to cover publication groups and independent contractors. Blanket insurance has the same requirements and provisions as other forms of group protection. The Commissioner does not fix rates, but they must be approved and they must be less than the usual rates for equal protection. The term of a blanket policy may not exceed one year. Blanket insurance coverage is automatic unless a written request for exclusion is submitted by more than 10% of a defined covered group. If the total requests for exclusion exceeds 10%, coverage will either not be issued or not be renewed.



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6.2.12 Multiple Employer Trusts (METs) METs are legal entities that provide pensions, group health insurance and other types of employee benefits to groups of two or more unrelated companies. Employer contributions are paid to a common pool from which benefits are paid. This approach gives MET members similar rates and benefit levels to those received by larger corporations.

A “sponsor” (insurance company, agent, broker or third party administrator) usually sets underwriting guidelines, rules and requirements for METs. The sponsor also will typically develop and administer the plan.

NOTE: A third party administrator (TPA) is an outside organization that receives a fee for handling plan paperwork and/or processing claims.

6.2.13 Special Rules for Life Insurance The purpose of pension and other qualified plans must be to provide retirement benefits, however, incidental life and health insurance benefits may also be included. To meet IRS requirements, the cost of incidental benefits must satisfy the incidental limitation rule that requires the cost basis of benefits to be less than 25% of the cost of the total plan benefits. A portion of the cost of life insurance benefits in a qualified plan are also treated as taxable income in the current year but the employee only pays taxes on the Death Benefit or and other portion of the insurance protection that provides economic benefit. For cash value insurance, the taxable cost would be the one-year term rate for the face value, less the accumulated cash value (no matter how much actual premium is being paid). This is referred to as the relative cost. For term insurance, the full premium is taxable because it represents the cost for pure protection.

6.2.14 COBRA The CONSOLIDATED OMNIBUS BUDGET RECONCILIATION ACT (COBRA) is a federal law that guarantees continuation of employee health insurance (at group rates) when group coverage is terminated for any reason other than gross misconduct. All employers with 20 or more employees must offer this extension of coverage to former employees and their families for either 18 or 36 months while they make the transition to coverage under another job or private insurance.

To be eligible, the employee must be a “qualified beneficiary” (covered employee, spouse of the covered employee or dependent children of the covered employee) on the day before the “qualifying event” (termination).



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The following six qualifying events each provide coverage for a specific period of time: 18 Months

x Termination of employment, other than gross misconduct. x Reduction of hours worked to the point where the employee is no longer

eligible for group coverage.

36 Months x Death of the employee (coverage for spouse and dependent children). x Dependent child who no longer qualifies as a dependent. x Medicare eligibility of employee. x Divorce or legal separation of employee (continued coverage for former

spouse). Employers are required by law to notify terminated employees of their eligibility for COBRA, after which the employee has 60 days to elect coverage. The following “disqualifying events” can result in the termination of coverage:

x The first day when a premium is not made on time. x The day the employer terminates any or all group plans. x The first day when the individual is eligible for coverage under another

group plan. x The date the individual becomes eligible for Medicare.

6.2.15 TEFRA The TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982 prevents group term life insurance plans, which are always part of group health programs, from discrimination in favor of key employees (owners, officers, etc.). The act also makes Medicare secondary to group health plans and amends the AGE DISCRIMINATION IN EMPLOYMENT ACT (ADEA) to require employers to offer the same coverage to all employees, regardless of age. This rule of nondiscrimination applies to many group insurance issues, particularly those involving retirement plans.

6.2.16 Health Insurance and Portability Act of 1996 At the federal level one of the most often referenced laws is the Health Insurance and Portability Act of 1996 (HIPAA). The Act is designed to protect the continuation of health insurance coverage for workers and their families when they change, or lose their job and guarantees continuing coverage for those with preexisting medical conditions. HIPAA has separate provisions for small and large group markets and for the individual market. The group health insurance market is one, where individuals obtain coverage on behalf of themselves and their dependents: through a group plan maintained by an employer, a union, or both. The individual market is the for health insurance coverage that does not involve a group health plan.



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HIPAA has five provisions that do the following: x Require group insurance plans to provide coverage within one year of

starting a new job for employees with preexisting conditions. x Prohibits group insurance plans or an employer from dropping coverage

for sick employees. x Requires insurance companies to make individual coverage available to

people who have group plans. x Sets up tax-deductible medical savings accounts for small businesses, the

self-employed, and the uninsured. x Expands the tax-deductibility percentage allowable for health insurance

premiums paid by the self-employed (80%).

6.2.17 Jurisdiction Over Entities The Department of Insurance has jurisdiction over entities that provide coverages designed to pay for healthcare providers, services, and expenses unless the healthcare providers are appropriately licensed or certified by other governmental agencies. An example would be Medi-Care.

6.3 Retirement Plans RETIREMENT PLANS are either un-funded (based on the employers unsecured promise to pay future benefits) or fully funded. The negative part of an unfunded pension plan is if the business suffers financial setbacks so does the pension. On a fully funded program the employer puts funds aside as security for retirement benefits. Life insurance and annuity products, as well as mutual funds, certificates of deposit, thrift accounts and funds, stocks and bonds and cash are often used to provide retirement plan funding. Retirement plans are classified as either non-qualified or qualified.

6.3.1 Non-Qualified Plans x Terms of the plan must be in writing and communicated to the

participants. x Must not be filed and approved by the IRS. x May discriminate regarding participation (specifically as to who is

covered). x Does not provide the employer with a tax deduction for plan contribution.

The deferred compensation plans discussed earlier are examples of non-qualified plans and annuities.

6.3.2 Qualified Plans x Terms of the plan must be in writing and communicated to the

participants. x Must be filed and approved by the IRS. x Cannot discriminate regarding participation. x Must usually be established by an employer for the benefit of employees. x Provide the employer with a tax deduction for plan contribution.



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x Allow employer contributions to be excluded from the employer’s gross income, resulting in no tax due until benefits are distributed to the employee.

x Defer investment income earned by the plan until it is received by the plan participants.

All qualified retirement plans (for example, profit sharing and 401(k) plans) must also state “vesting” requirements and provide a “vesting-schedule” to employees participating in the plan. However, some employers, to entice new employees, often use full and immediate investing.

VESTING is the right each employee has to the money in his or her retirement fund. Every employee has a 100% vested interest (is "fully vested"), in funds that accrue as a result of his or her own contributions. However if the employer matches the contributions by the employee, then the individual might be required to perform a minimum certain # of years of work for the employer before he/she has 100% vesting. Employer contributions that are not fully vested in the employee are usually forfeited upon the (1) termination of service and (2) payment of the vested account balance to the terminated employee.

Benefits that accrue, as the result of the employer’s contributions, become vested over a period of time, according to vesting schedules prescribed by the IRS The maximum vesting schedule presently allowed by the IRS is seven years as shown below in a 401(k) plan example.

401k Vesting Schedule, established by the Employee Retirement Income Security Act (ERISA) as a minimum guideline both for 401k contributors and employers.

Example-6.3.2

401k Vesting Guideline Schedule A set by ERISA Years of Work Vested Percentage of Accrued Benefits Vested Less than 3 0% At least 3, but not >4 20% At least 4, but not >5 40% At least 5, but not >6 60% At least 6, but not >7 80% At least 7 100%

401k Vesting Guideline Schedule B set by ERISA

Years of Work Vested Percentage of Accrued Benefits Vested Less than 3 0% Minimum 5 100%

The # of years vested starts counting even before the individual begins contributing towards a 401k plan. Thus, if someone has been working for a



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company for 7 years but only began making contributions towards the company 401k plan 2 years ago, then 100% of his/her accrued benefits is vested - because he/she has worked for 7 full years - check the schedule above).

When joining a company that offers 401k plans, always remember: x The day you started working for the company x The date you started contributing towards a 401k plan x Any absence or leave that will be deducted from years vested 6.3.2.1 Regulation of Qualified Plans The 1974 Employee Retirement Income Security Act (ERISA) provides for the regulation of qualified retirement plans, including group insurance. ERISA establishes reporting and disclosure requirements for employer-sponsored plans including mandates regarding information that must be provided to plan participants and beneficiaries.

Specific ERISA regulations establish requirements for:

x Program eligibility x Tax rules x Contribution requirements x Vesting x Penalties for non-compliance with plan requirements x Annual financial statements

NOTE: ERISA requirements will change and be updated as laws (especially tax laws) change.

6.3.2.2 Rollovers Qualified plans usually permit ROLLOVERS from one plan to another. This means tax-free withdrawals (of cash and other assets) can be made from one retirement plan and reinvested in another retirement program. The amount rolled over is not considered current income or taxable until it is withdrawn at a later date. Rollovers must, however, be completed in 60 days after the distribution is received or the full amount will be considered taxable income.

NOTE: When funds are rolled over to an IRA, the normal $5,000 annual contribution limit does not apply. It’s important to remember, however, that a rollover actually releases funds to the owner but, in a transfer, the owner never actually has the funds in his or her possession.

6.3.2.3 Contributions/Withdrawals & Penalties Since the purpose of qualified plans is to provide retirement income, there are penalties for early withdrawals. All withdrawals are fully taxable as current income and withdrawals before age 59½ carry an additional 10% tax penalty. No penalty is charged, however, for distributions that are:



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x Due to death or disability. x Received by a participant at least 55 years old who has satisfied

the plan’s retirement rules. x Part of a series of periodic payments from an annuity. x Allowable plan loans. x Due to removal or excess contributions.

NOTE: There is a 6% excess contribution penalty (for individual contributions of more than $5,000/year) for IRAs.

All distributions from qualified plans must begin by April 1st of the year the member reaches the age of 70½. Failure to do this will result in a late withdrawal penalty of 50% of the amount that should have been received.

NOTE: The exception ROTH IRAs do not require a distribution beginning at age 70 1/2.

6.3.3 Corporate Pension Plan Many qualified plans are company pension plans. An employer will usually set up a plan for all eligible employees. Plans are either structured as “defined benefit” or “defined contribution” plans. Defined Benefit Plan Defined benefit plans look at the amount of income that is needed for retirement at a future date. The future “benefit” is calculated using a specific formula that enables plan members to know exactly what will be paid to them. Benefits are based on years of service and/or the amount of compensation the member receives. The amount of retirement benefit is clearly defined, usually as a percentage of the member’s salary, but the amount of the employer’s contribution is not known. Defined Contribution Plan This type of qualified plan is based on the employer’s agreement to make a specific contribution for all eligible employees (usually based on percentage of salary). The amount of the employer contribution is clearly specified but the amount of retirement benefits to be received is not known.

6.3.4 Profit-Sharing Plans PROFIT-SHARING PLANS allow employees to participate in and share company profits. Established and maintained by the employer, they are able to provide a distribution on an annual basis, with no tax penalty, but distribution is fully taxable as income to the employee in the year received. The primary purpose of profit-sharing plans is to stimulate productivity, morale and teamwork among employees. Plans include a predetermined formula for



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allocating contributions and for the distribution of funds at the time of retirement, death, disability or termination of employment.

6.3.5 Keogh Plans KEOGH PLANS were established as a result of the Self-Employed Individuals Tax Retirement Act of 1962. A retirement plan designed for unincorporated businesses, Keoghs allow the owner of the business to make contributions on his behalf (as both an owner and employee) and on behalf of all eligible employees of the business. Corporate retirement plans and Keoghs are similar in three ways:

x Both are subject to the same maximum contribution limits. Allowable contributions are 25% of compensation, up to an annual maximum that changes regularly (whichever is less). However, the 25% limit is total earnings minus the amount contributed to the Keogh. Therefore, the effective percentage after this calculation is 20%.

x Both plans must comply with the same participation and coverage requirements.

x Both plans are subject to the same nondiscrimination rules.

The contribution limits to a Keogh plan are indexed to the cost of living and are increased periodically. The plan must cover all full-time employees who have been with the business at least three years, and must have a vesting schedule.

6.3.6 Traditional IRAs (Individual Retirement Arrangements) An IRA enables individuals under the age of 70 ½ to save money for retirement and defer income tax payment on the contributions and earnings until the money is withdrawn. An individual can contribute up to the annual maximum each year of $5000.00, plus up to the same amount for a nonworking spouse. An IRA can also be fully or partially tax-deductible in the year the contribution is made. Whether or not the contribution is deductible depends on:

x The amount of income. x If the individual participates in an employer-sponsored qualified retirement

or pension plan.

Individuals or married couples not covered by an employer-sponsored retirement plan can deduct contributions of up to the annual maximum each per year, regardless of their level of income. Covered individuals or married couples can still make a contribution to an IRA but the amount of their deduction will depend on their Adjusted Gross Income (AGI). A single person with AGI of $62,000 or less is eligible for up to a full deduction. As AGI exceeds $62,000, the amount of the deduction is phased down by $200 (20%) for each $1,000 in excess of $62,000. When income reaches $62,000 or more, there is no deduction allowed. Married couples filing jointly can receive a full deduction if AGI is less than $103,000 and at least one person is part of a qualified retirement plan. Again, the



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deduction is phased down by $200 (20%) for each $1,000 in excess of $103,000. When combined adjusted gross income reaches $156,000 there is no deduction allowed.

6.3.7 Roth IRAs Under the Tax Reform Act of 1997, single taxpayers with income up to $114,000, and married taxpayers with income up to $166,000, may opt for a ROTH IRA that allows interest, dividends and capital gains to accumulate tax-free. However, the contributions to these accounts are not deductible, and interest cannot be withdrawn for five years. The advantage of this option is that qualified distributions are not taxable, and distributions do not need to start by age 70 ½. IRAs can be funded with a number of investment vehicles or instruments; the most commonly used are annuities through life insurance companies, mutual funds, trust accounts, thrift accounts and funds, CDs, or other financial institution accounts.

6.3.8 Simplified Employee Pensions (SEP or SEP-IRA) A SEP is a fund established by a small business owner, in which the owner/employer contributes funds directly to an IRA maintained for the benefit of an employee. Contributions are immediately vested and employees have control of both the investment vehicles and instruments being used. The amount of the contribution is not included in the employee’s gross income.

The limits on a SEP are much higher then a regular IRA (up to $44,000 or 25% of the employee’s compensation, whichever is less). In order to be eligible for inclusion in a SEP-IRA plan, employees must be at least 21 years of age, and have worked for the employer at least three of the preceding five years.

6.3.9 401(k) Plans (Salary Reduction Plans / Thrift Plans) Named after the section of the IRS Code, 401(k) plans are employer-sponsored retirement savings programs in which employees contribute and invest pre-tax dollars into investment vehicles provided by the employer. These investment vehicles must provide investment options in three diverse areas:

x Capital preservation and income. x Capital appreciation. x Safety of principal (assured through fixed income contracts, mutual funds,

annuities, and/or life insurance).

An advantage of 401(k) plans is that employers often match employee contributions up to a certain dollar amount. Earnings (interest or dividends) grow tax-deferred and lower both the employer’s and the employee’s current taxable income. Employee contributions to the plan, called “elective deferrals,” are immediately and totally vested regardless of the matching amount contributed by the employer. Vesting schedules range from five to seven years based on the employee’s years of service.



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Thrift Savings Plans (TSP) The Thrift saving plans is for federal employees. The savings and tax benefits are the same as 401-k plans.

6.3.10 Tax-sheltered Accounts (TSA) TSA programs, (also called 403(b) and 501(c) (3) plans) are qualified plans available to employees who work for tax-exempt organizations. These include nonprofit charities, educational institutions, public and private school systems, hospitals, museums, zoos and not-for-profit religious organizations.

In a TSA, the employer purchases investing funds that are deducted from the participating employee’s before-tax income and placed in an account with an insurance company or other investment institution. The benefit to the employee is that it reduces current taxable income and, at the same time, builds retirement income.

NOTE: There is no cost to the employer in this type of a plan.

6.3.11 Employee Stock Ownership Plans (ESOP) An EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) is a qualified employee benefit plan through which an employee gains part ownership in his or her company by obtaining stock. The amount of stock is determined by the employee’s income. Here’s how an ESOP Plan works:

x ESOP borrows money to buy shares of stock from the company. x The company pays “contributions” to ESOP on behalf of employees.

(Contributions are tax deductible and not taxable to employee until benefits are received).

x ESOP uses contribution dollars to repay original loan and interest Coverdell Education Saving Account (ESA) This is something all parents or guardians of children should investigate. Educational IRAs have been in existence for some time. The basic concept is to save for your child’s education with a tax favored vehicle. Although ESA are not tax deductible the contributions do grow tax deferred until distributed. Any of the funds that are not used for qualified educational expenses will be taxed to the beneficiary. It’s always a good idea to completely understand the limitations of ESAs before contributing to one.

x For higher education: qualified elementary and secondary education expenses.

x Qualified expenses: tuitions, fees, supplies, books and qualified room & board.

x If distributions exceed qualified education expenses, the unqualified portions of the expense are taxed, plus a 10% penalty.

x Exceptions to the additional 10% tax penalty for non qualified expenses: death, disability or the beneficiary receives a (qualified) scholarship



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6.3.

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IRA

GOVERNMENT INSURANCE AND MARKET REGULATION CHAPTER 7


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7 Government Insurance and Market Regulation 7.1 Government Insurance

In certain cases, the federal, state and local governments act as insurers for those who could not otherwise afford coverage. The most common forms of coverage are paid for through tax revenues and include:

x Social Security (including Medicare). x Service-members Group Life Insurance (SGLI). x Veterans Group Life Insurance (VGLI). x Medicaid (Medi-Cal in California). x Worker’s Compensation.

The major differences between government insurance and other types of coverage are:

x Participation is mandatory for eligible citizens. x Benefits are prescribed by law and changes in benefits result from

changes in law. x Goal of social insurance is to meet the public’s needs, rather than to be

equitable, so people with less usually receive greater benefits. x Governments are the only carriers of government insurance, so it is not

available in the private sector.

Other than Medicare, Medi-Cal and long-term care insurance, which are discussed elsewhere in this text, the most common government insurance programs include:

x Social Security. x Service-member’s Group Life Insurance (SGLI). x Federal Employee Group Life Insurance (FEGLI).

7.2 Social Security When Social Security was established in 1935, it was designed to provide only a basic minimum floor of income support for all eligible workers. Since the average life expectancy for the working male at that time was approximately 62, the government set the retirement age at 65. This meant there were approximately 20 workers paying into the system for every recipient. Today there are approximately 3 workers paying into the system for every recipient and the number is shrinking. At the same time, the average life expectancy of

Chapter

7



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working males is now about 84. This shift in longevity is causing a huge strain on the Social Security system that must be addressed if it is to survive.

Our present Social Security system provides four types of benefits:

x Disability income. x Retirement. x Medicare health benefits. x Survivors’ income and death benefits.

The system is funded by employee payroll deductions (FICA). One portion of the FICA tax consists of a percentage of employee income matched with an equal amount from the employer and capped off at a maximum limit. There is an additional tax, currently 1.45% with no maximum limit. Self-employed people pay both the employee and employer portion. The true name of Social Security, reflecting the benefits shown above is Old Age Survivors Disability Insurance (OASDI).

7.2.1 Eligibility Eligibility for Social Security benefits is dependent upon a worker achieving “insured” status. There are three types of “insured” status:

x Fully insured (having earned 40 quarters over a lifetime). x Currently insured (having earned 6 quarters in the last 13 quarters). x Disability insured (having earned 20 quarters in the 40 quarters

immediately prior to the disability).

A worker is eligible for full retirement benefits at age 65. This is currently scheduled to increase to age 67 depending upon year of birth. There is legislation before Congress to increase that age in order to keep costs within reason. When the system was initiated, the average age at death was prior to age 60. With today’s life expectancy, the current tax rates cannot support the system without such modifications. A reduced amount (about 80% of full benefit) is available to a worker starting at age 62. However, once a worker chooses to go on Social Security at 62, they may not change to a full benefit at age 65.

The survivors of a deceased worker, who was covered under Social Security, are also entitled to income benefits. The surviving spouse is entitled to receive benefits until the youngest child turns 18 or, if still in high school, 19. When the youngest child reaches age 18 or 19 (If still attending high school), benefits cease. The surviving spouse must wait until he or she reaches age 60 to collect benefits. This is referred to as the “black out” period.

There is also a death benefit available to the surviving spouse of $255. This is a benefit that has not increased since Social Security’s inception, and is not likely to increase in the future. The taxes required to increase this benefit to the current funeral cost would be prohibitive.

A Blackout period is the period of time a widow or widower must wait to become eligible for benefits based upon the work record of their deceased spouse.



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7.2.2 Disabled Workers Disabled workers, who meet certain qualifications, may be entitled to Social Security and Medicare benefits – even though they are not senior citizens (65 and older). It is very difficult to qualify for Social Security disability. The requirement is that a person must not be able to make a substantial and gainful wage (the amount defined changes every year) at any job that exists in the national economy. This is very stringent and hard for which to qualify.

7.2.3 Service Member’s Group Life Insurance (SGLI) Provides automatic group life insurance coverage up to $400,000 for members of armed services & reserves. A consortium of commercial insurance companies provides coverage. Premiums are deducted from the paychecks of military personnel. Veterans Group Life Insurance (VGLI) is a post separation insurance which allows members to convert their SGLI coverage to renewable term insurance. Maximum $400,000.

7.2.4 Federal Employee Group Life Insurance (FEGLI) This plan provides group term life insurance coverage to working and retired federal workers. The plan is administered by commercial life insurance companies and provided automatically unless employees reject it. The federal government pays about one-third of the monthly premium each month. Benefits are based on a percentage of an employee’s salary up to age 65. As retirement approaches, there are options available that range from a 75% reduction in death benefit to no reduction in death benefit.

7.2.5 Health Insurance and the Government Health insurance in the United States is the subject of on-going scrutiny at all levels of government and concerned individuals must be vigilant in considering possible changes to their health programs. For example, most people are directly affected, at some point in their lives, by on-going health insurance programs such as workers compensation, social security, Medicare, and Medicaid. In addition, more and more people are planning for their senior years by purchasing long term care insurance and annuity products. Others, such as the sole proprietor, are beginning to recognize the importance of disability insurance as an attractive alternative to a simple life insurance policy.

Insurance carriers are beginning to rethink their health policy structure, within legislative guidelines, to offer gender specific coverage with, for example, maternity options. More and more carriers are authorizing alternative care coverage that stretches the boundary of traditional basic health services. In addition, the Americans with Disabilities Act (ADA) is having a dramatic affect on the workplace and construction requirements. Human resource departments are also feeling the changes with on-going changes in Cal-Cobra, ADA and the Family and Medical Leave Act (FMLA). The latter, that addresses medical leave from work, is undergoing constant reinterpretation as to what



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constitutes a serious health condition, the medical certification process and continuing treatment.

The Family Medical Leave Act (FMLA) allows an eligible employee up to a total of 12 work weeks of unpaid leave during any 12 month period for one or more reasons. These include:

x Birth and care of a newborn child of the employee x Adoption or foster care x Care for an immediate family member. Ex. spouse, child or parent with

serious health issues x Medical leave when the employee is unable to work because of a serious

health issue x Pregnancy Discrimination Act – Forbids discrimination based on

pregnancy when it comes to any aspect of employment including hiring, firing, pay, job assignments, promotions, layoff, training and fringe benefits such as leave and health insurance. If the woman is unable to temporarily perform her job due to a condition related to pregnancy or childbirth, the insured must treat her in the same way as it treats any other temporarily disabled employee- light duty, alternative assignments, disability leave etc.

MEDICARE, also called Health Insurance for the Aged, was introduced on July 30th, 1965, when the Social Security Act was amended to include health and medical care benefits. The purpose of this federal program is to provide hospital and medical expense insurance to:

x People 65 and over. x People (of any age) with chronic/permanent kidney disease. x Certain disabled people (usually those receiving Social Security benefits).

There are two types, or parts to the original Medicare:

x Part A: Hospitalization Insurance x Part B: Medical Insurance

7.2.5.1 Part A: Hospitalization Insurance “PART A” MEDICARE HOSPITALIZATION INSURANCE pays for inpatient hospital care fees, services and follow-up care. The program is financed through a portion of all covered worker’s Social Security payroll tax and deductible amounts payable by Medicare enrollees. Benefits are automatically provided, with no monthly premium payments to an individual at the age of 65, who has qualified for Social Security benefits.

7.2.5.2 Part B: Medical Insurance “PART B” MEDICAL INSURANCE coverage provides medical insurance covering the costs associated with care received from physicians, surgeons, and other health services not covered by PART A HOSPITALIZATION Insurance. This supplementary program is voluntary and paid for by the enrollee’s monthly premiums and general revenues, rather than through Social Security tax.



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7.3 Major Risk Medical Insurance Program (MRMIP) Recognizing that many individuals and groups are unable to obtain health insurance, or can only purchase it by waiving pre-existing conditions, California established the California Major Risk Medical Insurance Program (MRMIP). The purpose of this program is to authorize expenditures from the MRMIP Fund to cover the cost of medically necessary services needed by approved applicants, who are not able to meet the full expenses of treatment. In some cases, the MRMIP contracts with major insurers to provide coverage or issues stand-alone Board policies.

The MRMIP Board has the authority to: x Determine the eligibility of applicants x Determine the medical coverage to be provided x To approve subscriber contributions, plan rates and program contributions

Benefits received under this program are secondary to any other form of health care coverage and may be subject to any Board authorized copayments and deductibles. Authorized copayments may not exceed 25% and any authorized deductible shall exceed an annual household deductible of $500.00. The aggregate amount of copayments and deductibles paid annually shall not exceed $ 2500.00 for an individual or $4000.00 per family.

Eligibility requirements for an applicant/subscriber are: x State residency x Unable to obtain health insurance coverage – rejected by at least one

private health plan x Cannot be eligible for both Part A and Part B of Medicare, unless eligible

solely because of end-stage renal disease x Cannot be eligible to purchase any health insurance for continuation of

benefits under Cobra or CalCobra x Rejection by a private insurer includes situations where the private plan

asked for coverage waivers that would have left the applicant with inadequate medical service

x May be ineligible for a period determined by the Board if the applicant voluntarily disembroiled or was terminated for nonpayment from a private health plan

x Because of funding limitations, the Board may establish alternative mechanisms applicable to program enrollment in health plans. These mechanisms may include but are not limited to a post-enrollment waiting period.

Premiums Once approved for the MRMIP and having chosen a private health plan or received a Board policy, the subscriber is responsible for payment of a subscriber premium, as set by Board regulations. Failure to make the contribution will result in policy termination under the same rules and regulations that normally regulate the private insurers. Subscriber premiums for participating health plans are generally established at 125% of the standard average individual rates for comparable coverage.



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6

7.4 Patient Protection and Affordable Care Act (PPACA)

Overview PPACA was passed in 2010 as Public Law 111-148. It was later amended by the House Care and Reconciliation Act of 2010, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy and The Overpayments Act of 2011.

It has several provisions timed to become effective over a number of years. These include:

x Guaranteed issue and partial community rating will require insurers to offer the same premium to all applicants of the same age group and geographical location without regard to most preexisting conditions

x Individual mandate- All persons not covered by an employer-sponsored health plan, Medicaid, Medicare or other public insurance company must purchase an approved private insurance policy or pay a penalty. This may be waived in cases of financial hardship or religious exemption

x Medicaid eligibility will be expanded to include all individuals and families with incomes up to 133% of the poverty level

x Health insurance exchanges, including the California Health Benefit Exchange will commence operation in each state, where individuals and small businesses can compare policies and premiums and buy insurance. Low income families and persons above the Medicaid level and up to 400% of the federal poverty level will receive subsidies on a sliding scale if they decide to purchase insurance via an exchange

x Establishment of minimum health insurance standards and a ban on lifetime coverage caps

x Mandated Medical Loss Ratios All health plans are now required to adhere to a Medical Loss Ratio (MLR) established by law. The MLR refers to the percentage of premium revenues for health insurance plans spent on medical claims. For example, if a plan collected $100 of premiums and spent $85 on medical claims it would have an MLR of 85%. Since the beginning of 2011, PPACA requires a health plan to provide an annual rebate to each enrollee if the ratio of the amount of premium revenue expended by the insurer on clinical claims and health quality costs, is less than 85% in the large group market and 80% in the small group and individual markets.

x Dependents (children) will be allowed to remain on their parent’s insurance until their 26th birthday. This includes dependents no longer living at home, married, are no longer a student or on their parent’s tax return.

x Insurers may no longer exclude pre-existing conditions for children under the age of 19 (except for grandfathered individual health insurance plans)



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x Firms employing more than 50 people that don’t provide health insurance will have to pay a shared responsibility requirement when the government has to subsidize an employee’s health care.

x Very small businesses will be able to purchase insurance through an exchange

x Insurers must spend a certain percentage of premium dollars on eligible expenses

x Co-payments, coinsurance and deductibles are to be eliminated for select health care insurance benefits (Level A and B of preventive care)

x Restructuring of Medicare from fee-for-service to bundled payments x Support for medical research through the National Institute of Health

7.5 Public Coverage Programs Access for Infants and Mothers Program (AIM) California recognizes that going without prenatal care can cause many problems for both the mother and the baby. It has been shown that a lack of prenatal care can result in more expensive and complicated births. To qualify, an applicant must:

1. Not more than 30 weeks pregnant, as of the application date 2. A California resident 3. Not be enrolled in other programs (including no cost Medi-Cal or Medicare

A or B benefits) 4. Not covered by a private insurance plan 5. Be within the AIM income guidelines

Healthy Families Program Healthy families is a program that provides health, dental and vision coverage to children who do not have insurance and do not qualify for no-cost Medi-Cal. Once enrolled in the program, the member can choose the appropriate plans, which pay most of the child’s costs for primary care and specialist visits. The insurance plans also contract with clinics, laboratories, pharmacies and hospitals.

Qualifications: Children

x Up to their 19th birthday x Children living in California x Without employer sponsored insurance in the last 3 months x Not eligible for no-cost Medi-Cal x Who meet citizenship or immigration rules x With families within the Healthy Family guidelines x Born to mothers enrolled in AIM

Applicants:

x Parents, legal guardians, stepparents, foster parents or caretaker relatives may apply for a child living in their home

x Only consider the parents’ income



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x Children over 18 may apply for themselves x A minor may apply for his/her child x An application must be filed to gain access to the program. A recent

alternative to the traditional paper application process is the Health-e-App or HeA. The HeA allows immediate preliminary eligibility screening, error checking, electronic payment of the initial monthly payment and electronic signatures.

California Pre-Existing Condition Program As a result of the federal Affordable Care Act of 2010, California has an agreement with the federal Department of Health and Human Services to establish a federally funded high- risk pool service to provide health coverage to eligible individuals. It is called the California Pre-Existing Condition Program and is administered by the Managed Risk Medical Insurance Board (see this chapter). The program is expected to end on 12/31/2013 as there will no longer be a need for high risk pools because federal rules will not allow insurers to reject persons with pre-existing conditions or charge them higher rates than those with such conditions.

7.6 Market Regulation Through the years, various laws have helped shape and regulate the insurance industry as it evolved to adapt to an ever-changing marketplace. The following court cases provided major turning points for this evolution during the last 150 years.

Paul vs. Virginia (1869) This case concerned an agent who was working for an insurance company in New York State, who was also transacting insurance in the state of Virginia, where the company had not yet complied with state laws. This reference, PAUL vs. VIRGINIA (1869), is a United States Supreme Court decision, which held that an insurance policy is not an “instrument of commerce,” and, therefore, did not involve interstate commerce transactions. This Supreme Court decision placed the insurance industry under state regulation. In other words, each individual state then had the absolute power to regulate the transaction of insurance within its borders.

SEUA (1944) The UNITED STATES vs. SOUTHEASTERN UNDERWRITERS ASSOCIATION (1944) had the effect of reversing PAUL vs. VIRGINIA. This Supreme Court decision held that the insurance industry was indeed subject to a number of federal laws, many of which at the time were in conflict with state laws. Therefore, insurance was considered a form of interstate commerce and fell under the control of the federal government. The end result was a shift of control from the states to the federal government.

McCarran-Ferguson Act A.K.A. Public Law 15 (1945) The resulting turmoil and confusion due to the Southeastern Underwriters Case prompted the United States Congress to sign into federal law the MCCARRAN-



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FERGUSON ACT (1945). Through this act Congress declared that each individual state might continue to regulate its insurance industry provided that individual state laws conformed to federal standards and did not conflict with federal laws. In addition, the federal government would play a “watchdog” or “overseer” role. Essentially, the federal government can only regulate the business of insurance to the extent that is not regulated by state law. Today each individual state is the primary regulator of the insurance industry within its jurisdiction; however, the federal government still retains regulatory power over interstate commerce as it affects the business of insurance. Accordingly, anyone, including an officer, director, broker or agent, who engages in the business of insurance, shall be subject to fine, imprisonment or both for any of the following actions:

1. Deceiving, making false material statements or reports, or overvaluing any land, property or security in connection with any financial documents presented to any insurance regulatory official for the purpose of influencing the actions of such official

2. Embezzling or misappropriating the money, funds, premiums, credits of others so engaged in insurance.

3. Knowingly making any false entry of material fact, as to his/her financial solvency, in any report or statement, with the intent of deceiving those engaged in the business of, or the regulation of, the insurance business.

4. By threat or force corruptly influencing, obstructing or impeding the due and proper administration of the business of insurance, as it affects matters of interstate commerce and the regulation thereof.

5. Being convicted of any criminal felony involving dishonesty or a breach of trust and engaging in insurance business activities that affect interstate commerce. Similar legal proceedings may be taken against anyone engaged in the insurance business that willfully permits such participation on the part of someone convicted of criminal felony. A criminal felon may participate in the insurance business if that person has the written permission of the insurance regulatory official authorized to regulate the insurer.

The Attorney General may bring a civil action against any person who engages in conduct constituting an offense as outlined in items 1-5 above. The punishment for such an offense can be a fine of not more than $50,000 for each violation or an amount equal to the compensation attributed to the prohibited conduct, imprisonment for not more than ten years (or both). However, the term of imprisonment shall not be more than fifteen years if the violation jeopardized the safety and soundness of an insurer and was a significant cause of such insurer being placed in conservation, rehabilitation, or liquidation by an appropriate court. Embezzlement (item 2) of less than $5,000 can result in the levy of a fine or imprisonment for not more than one year.



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7.6.1 The California Insurance Code (CIC) The CALIFORNIA INSURANCE CODE is a collection of laws established by the state legislature that shape, govern and regulate the business of transacting insurance in the State of California. The California State legislature writes and amends the California Insurance Code by proposing new legislature and enacting and passing new laws. To modify the Code, the legislature must pass a bill and present it to the Governor. The bill becomes law if the Governor does not return it within a certain period of time (between 12-30 days). While the California Insurance Code is enacted at the legislative level, it is implemented, monitored and enforced by the California Department of Insurance. The Commissioner of Insurance, who is elected by the citizens of California, heads the Department. The Code gives the Commissioner a broad range of powers, including the authority to institute, change and enforce rules and regulations to implement the Code (after a notice and public hearing). These rules and regulations are known as the:

7.6.2 California Code of Regulations (CCR Title 10, Chapter 5) The California Code of Regulations consists of policies issued by the California Insurance Commissioner that detail how the Code is to be administered. It includes standards for approval and disapproval of names of insurance producers, continuing education requirements, various requirements for record keeping, standards for claim settlement practices, and specific requirements for different types of insurance (motor vehicle insurance, surplus lines, health insurance, and insurance with sales and lending institutions). These regulations also address many procedural issues related to agent and insurance company practices, filing of various documents, and the conduct of hearings and investigations. All regulations are issued by the Insurance Commissioner, and may be modified so long as the change doesn’t materially affect any requirement, right, responsibility, condition, prescription or other regulatory element of any California Code of Regulation. Interpretation of policy provisions is not a primary objective of insurance regulation.

Important Code Terminology The following terms and meanings are used repeatedly in the California Insurance Code and should be understood as they are used in this context.

Shall Mandatory, required, must, no discretion May Permissive, an option



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Person Any person, natural or legal e.g. trusts, partnerships, LLCs and corporations. Notice by Mail Unless otherwise provided, any notice that must be given to a person under the guidelines of the California Insurance Code requires mailing the notice to that person at their residence or place of business in this state. The affidavit of the person who mails the notice is evidence that the notice was mailed. Notice of Legal Action Notice of an action commenced against the insurer with respect to a claim or notice of an action taken against the insured, received by the insurer, or notice of action taken against a principal under a bond, including any arbitration proceeding. Proof of Claims Any documentation in the claimant’s possession, submitted to the insurer that supports the magnitude of the claim loss and provides any evidence supportive of the claim.

7.6.3 File and Record Documentation In the event of a loss, the insurer, insured and the agent all have duties concerning payment of claims. The insured has a duty to report the loss to the insurer. Proper claim forms need to be filed and sent to the insurer in a timely manner. The Insurer must process the claim form and respond to the insured. The agent must assist both the insured and the insurer as needed. Licensee’s claim files are always subject to examination by the Commissioner’s office. Files shall contain all documents, work papers and notes which reasonably pertain to each claim in such detail that pertinent events can be reconstructed and the licensee’s actions, pertaining to the claim, be determined by the Commissioner.

To aid in this:

x Each insurer shall maintain and hold accessible claim data for 5 years. x The file should reference when the licensee received, processed,

transmitted or mailed material and relevant documents in the file. x In cases of catastrophic losses and other circumstances, where some or

all documentation is difficult to procure, the licensee shall document these circumstances to satisfy the Commissioner’s requirements.

Duties upon Receipt of Communication

x Upon receipt of a request from the Commissioner for information concerning a claim, the licensee shall furnish all available facts then known to the licensee.



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x Upon receiving a communication from a claimant, the licensee shall give a complete response in no less than 15 calendar days.

x Every licensee must, upon receiving notice of a claim, immediately transmit notice of the claim to the insurer.

Standards for Prompt, Fair and Equitable Settlements

1. No insurer shall discriminate in claim settlements based on claimant’s age, race, gender, income, religion, language, sexual orientation, ancestry, national origin or physical disability.

2. Upon receipt of proof of claim, the insurer shall accept or deny the claim (in whole or part) in less than 40 calendar days.

3. When an insurer denies a claim, it shall do so in writing and list all bases for rejection, including specific policy provisions, conditions and exclusions. The claimant shall further be notified that they may contact the California Department of Insurance and be given the address and unit of the Department unit, which reviews claims practices.

4. If more time is required to review a claim, the insurer shall provide the claimant with written notice of the need for more time. The notification will detail the circumstances and specify any additional information needed by the insurer. Notifications will be made every 30 days thereafter, until resolution of the claim.

5. The insurer shall conduct a diligent, thorough, fair and objective investigation.

6. No insurer shall discriminate in claim settlements based on claimant’s age, race, gender, income, religion, language, sexual orientation, ancestry, national origin or physical disability.

7. Upon receipt of proof of claim, the insurer shall accept or deny the claim (in whole or part) in less than 40 calendar days.

8. When an insurer denies a claim, it shall do so in writing and list all bases for rejection, including specific policy provisions, conditions and exclusions. The claimant shall further be notified that they may contact the California Department of Insurance and be given the address and unit of the Department unit, which reviews claims practices.

9. If more time is required to review a claim, the insurer shall provide the claimant with written notice of the need for more time. The notification will detail the circumstances and specify any additional information needed by the insurer. Notifications will be made every 30 days thereafter, until resolution of the claim.

10. The insurer shall conduct a diligent, thorough, fair and objective investigation.

11. Every insurer shall provide written notice of any time period or statute of limitations upon which the insurer may rely to deny a claim.

12. No insurer shall attempt to settle a claim by making a settlement offer that is unreasonably low. The DOI will determine whether the insurer has violated this provision by reviewing:

A. Evidence submitted by the claimant supporting the claim.



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B. The extent to which the insurer considered the advice of its claims adjuster.

C. The extent to which the insurer considered the advice of counsel as to a substantial likelihood of recovery in excess of policy limits.

D. Insurer procedures in determining the dollar amount of property damage.

E. Credible evidence that the amount offered by the insurer is below the amount that a reasonable person, with knowledge of the facts, would have offered in settlement.

13. Upon acceptance of the claim, an insurer shall immediately, but in no less than 30 days, tender payment or take action to perform its claim obligation.

14. No insurer shall request a polygraph examination unless authorized by the applicable insurance contract and state law.

15. If there is a reasonable basis to believe that the claimant has submitted a false claim, the settlement period will be extended to 80 days.

16. No insurer shall make payment to a provider and then demand reimbursement from the insured, on the basis that the payment was excessive or the services were unnecessary.

17. Every insurer shall require that a claimant withdraw, rescind or refrain from submitting any complaint to the California Department of Insurance as a condition precedent to the settlement of a claim.

18. Every insurer requesting a medical examination, for the purpose of determining liability, shall only do so based on a good faith belief that such an examination is reasonably necessary.

Administrator An ADMINISTRATOR is one who collects any charge or premium from, or who adjusts or settles claims on, California residents in connection with life, health or annuities coverage other than:

x An employer on behalf of its employees. x A union on behalf of its members. x An insurance company. x A life or health agent or broker exclusively selling insurance. x A creditor on behalf of its debtors. x A trust, its trustees, agents, and employees. x A trust exempt from taxation under IRS Code Section 501(a) or 401(f). x A bank, credit union, or other financial institution. x A company that advances and collects premium or charges from credit

card- holders, provided it does not adjust or settle claims. x A person who adjusts or settles claims as an attorney and does not collect

premiums in connection with life or health or annuity coverages. x An adjuster. x A nonprofit agricultural association.



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An administrator shall not act without a written agreement with the insurer, a copy of which must be retained by both parties.

7.6.4 Unfair Trade Practices The following acts are considered to be UNFAIR PRACTICES if they are committed with frequency that suggests they are part of a person’s day-to-day business practice:

x Illegal dealing in premiums x Commingling -mixing personal funds with the client’s money x Charging too much and keeping the excess x Charging premiums for coverage not in effect x Selling insurance without a license x Selling insurance outside the scope of a license x Obtaining a license to write only controlled business x Obtaining a license by fraud

Coercion Compulsion by physical force or a threat of physical force. Intimidation Unlawful coercion or extortion. Boycott A concerted refusal to do business with a party to express disapproval with that party’s practices. Rebating Definition: returning a portion of the agent’s commission, or anything else of value, to an insured as an inducement to buy insurance. In most states, rebates are illegal for the agent or insurer to give away or for the insured to receive. Giving more than $25 to induce a prospect to buy a policy, guarantying dividends, splitting commissions, and paying premiums, are forms of rebating. In California, except for specific lines of insurance –including title, life and health insurance- there is no law on rebating and referral fees. This is because in 1988 the California legislature passed proposition 103, making it legal for California insurance agents to rebate a portion of their commissions to clients who purchased insurance from them in California. California and the state of Florida are the only states currently allowing agents to do this. Residents of other states can enjoy the rebate benefits by purchasing their insurance from a licensed California agent and completing the application with the agent while physically in California. To date, however, few California agents have reduced their commissions, largely because insurance companies have actively discouraged such competition.



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Illegal Inducement Giving a gift of more than $25 to induce a prospect to buy a policy. (Offering meals, special contracts, or positions on exclusive advisory boards are examples of illegal inducements). Misrepresentation (lying) Concealment (withholding of facts) Twisting Lying about a client’s current policy to induce him or her to drop it, giving an inaccurate disclosure statement or not giving a disclosure statement at all. Defamation The malicious discrediting or slandering of a person or entity (personal injury). Sales & Loan Requirements Lenders may require that insurance be purchased as a condition of a loan. They may not, however, require that the insured get that insurance through a specific agent, broker or company. Lenders may not reject an insurance policy that satisfies a specific loan condition. Similarly, no person who sells real property shall require, as a condition of the sale, that the buyer must negotiate the purchase or renewal of any insurance coverage for such real property through a particular insurance agent, broker or solicitor.

Free Insurance Free insurance is a prohibited practice and violation of the California Insurance Code. An insurance agent or insurance company may not offer free insurance coverage as an inducement to lease, rent or purchase real or personal property or services.

7.6.5 Procedures for Violations

Examinations, Investigations & Hearings The Commissioner may examine and investigate the affairs of every person engaged in the insurance business in California, if it is believed that the person has or is engaged in an unfair or deceptive act or practice and that proceeding into the matter would be in the public interest. False & Fraudulent Claims Article It is unlawful for anyone to knowingly:

x Present a false or fraudulent claim for the payment of a loss. x Present multiple claims for the same loss or injury, including claims to

more than one insurer, with the intent to defraud.



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x Cause or participate in a vehicle collision for the purpose of making a claim.

x Present a false or fraudulent claim for the payment of loss for theft, destruction, damage or conversion of a motor vehicle, motor vehicle part, or motor vehicle contents.

x Prepare, make or subscribe any writing with intent to use it in support of a false or fraudulent claim.

x Assist, abet, solicit or conspire with any person who knowingly commits any of the above violations.

x If an insured signs a fraudulent claim form, the insured may be guilty of perjury.

x Violators are punishable by imprisonment of two, three, or five years and/or a fine of up to $150,000 or twice the dollar amount of the fraud- whichever is greater.

All insurers admitted to do business in California must maintain a unit or division to investigate and combat possible fraudulent claims by insureds or persons making claims for services against policies held by insureds. These divisions perform the following functions:

x Collect and compile information and data from members or subscribers concerning insurance claims

x Disseminate information and data from members or subscribers concerning insurance claims

x Promote training and education to further insurance investigation, suppression and prosecution of insurance fraud

x Provide, at no charge, to the Commissioner, all California data contained in the records in order to continue the prosecution of insurance fraud.

When an insurer knows or believes it knows the identity of a person believed to have committed a fraudulent act relating to a workers’ compensation policy, application or claim, and it is believed that this has not been reported to an authorized government agency, the insurer must notify the local District Attorney’s office and the Bureau of Fraudulent Claims of the Department of Insurance. Penalties for Violations Anyone who engages in an unfair method of competition or an unfair or deceptive act or practice that is prohibited by the Code is liable for a civil penalty to be fixed by the Commissioner. This fine may be up to $5,000 for each act or, if the act was willful, up to $10,000 for each act.

7.6.6 Fair Claims Settlement Practices The California Department of Insurance is also desirous of promoting prompt, efficient and equitable settlement of claims on a cost effective basis.



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Therefore, the Department has formulated certain minimum standards for the settlement of claims, which, when violated with such frequency as to indicate a general business practice, shall constitute an unfair claims settlement practice. In the process of monitoring such practices, the following definitions are of importance:

Claimant Anyone asserting a right under an insurance policy as the named insured, other insured or beneficiary (first party); any person asserting a claim against the interests insured under an insurance policy (third party); anyone who asserts a right of recovery under a surety bond or an attorney or anyone authorized to represent the claimant or an insurance adjuster, a public adjuster or a member of the claimant’s family.

7.6.7 Insurance Information and Privacy Protection Act Insurers who engage in, collect, receive, or maintain information about insurance transactions involving California residents are subject to privacy protection laws. There are three federal laws that regulate access and uses of information and disclosure to consumers regarding uses and exchanges of this information. These are “The Fair Credit Reporting Act,” the “Privacy Protection Act,” and the “Insurance Information and Privacy Act.”

7.6.8 Gramm-Leach Bliley Act The Gramm-Leach Bliley Act (GLB) contains provisions to protect consumers’ personal financial information held by financial institutions. These include:

x Grants authority to named federal agencies and the states to administer the Financial Privacy and Safeguard rules, as they apply to financial institutions – banks, security firms and insurance companies.

x The Financial Privacy Rule governs the collection and disclosure of customers’ personal financial information by financial institutions.

x The Safeguards Rule requires all financial institutions to design, implement and maintain safeguards to protect customer information

The Gramm-Leach Bliley Act (SB 1) has been expanded in California by the California Financial Information Privacy Act, commencing with Section 4050 of the California Financial Code. This Act is designed to provide California consumers with greater financial privacy than the GLB Act. It particularly requires financial institutions to provide consumer notice and meaningful choice about how nonpublic personal information is sold or shared by financial institutions.

7.7 Insolvency and Conservation A major goal of the Insurance Commissioner and the Department of Insurance is to protect the public by monitoring insurer finances to ensure that they remain solvent.



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7.7.1 Insolvency To be solvent, an insurance company must:

x Be able to cover its liabilities. x Be able to reinsure outstanding risks. x Have additional assets equal to the required paid in capital (the amount

necessary to pay all claims and overhead costs). Paid in capital is the lesser of the value of the company’s assets in excess of all liabilities (net worth) or the combined total of all issued shares of stock, including treasury shares. All insures must file major financial reports to the commissioner each year.

When an insurer goes bankrupt or can no longer meet these financial obligations to policyholders, it becomes insolvent. This would include any impairment in minimum paid in capital required in the aggregate by any insurer for the classes of insurance it transacts anywhere. An insurance company cannot escape insolvency by being able to provide for all liabilities and reinsurance. The insurer must also be able to meet the paid in capital requirements It should be noted that it is a misdemeanor to refuse to release books, records or assets to the Commissioner’s office, once a seizure order has been handed down in an insolvency hearing.

7.7.1.1 The California Insurance Guaranty Association The CALIFORNIA INSURANCE GUARANTY ASSOCIATION ACT (CIGA) provides protection to claimants or policyholders because of insolvency of an insurer.

7.7.1.2 California Life & Health Guaranty Association The CALIFORNIA LIFE & HEALTH GUARANTY ASSOCIATION is a non-profit organization that resulted from a merger of The California Life Insurance Guaranty Association and The Robbins-Seastrand Health Insurance Guaranty Association. California residents, who purchase life and health insurance and annuities, should be advised that insurers who are licensed to transact such insurance in California are required to join the California Life and Health Insurance Guaranty Association.

The purpose of the Association is to provide protection to life and health policyholders, within limits, in the unlikely event that a member insurer should become financially unable to meet its obligations. If this happens, the Association will assess the other member insurance companies for the money required to meet the claims of insured parties living in this state and, in some instances, may keep coverage in force. It should, however, be noted that the protection afforded by these member insurance companies is not without its limits and is not a substitute for consumer diligence in selecting an insurance carrier. Specifically, the Association may:



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x Guaranty or reinsure an impaired or insolvent insurer’s covered policies.

x Provide money. x Assure payment of the insurer’s obligations, pledges or guarantees. x Loan money. x Provide substitute benefits for the insurer’s contractual benefits for

covered claims. x Enter into contracts. x Sue (or be sued). x Employ people to handle financial transactions and other functions. x Advise and assist the Commissioner of Insurance in dealing with an

impaired or insolvent insurer. x Fulfill all the functions of a life or health insurer, except the issuance

of policies.

The California Life & Health Guaranty Association is funded by member assessments that fall into two classes:

Class A Assessments to meet administrative, legal, and other general costs.

Class B Assessments to assist impaired or insolvent insurers.

When dealing with impaired or insolvent insurers, the Association is considered to be a creditor and is subject to regulation and examination by the Commissioner. Those protected by the Association are known as COVERED PERSONS. Association coverage typically applies to individual residents of California, although non-residents are covered in the following cases:

x The issuing insurer is domiciled in California. x The insurer never held a CERTIFICATE OF AUTHORITY in the

state in which the covered person resides. x The resident state of the covered person has a Guaranty

Association similar to that of California. x The covered person is not eligible for coverage under the

Association in their state of residence.

The beneficiaries, payees or assignees of insured persons are protected as well, even if they live in another state.

Policies included under the terms of the Association are called COVERED CONTRACTS and include:

x Individual (non-group) direct life, annuity, health, and supplemental policies and contracts.

x Direct group life, health, annuity, health, and supplemental policies and contracts.



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Association coverage is not provided for: x Contracts not guaranteed by the insurer or for which the insured

has assumed the risk – such as a variable contract sold by prospectus.

x Contracts of reinsurance. x Policies issued by a health care service plan (HMO, Blue Cross,

Blue Shield), a charitable organization, a fraternal benefit society, a mandatory state pooling plan, a mutual assessment company, an insurance exchange or a grants and annuities society.

x Contracts with interest rates that exceed statutory limits. x Guaranteed investment/interest contracts. x Employer self-funded contracts. x Contracts that pay dividends or fees for administration of the

contract. x Contracts issued by insurers that do not have a CERTIFICATE OF

AUTHORITY. x Annuity contracts issued by charitable organizations that are not

insurance companies.

Covered claims receive Association protection to the following limits for each type of insurance: Health Insurers Limited to $200,000, or less, of the policy obligations, based on the amount that would normally have been paid by the health insurer. Life Insurers Payment will not exceed the lesser of:

x 80% of the limit of contractual obligations. x $250,000 in life insurance death benefits on any one life, but not

more than $100,000 in net cash surrender and withdrawal values. x $100,000 in the present value of annuity benefits for any one life

(including net cash surrender and withdrawal values).

NOTE: The California Life & Health Insurance Guaranty Association is not liable for more than $250,000 in benefits for any individual or more than $5,000,000 for any one owner of a firm, corporation or legal organization.

Association Restrictions While the California Life & Health Guaranty Association’s mission is to protect the public, not all claims are fully covered. Therefore, it is unlawful for insurers to proclaim their membership in the organization or to use it in advertising.

In June of 1991, the Association developed a SUMMARY DOCUMENT AND DISCLAIMER that describes its purpose and limitations. This document must



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be provided to all covered life and health and annuity policyholders at the time they receive their policy and must also be made available at any time on the request of the policyholder. In the event that the Association does not cover a policy, the insurer must provide a separate written disclosure notice to the policyholder at the time the policy is issued.

7.7.1.3 Insurer Reporting Requirements California requires all insurers conducting business in the state to submit an annual report regarding their financial condition. This report must include:

x The condition of the company x Results of the previous year’s operation x Any changes in the company’s financial condition x Changes in capital and surplus

Specific information must also be provided regarding the company’s:

x Income x Liabilities x Expenditures x Premium note accounts x Company balance sheets x Total amount of new business. x Amount of new business in California x Total premiums from business written in California

Insurers’ assets must equal the sum of total liabilities, capital and surplus required for admission to transact business in California. Within the scope of the law, insurers may invest these assets. Generally, investments must be considered safe and fairly stable and they may not put policyholders in an insecure position. Investments must be approved by the insurer’s Board of Directors and may not provide a personal benefit to any of the directors. Typical investments include:

x Bonds (government, corporate and mutual). x Real estate mortgages. x Policy loans.

7.7.2 Conservation When the Commissioner of Insurance files an application with the Superior Court to issue an order to become Conservator of a financially impaired or insolvent insurer, he or she will be vested with all of the insurer’s assets, books, records and property and will conduct their business if any of the following conditions exist:

x The person or entity has refused to submit its books, papers, accounts or affairs for the reasonable inspection of the Commissioner.



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x The person or entity has rejected or refused to observe an order of the Commissioner to make good any deficiency in its capital or reserve.

x The person or entity has, without first obtaining the Commissioner’s consent in writing, transferred its entire property or business, or entered into a merger, consolidation or reinsurance transaction of its property or business with the property or business of another person or entity.

x The person is found, after an examination, to be in hazardous financial condition.

x The person has violated its charter with state law. x Any officer refuses to be examined, under oath, regarding its affairs. x Any officer or attorney in fact has embezzled, sequestered or wrongfully

diverted any assets of the person. x A domestic insurer does not comply with the requirements for a Certificate

of Authority or its Certificate of Authority has been revoked. x The last report of examination shows the person or entity to be insolvent.

It should be noted that any person having possession of and refusing to deliver any of the books records and assets of a person against whom a seizure order has been issued by the commissioner shall be guilty of a misdemeanor. If the Commissioner determines that it is futile to proceed as Conservator, he or she may apply to the court to liquidate the business of the insurer. After a full hearing, the court may order liquidation, with the Commissioner as liquidator.

7.8 Special Provisions for Health Coverage In California, any person or organization that offers health coverage falls under the jurisdiction of the Department of Insurance, unless it can show that it is controlled by another government agency. Such agencies could include any branch of the Federal Government, an agency of another state, or another California agency.

Individuals or organizations that fall under the jurisdiction of the Department of Insurance must obtain a Certificate of Authority to do business in California and must adhere to all the provisions of the Insurance Code.

NOTE: The provisions of this section do not apply to Health Care Service Plans, which will be referred by the Department of Insurance to the Department of Managed Care.

7.9 NAIC & Investment of Assets The National Association of Insurance Commissioners (NAIC) is composed of insurance commissioners and directors from all 50 states. The association was formed to exchange information and provide uniform regulatory practices for the industry through model legislation and regulations. In 1951, the NAIC created the Mandatory Security Valuation Reserve (MSVR) to prevent sudden changes in policyholder surplus due to fluctuations in the value of



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securities and other investments. As market conditions change, this method absorbs small changes in value up to a maximum amount, then increases or decreases the surplus to the actual gain or loss. Increases are related to capital gains earned by the stocks or bonds. Additional controls include regulation of investment vehicles to prevent insolvency.

7.9.1 Insurer Reporting Requirements

California requires all insurers conducting business in the state to submit an annual report regarding their financial condition. This report must include:

x The condition of the company. x Results of the previous year’s operation. x Any changes in the company’s financial condition. x Changes in capital and surplus.

Specific information must also be provided regarding the company’s:

x Income. x Liabilities. x Expenditures. x Premium note accounts. x Company balance sheets. x Total amount of new business. x Amount of new business in California. x Total premiums from business written in California.

Insurers’ assets must equal the sum of total liabilities, capital and surplus required for admission to transact business in California. Within the scope of the law, insurers may invest these assets. Generally, investments must be considered safe and fairly stable and they may not put policyholders in an insecure position. Investments must be approved by the insurer’s Board of Directors and may not provide a personal benefit to any of the directors.

Typical investments include:

x Bonds (government, corporate and mutual). x Real estate mortgages. x Policy loans.

7.10 Senior Issues The fact that people are living longer today then ever before has put a huge burden on our healthcare systems. Medical expenses continue to rise for seniors (60+) and the cost of a long-term critical illness is becoming so astronomical that many insurers are concerned about their ability to cover claims. After Medicare benefits have been exhausted, the only way for many seniors to be sure their medical expenses will be covered is to obtain Medicare supplement or long-term care coverage.



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When purchasing this extra coverage, many seniors buy out of fear, and those who transact insurance (insurers, brokers and agents), have an obligation to be honest, ethical and especially sensitive when dealing with this market.

7.11 Conflicts of Interest Many agents and brokers often represent several different insurance companies and handle a wide range of products. This enables them to fit each client with the best type of protection for their unique needs and budget. At the same time, this flexibility can often result in a CONFLICT OF INTEREST between client needs, potential commissions, and insurer expectations of loyalty. The only way to effectively handle this situation is for agents and brokers to always put the interest of their clients first.

7.12 Prepaid Commission Many insurers pay new agents their full first year commission upon issuance of a policy or receipt of the application and initial check. This is called an ANNUALIZED COMMISSION. A potential problem with this type of payment is that annualized commissions are prepaid to the agent before they are actually earned by the company and, if the policy is returned or cancelled, the agent will be expected to pay back any unearned premium.

7.13 Ethics The California Insurance Code and the California Code of Regulations identify many unethical and/or illegal practices but they do not provide a complete guide to good behavior. The following ten points offer guidelines and are the basis for several questions in the California Life Agent exam.

x Place the customer’s interest first. x Know your job and continue to increase your level of competency. x Identify your customer’s needs and recommend products and services

that meet those needs. x Accurately and truthfully represent products and services. x Use simple language; talk the layman’s language whenever possible. x Stay in touch with your customers and conduct periodic coverage reviews. x Protect your confidential relationship with your client. x Keep informed of and obey all insurance laws and regulations. x Provide exemplary service to your clients. x Avoid unfair or inaccurate remarks about your competition.

HEALTH POLICY REQUIREMENTS AND PROVISIONS CHAPTER 8


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8 Health Policy Requirements & Provisions 8.1 The Individual Health Policy

While Individual Health policies are created to meet the specific needs of each individual, all share certain common characteristics.

8.2 Health Insurance Terms and Definitions The following important terms and definitions are common to Health and Disability Insurance policies:

8.2.1 Underwriting UNDERWRITING is important for all Health Insurance policies because the types and amount of risk affects the ratio of claims paid to policy rates. The role of the underwriting department for individual policies is to select risks that fall into a normal range of expected losses. Selecting these risks is based on the concept of “morbidity”, whereas in life insurance risk calculations are based on mortality rates.

8.2.2 Morbidity MORBIDITY is defined as the amount of sickness or illness within a population. Through the use of morbidity tables and statistical analysis of an applicant’s age, sex, family history, medical history, lifestyles, etc., underwriters can predict the probability of an illness or disability occurring within a specific group of insureds.

NOTE: Group underwriting is different than individual underwriting in that there is often no medical history information required of plan participants. Therefore, underwriters must base their assessment on the entire group rather than individuals. Some disadvantages of individual health, long term care, disability and life insurance policies is the underwriting process. The rate (Premium) is based on medical history, chronic or on-going health conditions, catastrophic conditions, as well as pregnancies. All of these aforementioned factors may be considered when calculating the cost of premiums.

8.2.3 Pre-existing Conditions A PRE-EXISTING CONDITION is any illness, impairment or disability that an insured contracted or which manifested itself or for which the insured received advice, diagnosis, or treatment within a certain period of time prior to the date of application or issuance of the policy. There are generally

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five ways that an insurer will handle a preexisting condition when underwriting a Health Insurance policy:

Decline (Reject) The application indicates that the condition is so severe that the insured does not meet the company’s underwriting criteria to be insurable at any cost. Totally and Permanently Exclude The preexisting condition is excluded from coverage at the time of issuance of the policy and at any time in the future. Waiver for Impairments Insurers often include a “waiver for impairments” as a policy rider that explains what coverage will be excluded because of the pre-existing condition. This waiver is signed by the insurer and must often be acknowledged and signed by the insured. Temporary Exclusion Insurers use this exclusion to deny benefits for losses resulting from a specific condition and, at the same time, to allow the insured to request, at a future date, that the condition be fully covered. Acceptance of this request by the insurer will depend on whether the insured received treatment or medical advice regarding the condition within a certain period of time. Issue on a Sub-standard Basis At times, insurers will cover a specific higher risk condition but charge the insured a higher premium to cover risk. This “Sub-Standard” rating can be permanent or temporary. If it is temporary, the insured has the right to request that it be reevaluated at some future date.

8.2.4 Co-payment CO-PAYMENT is a term that is found in Group Health Insurance policies and Health Maintenance Organizations (HMOs). The Co-Payment Agreement states that the insured pays a specific dollar amount for the services rendered. The insurer pays the remaining portion of the claim, up to the limits of the policy.

8.2.5 Coinsurance Because the words “coinsurance” and “co-payment” sound so similar, their meaning is often confused but, in fact, they are very different terms. COINSURANCE is a cost-sharing feature that is found in Health Insurance policies. The Coinsurance Clause is a specific ratio (or percentage) of shared medical expenses between the covered party (the insured) and the insurance company (the insurer). Typically, the insured will pay a higher portion of his or her medical expenses until the deductible is met. Once the deductible is paid, however, the insurer pays a proportionately higher amount of medical expenses than will the insured.



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8.2.6 Stop Loss This is the maximum amount that the insured is required to share. Typically, it is a stated dollar amount, such as $3,000 or $5,000. Once this limit is met, the insured no longer has to pay any of the incurred expenses; the insurer will then pay for all expenses to the policy limits.

8.2.7 Out-of-Pocket Limit In the Coinsurance Agreement, this is the amount that the insured must pay “out-of-pocket.” It usually consists of the insured’s deductible plus his/her share of the co-insurance, up to the “stop-loss” barrier.

8.2.8 Policy Effective Date The date on which an insurance policy goes into effect is the Policy Effective Date.

8.2.9 Free Look (Right of Rescission) Individual Health and Disability Income policies have a FREE LOOK PERIOD, during which the policy can be returned for any reason and the applicant will receive a full refund of all premiums paid. The Free-Look Period, also known as the RIGHT OF RESCISSION, is usually 10 days but may be as much as 30 days from the date of receipt of the policy (regardless of the issue date or the date it is received by the agent). Many insurers require the insured to sign an ACKNOWLEDGMENT OF DELIVERY RECEIPT, indicating that the policy was received on an exact date.

NOTE: When the premium is refunded, the policy is rescinded and the contract becomes void. If the policyholder exercises his or her option to return the policy during the Free Look Period, the company is not liable for claims originating during the period.

8.2.10 Accumulation and Benefit Period The ACCUMULATION PERIOD is the time during which the insured accumulates medical expenses that add up to an amount equal to the deductible (usually 90, 120, or 180 days). The BENEFIT PERIOD for eligible medical expenses begins after expenses exceed the deductible amount. The Benefit Period is the number of days for which benefits are paid to a named insured or dependents.

8.2.11 Waiting Period The period of time before health insurance benefits begin.

8.2.12 Elimination Period A period of time that must pass, after the effective date of an insurance policy, before a covered individual will begin to receive benefits. As a general rule, the longer the elimination period and the shorter the coverage period the lower the premium. It is sometimes called the probationary period, although in group



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health policies, this term is intended for people who join the group after the policy effective date.

Probationary Period The length of time until the healthcare benefits become available: 30, 60 or 90 days.

8.3 Deductibles Found in most insurance policies, the deductible is the amount (part of the “self insurance”) that the insured must pay before the insurer pays benefits. Deductibles make the insured party more conscious of the claim they are submitting. At the same time, they help cut down the costly administration required for smaller claims. This keeps overall premiums lower.

Deductibles can be written in the following ways:

Each Policy or Calendar Year The new deductible begins each year or on the anniversary of the policy. Each Covered Person A deductible is charged for each covered person. Each Accident or Illness A per-cause deductible applies for each covered event (accident or illness). Family Deductible Any family member that has filed a claim contributes to satisfy a single deductible.

8.3.1 Types of Deductibles The following types of deductible are commonly found in insurance policies: Flat Deductible Also known as “Deductible,” this is a stated dollar amount that the insured must first pay prior to the insurer paying any benefits of the policy. Corridor Deductible Usually found in supplemental major medical policies, the corridor deductible is the amount that the insured must pay after the payments of the Basic Medical Expenses policy end and prior to the payment of benefits under the Major Medical Policy. Integrated Deductible This type of deductible is found in Major Medical policies, but it is “integrated” or mixed in with the amount of benefits that are provided by the Basic Plan.



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8.3.2 Common Accident Provision This provision states that, if there is more than one family member injured in an accident, only one deductible will apply.

8.3.3 Carry-over Provision Some insurers also include a CARRY-OVER PROVISION that allows expenses incurred during the last calendar quarter of a year to be used toward the deductible for the following year.

Flat Deductible Policy

Basic Medical Policy

Comprehensive Major Medical Policy

A specific sum is deducted from each loss or claim

Corridor deductible (Transition to)

Integrated deductible (Paid as part of basic)

Comprehensive Major Medical

Supplementary Major Medical

Supplemental Major Medical

After deductible, there is a coinsurance stop-loss amount. Deductible plus stop/loss = out of pocket

A fixed dollar amount per claim

Usually a large deductible

TABLE 8.1: Comparison of Deductibles

NOTE: The structure of “coinsurance,” “stop loss” and “out-of-pocket” is the same for comprehensive or supplementary major medical.

8.4 Common Exclusions, Restrictions and Limitations Exclusions address the times, conditions and circumstances when coverage is either limited or not provided. The most common health and disability policy exclusions eliminate liability for losses resulting from:

x “War” or “Act-of-War” x Military Service. x Attempted Suicide. x Intentional Self-Inflicted Injuries. x Committing or Attempting to Commit a Felony. x Aviation under certain circumstances, (i.e., serving as the pilot or crew

member of an aircraft).

Benefits may also be limited or denied if the loss occurs while traveling abroad or during an extended foreign or overseas residence. Medical expense policies may also exclude benefits covered under Worker’s Compensation, or any other statutory government program or treatment in a government hospital.

8.5 Conversion Privilege for Dependents An Individual Health Insurance policy can insure one person or be extended to the primary adult insured’s dependents. There are four categories of dependents:



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x The insured’s spouse. x The insured’s children. x The insured’s dependent parents. x Any other person for whom dependency can be proven.

Whether or not a person is a dependent is proven by:

x Relationship to the insured. x Residency in the home. x Listed on the insured’s income tax return as a financial dependent.

If the insurance terminates because that person no longer fits definition of “family” or “dependent,” the insured has the right to convert his or her policy without evidence of insurability. Conversion must usually take place within 31 days of the start of eligibility. Children (including adopted, stepchildren and foster children) are typically eligible for coverage under a family policy until they reach a specified age (19 or 22 if still in school) or get married. Insurers must provide coverage on a parent’s policy beyond the maximum age for a child who is incapable of self-support due to a physical or mental impairment. State law also requires that health insurance must provide coverage on newborns from the moment of birth. (Parent must submit a notice of the birth to the insurer along with an additional premium).

8.6 Policy Elements The following elements and provisions are common to Health and Disability Insurance policies.

8.6.1 The Policy Face The POLICY FACE is a summary of the benefits and coverage and contains the following information:

x Type of policy and type of coverage provided. x Identifies the insured. x Term of the policy (effective date and termination date). x Renewal of the policy. x Types of benefits.

8.6.2 Insuring Agreement Clause This clause, found on the first page of a health or disability insurance contract, defines the coverage and the conditions under which benefits will be paid. It usually lists:

x The insurer. x The insured. x Losses covered. x Amount of benefits.



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Typically, the agreement clause also includes a “promise to pay” for specific losses (subject to the provisions, conditions, and exclusions of the policy). Many policies also contain a “definitions” clause that explains, and defined terminology used in the contract.

8.6.3 Consideration Clause The CONSIDERATION CLAUSE includes the statements or representations made on the initial application (valuable consideration). It also lists the amount and frequency of premium payments. If the first premium has not been paid and the policy is issued on a COD basis, “consideration” is lacking and coverage is not effective until the initial premium is paid.

8.6.4 Benefit Payment Clause This clause defines the types of benefits provided by the insurer and the circumstances under which they will be paid. It includes specifics on elimination periods, benefit amounts, duration of benefits and the limit of liability (maximum amount of protection an insurer will provide on a given policy).

8.7 Mandatory Provisions The National Association of Insurance Commissioners (NAIC) is comprised of insurance commissioners from all 50 states. As part of the association’s mandate, it has developed twelve mandatory and eleven optional provisions to ensure contract uniformity among various insurers in different states. These laws, also known as the “Uniform Provisions Laws,” provide standard requirements for coverage, levels of benefits, and Grace Periods. Companies may use different wording from what is contained in the law as long as the coverage, protection, benefits, limitations, and exclusions provided are consistent.

8.7.1 Provision #1: Entire Contract/Changes This provision protects the policy owner by requiring that the entire contract is specific and includes:

x The policy x All provisions x Riders x Waivers or endorsements x Attached papers (application and, if needed, the medical exam)

Changes or modifications must be requested in writing, signed by the insurer and attached to the policy. Agents cannot change or waive any of the policy provisions.

8.7.2 Provision #2: Time Limit on Certain Defenses This provision, similar to the incontestable clause in a Life Insurance policy, makes a Health or Disability policy incontestable after it has been in effect a certain period of time (usually two years). There are two paragraphs used in this provision:



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Paragraph A After two years from the date of issuance, no misstatements (except fraud or intentional misstatements) made by the applicant on the application can be used to void the policy or deny a claim. This provision applies to legitimate mistakes and oversights.

NOTE: If the policy is “guaranteed renewable,” it cannot be contested for any reason.

Paragraph B The insurance company may not deny a claim on the basis of a preexisting condition after the expiration of a two-year period unless the preexisting condition is specifically excluded from the policy.

8.7.3 Provision #3: Grace Period The Grace Period is the period of time coverage remains in force after the premium is due and before it is paid. Typically, the Grace Periods are:

7 days: For policies with a weekly premium mode. 10 days: For a monthly mode. 31 days: For all other modes (quarterly, semi-annually or annually).

If the premium is paid during the Grace Period, full coverage remains in effect and there is no evidence of insurability required. If the policy contains a cancellation provision, this may be noted in the Grace Period provision.

If the policy gives the insurer the right to refuse renewal, an additional provision will allow it to waive the Grace Period by giving notice of its intention not to renew.

8.7.4 Provision #4: Reinstatement If the premium is not paid by the time the Grace Period has passed, the policy will lapse and coverage will cease. Under certain conditions, a lapsed policy can be put back in force through reinstatement. Many insurers require an application for reinstatement to demonstrate insurability. If the application is required and a conditional receipt is given, reinstatement is not effective until the insurer approves it. If the insurer does not deny the application within 45 days, the policy is reinstated automatically. To prevent adverse selection, losses resulting from illness are not covered for at least ten days. Accidents are covered immediately. If the insurer or its agent accepts the past due premium and an application for reinstatement is not required, reinstatement is automatic as soon as the premium is paid.



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8.7.5 Provision #5: Notice of Claims Also called NOTICE OF LOSS, this provision describes the policy owner’s responsibility to report a loss to the insurer within a reasonable period of time after the occurrence. Written notice of a claim must be given to the company within 20 days or as soon as reasonably possible. The second part of this provision requires an insured that is receiving long-term Disability Income benefits to submit proof that the disability is ongoing. If the loss requires benefits to be paid for two or more years, the insured must submit proof of the “continuance of disability” to the insurer or its authorized agent at least every six months (except in the absence of legal capability).

8.7.6 Provision #6: Claim Forms After the insurer has received notice of a claim, it is required to supply claim forms to the insured within 15 days. If the insurer does not supply the appropriate forms within 15 days, the insured will be deemed to have complied with all reporting requirements if he or she has submitted proof of loss (occurrence, character and extent of loss) in any form.

8.7.7 Provision #7: Proof of Loss This provision limits the amount of time the insured has to file proof that a loss has actually occurred. Proof may be a doctor’s statement, death certificate, or billing for medical treatment. Proof of loss must be filed within 90 days after a loss occurs or after the insurer becomes liable for Disability Income benefits. Benefits or payment for a claim will not be affected if the claimant cannot comply with this requirement for a period of up to one year and will be extended indefinitely if the insured suffers from a “legal incapacity.”

8.7.8 Provision #8: Time of Payment of Claims This provision requires immediate payment of a claim after the insurer receives notification and proof of a loss. The exception to this requirement is for periodic payments of disability policies (to be paid at least monthly).

8.7.9 Provision #9: Payment of Claims This provision specifies how and to whom payments are to be paid. If there is a benefit included in a Health Insurance policy, payments are made to a “named beneficiary.” If a beneficiary is not named, payment will be made to the estate of the insured. All other benefits are paid to the insured.

There are two optional provisions that insurers can add to this required provision. Facility of Payment Clause Gives the company the right to pay benefits of up to $1000 to any relative (blood or by marriage) or individual who is entitled to receive the payment.



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An Assignment Agreement That allows the company to make payments for medical, surgical, or nursing expenses directly to a provider rendering the covered services.

8.7.10 Provision #10: Physical Examination and Autopsy at Insurance Company Expense

The insurance company has the right, at its own expense, to examine the insured in order to prove the continuance of a disability or, in the case of death, to perform an autopsy (unless it is forbidden by law).

8.7.11 Provision #11: Legal Actions This provision states that the insured or policyholder cannot take legal action to receive benefits due less than 60 days or more than three years after proof of loss has been submitted to the insurer. The 60-day waiting period gives the insurance company time to evaluate the claim and the three-year limit sets a statute of limitations.

8.7.12 Provision #12: Change of Beneficiary As with a Life Insurance policy, Health or Disability policy owners may change the beneficiary designation at any time. (If the beneficiary has been named “irrevocably,” the permission of the beneficiary is required). The policy can also be assigned or surrendered without the permission of the beneficiary. Some insurers combine the assignment provision with the change of beneficiary provision. This makes it possible for a policy owner to assign benefits to a healthcare provider.

8.8 Optional Provisions In addition to the twelve mandatory provisions that must be part of in all policies, there are eleven “optional provisions” used by insurers. If the subject of any of these provisions is included in a policy, it must be worded in accordance with the law or stated in a way that is favorable to the insured. The wording of optional provisions is subject to approval by the insurance department.

8.8.1 Optional Provision #1: Change of Occupation This provision outlines rate and benefit adjustments that will be made to a Health Insurance policy if the insured changes occupation. If the insured changes to a more hazardous occupation, this provision allows the insurer to reduce benefits to fit the premium for the higher risk job. (New rates must be based on underwriting standards and ratings for that occupational classification.) If the insured switches to a less hazardous occupation, the premiums may be reduced.

8.8.2 Optional Provision #2: Misstatement of Age If the age of the insured is misstated on the application, all benefits are adjusted to whatever the premium would have purchased at the insured’s correct age. A higher age would result in lower benefits; a lower age would



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result in higher benefits. This provision is similar to the MISSTATEMENT OF AGE provision found in Life Insurance policies.

NOTE: On both the change of occupation and the misstatement of age provisions, the insurer will adjust the benefits instead of raising the premium.

8.8.3 Optional Provision #3: Other Insurance with Same Insurer This provision limits insurer risk, prevents over-insurance, and limits the amount of insurance an insured can have with any one company. Total insurance is restricted to a specified maximum amount with any one company, regardless of the number of policies written. Premiums paid for an excess amount of coverage must be refunded to the insured or the insured’s estate.

8.8.4 Optional Provision #4: Insurance with Other Insurers (Health Benefits Expense Incurred)

Under this provision, if the insured has other Health Insurance policies that an insurer doesn’t know about, liability is limited to a portion of the total loss suffered by the insured. If premiums paid are greater than the amount needed to cover the benefits the insurer will pay, the excess will be refunded to the policyholder.

8.8.5 Optional Provision #5 – Insurance with Other Insurers (Disability Income Benefits)

This provision prorates benefits that are paid directly to the insured instead of paying on an “expense” or “service incurred” basis (Disability Income benefits). It also requires the return of premiums in excess of the amount needed to pay the insurer’s portion of prorated benefits.

8.8.6 Optional Provision #6: Relation of Earnings to Insurance This provision, which can only be used in non-cancelable and renewable policies, addresses potential over-insurance in Disability Income policies by requiring that, in the event of a disability, the maximum benefit paid to an insured will not be in excess of earned income or a percentage of earned income. It states that, if benefits paid from all policies for the same loss exceed the insured’s monthly earnings at the time of disability, or average monthly earnings from the previous two years, that the insurance company is liable for only a proportionate amount of benefits provided by all policies. Total benefits paid, however, will not be less than $200 or the maximum provided by the policy. Any premium paid for excess coverage will be refunded.

8.8.7 Optional Provision #7: Unpaid Premiums (Deducted from Benefit Payment)

This clause states that if there are any outstanding unpaid premiums due at the time a claim is filed, the unpaid overdue amount will be deducted from the payable benefit.



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8.8.8 Optional Provision #8: Cancellation This provision, which is illegal in several states, allows insurers to cancel a policy with five days written notice. Any unearned premiums are refunded on a “pro rata” (appropriate portion of unused premium is returned) or a “short rate” basis (the insurer retains a portion of the unearned premium to cover administrative expenses incurred with the cancellation). Cancellation of group or blanket coverage requires 31 days advance notice before cancellation.

8.8.9 Optional Provision #9: Conformity with State Statutes This provision automatically amends a policy to conform to the minimum statutory requirements of the state where the insured resides at the time of issuance. If the provisions of the policy conflict with the law, the policy will be considered as valid and will be construed (interpreted) as provided by the laws of the state.

8.8.10 Optional Provision #10: Illegal Occupations This provision states that if the insured is involved in committing, attempting to commit, or being connected with a felony, or participates in any illegal occupation and a loss occurs, the company will deny liability for benefits.

8.8.11 Optional Provision #11: Intoxicants and Narcotics This provision releases the insurer from liability for any loss sustained, contracted or resulting from the insured’s being intoxicated or under the influence of an illegal narcotic. The exception to this would be the consumption of a prescription drug administered on the advice of a physician.

8.9 Additional Individual Options and Contract Riders The following optional riders can be included in individual Disability Income and Health Insurance contracts for an additional premium.

8.9.1 Waiver of Premium This rider is the same as that found in Individual Life Insurance contracts. It states that in the event of a disability, premiums will be waived retroactively to the beginning of the disability. The definition of disability is usually “permanent and total,” although some companies define disability in terms of one’s “own occupation.” This provision works the same as with Life Insurance policies: premiums paid on the policy are waived after the insured has been totally disabled for a certain time, usually six months. This provision is normally only found in guaranteed renewable and non-cancelable Disability Income and Health Insurance policies.

8.9.2 Cost of Living This option gives the insured the right to periodically increase monthly Disability Income benefit levels as the cost of living increases. This increase is tied to increases in the Consumer Price Index. The increase is offered without requiring evidence of insurability, but if the benefit is included in a disability income



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contract, evidence of an increase in income is required. This is to prevent the insured’s monthly benefit from exceeding a stated percentage of earned income.

8.9.3 Guaranteed Insurability Option This rider guarantees that at specified ages or dates in the future, the insured can purchase up to a specified additional monthly Disability Income benefit amount without providing evidence of insurability. Insurers will consider earned income. The rate for the additional benefit will be that for the insured’s attained age when the option is exercised.

8.9.4 Social Insurance Supplement A SOCIAL INSURANCE SUPPLEMENT provision prevents over-insurance of an insured party that is eligible for any form of social Insurance, such as Worker’s Compensation or Social Security. Under this supplement, total disability benefits are paid from the individual policy until Worker’s Compensation or Social Security benefits begin. The Social Insurance supplement kicks in if:

x The individual does not qualify for other benefits x A lower than expected benefit is received x Payment of other benefits ends

8.9.5 Accidental Death and Dismemberment (ADD) Accidental Death and Dismemberment policies or riders provide a benefit that is paid when death or dismemberment is the result of an accident. This coverage is sold as part of Life, Health or Disability insurance, or as a separate contract. The provision usually states that the loss must occur within 90 days of an accident. Dismemberment is defined as the loss of:

x Sight x Hearing x Speech x One or any two limbs

Benefits for dismemberment are usually paid according to a schedule found in the policy, with the amounts being determined by the severity of the loss. Benefits for accidental death are usually paid in a single payment, referred to as a “capital” or “principal” sum. The purpose of this coverage is to help the insured (or his or her beneficiary) through the initial “recovery-period” by providing an extra source of income or paying the cost of rehabilitation, (physical/occupational therapy and training).

8.9.6 ADD Beneficiary Designation ADD policies pay both Life and Health Insurance benefits, however, in order for the Life Insurance benefit to be paid, the death must be the result of an accident. The BENEFICIARY DESIGNATION PROVISION is the same as those found in ordinary Life Insurance contracts. There is no additional premium for this designation and provision.



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8.10 Renewal Provisions In Health and Disability Insurance, renewal provisions vary from one policy to another and apply to an entire “class” of insured individuals. A class may include all those in a particular age group, occupational classification, or geographical region. The renewal provisions that are more favorable to the insured usually carry a higher premium and undergo more intense underwriting. Less restrictive policies for insurers generally mean cheaper but less beneficial policies for insureds. More restrictive policies for insurers usually give insureds better benefits at higher costs. The following renewal provisions are ranked from least restrictive to most restrictive for the insurer.

8.10.1 Nonrenewable/Cancelable (Term insurance) This category of policies does not have a provision for renewal and allows early termination. If the insured wants coverage to continue, a new policy must be written and premiums may increase as the insured becomes older.

8.10.2 Optionally Renewable This option allows the insurer to non-renew the policy or terminate it on a date specified in the contract (usually the policy anniversary or a premium due date). It also allows the insurer to increase the premiums for an entire class of insureds.

8.10.3 Conditionally Renewable With this type of policy, the insurer may continue the policy from one period of coverage to another, but the insurer reserves the right to terminate the coverage based on conditions stated in the contract. These conditions, which cannot apply to a change in the insured’s health, are usually tied to the insured reaching a certain age or losing gainful employment. Premiums for conditionally renewable policies can only be increased for an entire class of policies.

8.10.4 Guaranteed Renewable This category allows the insurer to renew the policy and states that, if premiums are paid, the insurer must continue coverage until a certain age (usually 60 or 65). Premiums can only be increased for an entire class of insureds, but terms and benefits cannot be changed.

8.10.5 Non-cancellable Usually used for disability income rather than medical expense contracts, non-cancelable policies are the most restrictive in terms of renewability because:

x The insurer cannot cancel them. x Benefits cannot be changed. x The premiums cannot be increased under any circumstances.

The term of most non-cancelable policies is “to age 65.” Rates are specified in the policy and are often provided on a “graduated premium schedule.”



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There is also an additional category of renewal provisions referred to as “non-cancelable and guaranteed-renewable.” These contracts must allow the insured to continue the policy until age 50, or for at least five years, so long as the policy is purchased after age 44.

8.11 Extension of Benefits Policy benefits are extended if a disabled person’s coverage terminates for any reason. The extension period is typically:

x Three months for Basic Medical expense benefits. x Twelve Months for Major Medical expense benefits.

If coverage is terminated on an individual basic rather than on a group basis, the major medical extension of benefits may be effective until the end of the calendar year following the year in which the insurance is terminated. The purpose of this benefit is to prevent a disabled individual from losing coverage after there has been a change in health or insurability (resulting from the disability). If the discontinuance of a plan refers to a group contract, where the employer terminates the entire group plan with the existing insurer, any disabled employee will be treated the same as if he or she were not disabled at the time of the termination. This requires that if there are Life, Disability, or Health Insurance benefits, the disabled individual must have the same rights of conversion to an individual contract of coverage without the requirement of providing evidence of insurability.

8.12 Cost Containment through Managed Care The method by which insurers allocate their resources is called “managed care.” The following provisions are designed to help control the mounting cost of healthcare and health insurance coverage:

8.12.1 Second Opinion Many Health Insurance policies contain a provision requiring the insured to obtain a second opinion from a physician, other than the primary attending physician, before receiving surgery that is not life-threatening.

8.12.2 Utilization Review A utilization review is designed to evaluate the appropriateness, necessity, and quality of the healthcare being provided to an individual. This review may also include a preadmission certificate and/or concurrent review.

8.12.3 Pre-certification/Authorization Under this provision, the attending physician can submit information regarding a claim, in advance of the treatment, to discover whether the procedure will be covered under the insured’s plan and at what rate it will be paid. This method allows the insurer to review the appropriateness of the procedure and the length of the anticipated hospital stay.



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8.12.4 Concurrent Review Using this method of cost containment, the insurer monitors the insured’s hospital stay to be sure everything proceeds according to schedule and that the insured will be released from the hospital as planned.

8.12.5 Ambulatory Outpatient Care Today, advances in technology, methods of treatment, and medicine permit many types of surgical procedures to be performed on an “out-patient” basis. Ambulatory outpatient care provides an alternative to costly hospital stays. Many policies offer inducements (waiver of a deductible or coinsurance requirement) to policy owners who elect outpatient treatment.

8.13 Replacement of Health Insurance Replacement occurs when a new policy is written to take the place of an old or existing contract. Replacements are strictly regulated and require full and fair disclosure to the policy owner of all facts regarding the proposed new coverage, including the benefits provided and the advantages and disadvantages of the replacement over the existing policy. A NOTICE OF REPLACEMENT form must be given to the existing and replacing insurers, informing them of the proposed replacement. This is a “statutory requirement,” which informs the insured that the replacement may or may not be in his or her best interest. The insured may want to contact the existing company for a further explanation of the contract provisions, types of coverage, limitations and exclusions. Pre-existing conditions may not be covered under the new policy.

8.13.1 Medical History – Past and Present At times, conditions covered under an existing policy or preexisting conditions may not be covered in a replacement because of the exclusions or waiting periods that may be established for the new contract. This could also apply to deductible and coinsurance payments for an existing policy. All material medical information, both current and past, must be included on a replacement application to avoid denial of a claim or termination of the policy on the basis of fraud, misrepresentation, or concealment.

8.13.2 Benefit Comparison of Current Plan vs. Proposed Plan It is the responsibility of the agent to present a thorough comparison of the advantages and the disadvantages of both existing and the proposed coverage, so that the insured/prospect can make an educated buying-decision. This is especially important in the “senior” market, where elderly individuals are more vulnerable and tend to make buying decisions out of fear.

8.13.3 No Loss – No Gain This legislation requires that when health insurance is replaced, ongoing claims under the former policy must continue to be paid under the new policy, consequently overriding any preexisting condition exclusion. When group health



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insurance is replaced, a “transfer-of- benefits” statement assures that benefits provided under the old policy will continue under the new policy.

8.14 Policy Owner Rights As with all insurance contracts, Health Insurance policies are owned. The owner may or may not be the insured, but if he or she is not the insured, a relationship of “insurable interest” must exist with the insured. In the case of health insurance, this insurable interest refers to potential financial hardship that would result if the insured became sick or injured and required medical treatment. By law, Health Insurance policy owners have the right to:

x Change beneficiaries (in an accidental death & dismemberment policy). x Renew or reinstate a canceled policy. x Assign benefits (under certain conditions). x Increase or add coverage (with certain limitations and proof of insurability). x Cancel policy coverage by not paying a premium.

The owner of a Health Insurance policy has complete control of the contract and must agree to any changes or modifications requested by the insured, if they are not the same person.

8.14.1 Eligible Expenses The ELIGIBLE EXPENSES clause refers to those expenses resulting from claims where the testing, treatment, and all costs associated with the treatment, are covered. This clause also explains limitations that may apply to these expenses. There are “inside limits” placed on certain eligible expenses, limiting the dollar amount or the number of days that a payment will be made for a specific type of treatment. Eligible medical expenses are defined as those that are prescribed by a physician and rendered by either a physician or medical personnel.

8.14.2 Assignment Most Medical Expense policies (expense incurred/reimbursement) include a provision that gives the insured the option of having benefits paid directly or “assigned” to a healthcare provider. An ASSIGNMENT form, which must be signed by the insured before benefits are paid, usually stipulates that the insured is responsible for charges not covered by the insurance. The assignment of Disability Income benefits may be made on a collateral basis, to assure repayment of a loan in the event the borrower/debtor (insured) becomes disabled.

HEALTH INSURANCE CHAPTER 9


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9 Health Insurance 9.1 Health Principles and Concepts

Not long ago, health insurance was considered a luxury for those who could afford it, but today it is an absolute necessity. Recent advances in medicine have made all aspects of healthcare better and more effective than ever before and the result has been ever increasing numbers of people living well into their 80s, 90s and beyond. At the same time, the creation and demand for new products and services has caused the cost of healthcare to skyrocket. And, as the costs continue to rise, the demand for state-of-the-art, personalized health insurance has been struggling to keep pace.

The quality and types of Health Insurance policies have vastly improved over the last 15 years, and today insurers offer virtually every type of coverage, from basic medical to major medical, managed care HMOs and PPOs.

9.2 Types of Healthcare Providers While the most common type of healthcare providers are still physicians and hospitals, a broad range of “special service” organizations have become commonplace. Here are a few examples:

9.2.1 SurgiCenters This type of provider offers a location where a patient or insured can receive surgical service on an outpatient basis, meaning no overnight stay. SurgiCenters are very popular because they are less expensive to operate than hospitals.

9.2.2 Urgent Care Centers These centers are often open 24 hours a day, to provide outpatient treatment on a “walk-in” basis. They are less costly than the Emergency Facility in a Hospital.

9.2.3 Skilled Nursing Facilities These are facilities that will provide treatment for patients that are not well enough to go home, but not sick enough to be confined to a hospital.

9.2.4 Home Health Care Home Health Care provides another cost efficient measure that allows patients to continue to receive treatment for their aliment at home.

Chapter

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9.3 Healthcare Plan Benefit Structure The following six types of BENEFIT STRUCTURES are commonly used in healthcare plans:

9.3.1 Service Plan A SERVICE PLAN is a contractual agreement between the insurer and healthcare providers, who have agreed to accept a fixed price for services rendered. The plan pays healthcare benefits directly to the providers of treatment or care, as opposed to providing a monetary reimbursement to the insured (patient). Individuals who are covered by a service plan are called “subscribers,” and are provided with medical and hospital care as opposed to insurance. In exchange for medical and hospital care, subscribers pay a premium to the service plan. The most common types of service plan providers are Blue Cross Blue Shield, HMOs and PPOs.

9.3.2 Reimbursement Plan This plan pays the insured directly for the cost of treatment or care. Expenses are paid back to the insured, by submitting a paid medical bill from the provider to the insurance company that repays or reimburses the insured.

9.3.3 Indemnity Plan An INDEMNITY PLAN typically provides a stated amount ($50 to $100) of coverage per day, based on the care or treatment received. If the covered patient has intensive or cardiac care, this type of plan offers increased (often double) daily benefits. Typically, payments are made by the insurer to the insured, without regard to the actual bill, based on a claim form submitted by the participant. However, under a federal requirement known as DUAL CHOICE an employer who has at least 25 or more employees

x In the service area of a qualified HMO x Being paid at least minimum wage and who are x Being offered an indemnity health plan

Then that employer must offer them HMO coverage as well as an indemnity plan.

9.3.4 Scheduled Benefit Plan Payment for this plan is based on a maximum dollar amount (schedule) for each surgical operation or procedure. If an operation is not on the schedule, the insurer’s underwriting department will determine the limit paid, based on a sampling of normal pricing for that given procedure.

9.3.5 Usual Customary & Reasonable Plan (UCR) This plan is based on a specific geographical region, location or area. The plan pays for procedures and benefits that are consistent with doctors, hospitals,



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surgical centers, or other providers of healthcare services. So long as the fees charged are within the limits of the plan, the claim is paid in full. Two factors are used to determine the fee limits for a UCR plan:

x The fee must be consistent with fees that are charged by a physician of the same training or expertise in the same geographical location.

x The fee charged must be consistent with a particular procedure (not over the normal limits for said procedure).

9.3.6 Relative Value Unit Scale This type of plan provides a set of points for each procedure and converts those points to a specific dollar amount. The more complex the care or treatment received, the more points (and therefore cash benefits) are assigned to the covered patient.

9.4 Types of Healthcare Plans The following list gives an overview of the types and basic structure of health insurance plans:

9.4.1 Basic Medical Expense Plans There are three different types of basic medical expense plans:

x Basic Hospital Expense (including miscellaneous hospital expenses), x Basic Surgical Expense, x Regular Medical Expense.

Typically, coverage for all of these plans is provided from the “first dollar.” This means:

x No deductible. x No coinsurance. x No co-payment.

The downside of basic medical expense plans is that the limit of benefits payable to an insured is very low by today’s standards (usually about $2,000 to $3,000).

9.4.2 Basic Hospital Expense This type of plan is limited to coverage for the primary amount of hospital room and board. Many basic hospital expense policies set limits on the amount to be paid for room and board and provide very few extras like telephone or television services. If a patient is confined to the intensive care unit, additional benefits will be paid, and there is also a provision for outpatient care.

9.4.3 Miscellaneous Hospital Expenses This plan pays for extra items needed by hospital patients. Coverage usually includes:

x X-Rays. x Lab work.



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x Drugs. x Operating room charges. x Other supplies necessary for patient care and anesthesiologists services.

NOTE: Coverage limits are based on a multiplier of the daily hospital benefit charge.

9.4.4 Basic Surgical Expenses Basic surgical benefits are paid at either a limited dollar amount or a multiplier of the daily hospital benefit charge. Coverage is provided for the services (surgical services) of a physician and can be done on an inpatient or outpatient basis.

9.4.5 Regular Medical Expense Benefits This plan pays for non-surgical physician services. Coverage includes doctor visits while the insured is confined to the hospital, and office visits, lab work, x-rays, nursing expenses (including private duty nursing while in the hospital for emergency care and treatment) and ambulance expenses.

9.4.6 Major Medical Expense Policy This type of plan is structured to provide benefits in the event of a serious or catastrophic illness and/or hospital stay. At times, major medical policies are written to supplement basic medical expenses coverage but, in these cases, a portion of the risk is shared by the insured. One of the most important features of major medical plans is a “lifetime maximum benefit” level that can be as low as one, two or three million dollars or as high as an unlimited amount. A RESTORATION OF BENEFITS provision, in some policies, allows the amount of lifetime maximum benefit to be restored after a catastrophic illness, providing that a specific amount of time elapses between illnesses (usually one year or more). This is an important feature because policy benefits can easily be drained in the event of a catastrophic illness or a longer lasting condition that requires expensive treatment. If the policy has an unlimited lifetime maximum, then this particular provision is not necessary.

NOTE: MANY SUPPLEMENTAL MAJOR MEDICAL INSURANCE POLICIES CARRY A CORRIDOR DEDUCTIBLE, WHICH IS DEFINED AS AN AMOUNT OF MONEY AN INSURED MUST PAY AFTER BASIC BENEFITS END AND BEFORE THE MAJOR MEDICAL PORTION OF A POLICY, WILL PAY ANY PORTION OF THE CLAIM.

9.4.7 Supplementary Major Medical Expense This type of plan is often an add-on policy that will cover what a basic medical expense policy does not cover. Individuals who are concerned about gaps in their basic medical expense policy usually purchase it as insurance against unexpected medical expenses that may be devastating to their financial future.



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9.4.8 Comprehensive Major Medical This is an all-inclusive plan that combines the basic and supplementary major medical expense policies into one comprehensive policy, rather than two separate policies. A popular feature of the comprehensive major medical policy is a flexible deductible that allows the insured party to increase his/her deductible to lower the premium or, conversely, lower the deductible and pay a higher premium. Typically, deductible amounts for this type of plan are $500 to $1,000, although they can also be increased to as much as $2000 to $5,000.

9.5 Optional Coverage In the past, Optional coverage for additional health insurance benefits was only available on group health insurance contracts. This meant that an individual who terminated his or her employment was likely to be left without critical coverage for dental, vision, prescription drugs, accidental death and dismemberment. Today, major insurance carriers offer Optional coverage at a reasonable premium for all of the following areas of concern:

9.5.1 Dental Coverage Dental cost plans vary from scheduled to non-scheduled plans that have deductibles and coinsurance as a part of their major medical plan. Scheduled plans will provide payment for certain dental procedures and place limits (dollar amounts) on how much the insurer will pay. Some plans also have annual payout limits to $2,000 or $3,000 per insured. Cosmetic procedures, such as veneers or gold caps, are usually excluded from coverage.

9.5.2 Vision Care Optional Vision coverage is limited to a specific number of pairs of eye-ware per year and includes eye examinations and contact lenses (limited number per year). Vision care also covers reasonable and customary charges that are clearly pointed out in the policy itself.

9.5.3 Prescription Drug Coverage This plan covers prescription drugs on an outpatient basis. The plan is based on either a direct or reimbursement structure, administered through a contract with a major pharmacy.

9.5.4 Accidental Death and Dismemberment (ADD) This Optional coverage will pay for accidental death on or off the workplace. For example, if a person killed in a car accident were covered, his or her insurance would pay a lump sum benefit to the designated beneficiary, based on the limits of the policy. Dismemberment coverage would pay a stated amount for a loss of a limb, sight, hearing or speech. Proof of loss would have to be submitted to the insurer before the benefit would be paid. A variation of the standard ADD policy is the Accidental Injury policy that often has a specific sum limitation. Here again, the insured must demonstrate that the injury is accident related.



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9.5.5 Organ Transplants This type of Optional care provides benefits when an organ transplant is necessary in order to continue the life of the insured. Life-threatening illnesses, bone marrow and kidney transplants fall into this category.

9.5.6 Maternity Expenses The benefits for this type of coverage are structured as a flat amount, fixed dollar amount, or blanket coverage. Coverage usually includes hospital room and board, the delivery of the baby, doctor’s fees, and coverage for other complications that may occur.

9.6 Health Insurance Providers/Plans The Department of Insurance has jurisdiction over the various entities that provide health insurance plans, unless the provider(s) of those plans is licensed or certified by other government agencies. Some of the most common providers and plans are:

9.6.1 Health Maintenance Organizations (HMOs) An HMO is a prepaid medical service plan that provides comprehensive healthcare services and financial benefits to its members (subscribers). Medical providers contract with HMOs to provide services. HMO members must use these contracted providers for all covered services, with the exception of emergency medical assistance. All HMOs focus on preventive medicine and convenience. Many organizations offer wellness programs to help members identify medical issues before they become serious problems. This “proactive approach” to good health has been extremely popular with members and has produced many positive results. There are also no bills or time-consuming paperwork with basic HMO services. By paying a monthly fee, members have access to a wide range of healthcare services that include basic examinations, treatment and surgery. HMOs can be established as “for-profit” or “not-for-profit” organizations. In California, the Department of Managed Health Care regulates HMOs. All members must live in the service area of their HMO. There are three categories of HMO operation: Group Practice Model (GPM) An HMO contracts with a multi-specialty medical group to provide care for its members. Members are required to receive care from physicians within the group, unless a referral is made to a medical provider outside of the network. Staff Model



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This model is actually owned, staffed, operated and managed by the HMO. Participating physicians and others professionals in this type of group are usually salaried employees of the HMO and work out of its facilities. Independent Practice / Physician Association Model A network (IPA) of independent physicians, within a geographical area, who contract with an HMO to provide services to members. With this model, HMO members select a PRIMARY CARE PHYSICIAN (PCP), or GATEKEEPER, who sees a patient first and if necessary refers him or her to a specialist in the network. This model is similar to the GPM in that physicians may work on an open or closed panel basis and may be affiliated with hospitals in the HMO network. Gatekeepers are usually paid a fixed monthly fee for each member who chooses him or her as their primary care physician. This payment method is known as the CAPITATION SYSTEM.

9.6.2 Preferred Provider Organizations (PPOs) PPOs provide a combination of the types of services provided by commercial insurers (see below) and HMOs to give insured members cost-savings and the ability to select their healthcare providers. Like the HMO, a PPO organization provides managed care to its members. A PPO consists of a group of physicians, hospitals and clinics that provide healthcare services to member groups on a prearranged fee-for-services basis. (This differs from HMOs that operate on a pre-paid basis.). Insurers designate participating healthcare providers as PREFERRED PROVIDERS, AND PROVIDE 100% coverage (less any deductibles) when members use their services. If a member elects to use a non-preferred provider, the benefits are usually reduced to an 80/20% basis. Payments under a PPO are made directly to the doctors after treatment is received.

9.6.3 Exclusive Provider Organizations (EPOs) An EPO is a type of PPO that allows members to select specific providers instead of choosing from a list of preferred providers. These providers are paid on a fee-for-services basis.

9.6.4 Commercial Insurers Many commercial insurance companies have traditionally offered health insurance plans, as well as disability and life insurance. In recent years, however, many commercial carriers have shifted their health insurance products to “Service Plans,” in which they pay benefits directly to healthcare providers (Blue Cross, Blue Shield, HMOs, etc.). By working with these types of providers, commercial insurers are able to offer both group and individual plans that keep up with consumer demand for a greater selection of benefits and, at the same time, remain in a profitable and competitive position in the marketplace.



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9.6.5 Blue Cross Blue Shield Organizations BLUE CROSS and BLUE SHIELD are healthcare organizations that have established contractual agreements (service plans) with hospitals and physicians in specific geographic areas. Contracted hospitals and physicians are paid directly for the healthcare services they provide to organization members (subscribers). Members pay monthly premiums for benefits that are defined in a specific plan. Coverage ranges from minimal to comprehensive, and is usually based on a member’s need and ability to pay. While Blue Cross and Blue Shield are different organizations that offer some similar services, they often work in concert with each other. For example, a member may receive Blue Cross hospital services on a prepayment plan, and Blue Shield physician services to cover medical, surgical and other physician expenses. Blue Cross and Blue Shield are extremely popular today and are able to offer their members a wide range of HMO, PPO and EPO products.

9.6.6 Franchise Plans Also called “wholesale plans,” FRANCHISE PLANS provide coverage to associations, professional societies and small businesses. In a typical franchise plan:

x The organization becomes the sponsor of the plan. x All members are underwritten individually. x All members receive individual policies. x Benefits vary according to individual needs.

Franchise plans can be contributory or noncontributory, and receive premium discounts. These benefits make this type of plan popular with employers and groups that do not meet the requirements or definition of a true group. SELF-FUNDED PLANS provide an alternative to group insurance, where an employer sets aside funds and makes claims payments for their employees and dependents. The main advantages of self-funded plans are:

x The business saves money if losses are less than anticipated. x The elimination of administrative costs, commissions, broker fees and

premium taxes. x Reduces group insurance expenses. x Members tend to “work harder” to maintain good health. x The company may use funds that would have been paid as premiums for

other purposes.



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The major disadvantages of self-funded plans are: x If claims are higher than expected, the business must find funds to cover

losses. x The business may need to increase payroll to cover administrative costs. x Fund contributions are not tax deductible (but premiums are). x There are no mandated benefit laws. Self-funded plans are not state

regulated, so the Department of Insurance cannot help with consumer problems.

NOTE: There is a certain amount of ERISA regulation for self-funded plans.

9.7 Limited Coverage Insurance Policies The following types of limited and often very specific coverage insurance are also available: Blanket Medical Expense Insurance Covers all medical expenses with no exclusions or maximums, except for an aggregate policy maximum. Travel Accident Insurance Covers accidents that occur when an insured is traveling. Specific and Dread Disease A policy that offers blanket coverage up to a high maximum for specified diseases, such as small pox, polio, tetanus, etc. These are generally fixed dollar benefit policies limited to scheduled diseases and/or types of impairments. Such policies often provide one or both of the following benefits: Fee schedule reimbursement based on a percentage of usual and customary charges, in the area where service is provided, for such treatments as chemotherapy, surgery, and anesthesia. Coverage may include a policy maximum. Payment of a “first occurrence benefit” upon diagnosis of a covered disease For example, such a policy might pay $2,000, when the policyholder is diagnosed as having cancer. Critical Illness The carrier agrees to pay a specific amount of money, usually as a lump sum payment, if the insured is diagnosed with one of the “critical” illnesses listed in the policy Health Specified health policies are designed to pay a first occurrence including hospital confinement and continuing care benefits. The standard covered illnesses are end stage renal disease, heart attack and stroke.



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Hospital Indemnity Insurance Hospital indemnity plans pay a fixed amount dollar amount for each day the insured is in a hospital, up to a specified number of days. The benefits paid are not tied to actual expenses and are properly treated as a form of supplement coverage. Benefits are typically payable directly to the policyholder. Accident Only Insurance A form of health policy that insures loss by bodily injury. Credit Insurance Covers a debtor for the balance due on a loan if the insured dies before it is paid off.

9.8 Other Health Plan Types Employer Medical Insurance Most companies offer their employees medical insurance. Sometimes the employer pays the entire cost of the coverage (self-funded). Sometimes the individual is asked to share the costs. Health insurance can be one of the best benefits of any job. Employers usually offer a choice of programs and employees can pick out services that best meet their individual needs. Most quality programs offer similar benefits. Participants in manages care plans – including HMOs and PPOs – are offered the chance to receive quality care without paying a high deductible, or co-payment; as long as they use a physician that is sponsored by the plan. The employer benefits from this because the premiums are usually less than those of traditional plans. Point-of-Service Plans (POS) Point of service plans combine features of both HMO plans and PPO plans. POS plans offer the insured dual or triple options when the service is provided:

x The insured may receive care from a primary care physician and receive care for a small co-payment/no deductible.

x The insured may choose to receive care from any in-network provider without a PPO referral, and pay a larger co-payment plus the deductible.

x The insured may choose to receive care from any nonparticipating provider and pay a larger co-payment and deductible. By allowing employees to choose between a plan provider, and one outside of the plan, employers can achieve managed health care for a wide range of employees.

A dual or triple option usually provides an employee the following choices:

x A traditional indemnity, fee-for-service plan that places no restrictions on the choice of health care provider.

x An HMO plan that places substantial restrictions on the choice of health care provider,



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x A preferred provider program that rewards use of preferred providers through the plan cost sharing provisions.

The introduction of this plan effectively removed the requirement that an employee choose his/her health plan at the time of open enrollment. Instead, employees are allowed to exercise the choice at the time of seeking a health care service. Under a POS plan, an employee chooses the level of cost- sharing, based on the above options. Generally, the lowest level of cost sharing applies when the selected provider is from an exclusive group of providers, often those associated with an HMO or HMO-type delivery system. The highest level of cost sharing is required when the provider selected is not under any special contractual relationship with the employer – or the employer’s insurance carrier. To some, the availability of POS plans reduces confusion; to others, it just adds confusion.

x Most POS plans feature an in-network level of benefits that work like those of an HMO. Specifically, members contact a primary physician (PCP) when they need medical care. By doing so, participants typically receive preventive health care; wellness services, better coordinated care, and lower out-of-pocket expenses.

Flexible Spending Account Plans Allows employees to use pre-tax dollars to pay dependent care expenses, as well as bills not covered by insurance. The FSA is a tool that can take care of out-of-pocket expenses (e.g. day care, dental, co-pays, prescriptions drugs, and optional care deductibles) as detailed in each specific plan. The FSA helps pay for itself by increasing employee take-home pay, while decreasing employer payroll taxes. The employee determines the amount of salary to be set aside before taxes. This amount is automatically deducted from their paycheck each pay period and deposited into their FSA account. The employees may then pay their out-of-pocket expenses up front and submit a claim, with the reimbursement being made from their account. The most common FSA, known as a medical FSA, is very similar to a Health Savings account (HSA) or a Health reimbursement account (HRA). However, while HSA and HRA plans are almost always used as a component of a consumer driven health care plan, an FSA plan is commonly offered with more traditional health care plans. An FSA account may be drawn on by a paper claim or the use of an FSA debit card also known as a flex card. Consumer Driven Health Care A basic tenet of consumer driven health care is that the client knows his needs better than anyone else, so shouldn't he/she be in control of making health care spending decisions? Consumer driven health care (CDHC) refers to health insurance plans that allow members to use personal Health Savings Accounts (HSAs), Health Reimbursement Arrangements (HRAs), or similar medical payment products to take care of routine



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health care expenses directly, while a high-deductible health insurance policy protects them from catastrophic medical expenses. High-deductible policies cost less and the user pays standard medical claims using a pre-funded spending account. If the balance on this account runs out, the user then pays claims just like under a regular deductible. Users keep any unused balance or "rollover" at the end of the year to increase future balances, or to invest for future expenses. This system of health care is referred to as "consumer driven health care" because routine claims are paid using a consumer-controlled account versus a fixed health insurance benefit. That gives patients greater control over their own health budgets. Consumers assume the decision-making role regarding their health care. Consumer driven health care received support in 2003, with passage of federal legislation providing tax incentives to those who choose such plans. Proponents argue that most Americans will pay less for health care in the long haul under CDHC not only because their monthly premiums will be lower, but also because the use of HSAs and similar products increases free-market variables in the health care system, fostering competition, which in turn lowers prices and stimulates improvements in service. Critics argue that CDHC will cause consumers to avoid needed and appropriate health care because of the cost and the inability to make informed, appropriate choices. Medical Savings Accounts Medical savings accounts, which have since been renamed Archer MSAs, are designed to pay the costs of routine medical expenses for employees of small businesses and self-employed persons. The medical plan combines a high deductible health insurance policy with a medical savings account. MSAs are tax-free savings accounts from which employees withdraw funds to pay medical bills and related health insurance deductibles. In establishing an MSA, employees or their employers take a percentage of the wages currently spent on traditional health insurance policies and purchase high-deductible catastrophic policies. The remainder of the wages is then deposited into each employee’s individual MSA to pay for any medical expenses. The catastrophic insurance policy becomes effective after the annual deductible is met. Any remaining funds can accrue from year to year and can be spent on any qualified tax deductible medical expense listed in the Internal Revenue Code. In addition, like an IRA, MSA funds earn tax-free interest and can be withdrawn at retirement. Health Reimbursement Accounts HRAs go by many names, such as personal care accounts, or consumer-driven health care plans. Whatever label you give them, HRAs allow an employer to fund an account to pay the employees’ healthcare expenses that are not covered by insurance.



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An HRA account may pay any or all of the same expenses as a Flexible Spending Account (FSA). Unlike an FSA, only employers can make contributions to an HRA. Benefits that an employer can include in an HRA Plan include:

x Insurance co-pays and deductibles, medical exams, vision expenses, dental care, mental healthcare, chiropractic services, and prescription drugs.

x Over-the-counter drugs that are medically necessary, like allergy

medications or aspirin, may also be paid through an HRA plan.

x The employer may also limit the types of expenses paid through the plan. For example, the HRA plan can exclude big-ticket items like orthodontia and LASIK eye surgery.

x Insurance premiums. Health insurance provided by the employer,

individually owned policy premiums, or long-term care insurance premiums may be paid from the HRA plan.

Once the employer establishes an HRA, the plan pays for eligible expenses incurred by participants. Unlike an FSA, there is no requirement that the entire annual allocation be available on the first day of the plan year. HRA funds can be made available all at once or in equal portions throughout the year. Employees can be allowed to carry over unused dollars to the next year. The Health Savings Account More and more often, insurance agents are hearing requests from prospective clients for a pure insurance policy with no frills, no prescription co-pays and no office visits. They want health coverage that does what it was really meant to do – provide catastrophic coverage from expensive and unanticipated medical bills. A properly designed policy that would satisfy these requirements would probably have a high deductible with a correspondingly low premium, while individuals would recognize that it would be their responsibility to handle the normal costs of prescriptions and office visits. In addition, most of the annual incurred healthcare expenses would then count toward the satisfaction of the high deductible. The ideal policy to accomplish these goals might well be a high deductible, pure catastrophic policy that is compatible with an HSA program. A Health Savings Account (HSA) is a special account, owned by an individual that is used to pay for current and future medical expenses. The HSA account has been deliberately created for use with a specific “High Deductible Health Plan” (HDHP) – an insurance plan that does not cover first dollar. The HDHP, by definition, must have a high deductible and a maximum out-of-pocket amount that meets the government requirements regulating HSA plans. The HSA can be used to pay for medical expenses (except for some types of preventive care) and can be tied to an HMO, PPO or indemnity plan, as long as the plan meets the basic requirements for an HSA.



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The funds contributed by the individual are not taxable and earn interest tax-free. This reduces taxable income and, potentially, tax liability. When the funds in the HSA are used for qualified medical expenses, the individual does not have to pay taxes on the withdrawn funds. The funds are 100% vested in the individual/employee and he/she has complete control over the assets. It should be kept in mind that, in an employer/employee situation, if the employer contributes to the account the employer can determine how often contributions are made – yearly, weekly etc. HSA plans were created through Medicare legislation signed into law by President Bush on December 8, 2003 and were modeled after Archer MSAs. The Tax Relief and Healthcare Act of 2006 later followed this legislation.

EMPLOYEE BENEFIT PLANS: CHAPTER 10 GROUP HEALTH INSURANCE


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10 Employee Benefit Plans: Group Health Insurance 10.1 Business Uses of Insurance

Depending upon the way a business is structured, Health and Disability Insurance policies are often used in business. The following pages provide an overview of some of the most common types of coverage:

10.2 Group Accident and Health Insurance Since Group Accident and Health Insurance is written on a “group basis,” the underwriting process is different from individual insurance. Specifically, there is usually minimal or no evidence of insurability required. There is no individual medical underwriting for group insurance and no medical question on the group enrollment form. Instead, group underwriters are concerned with criteria that relate to the group as a whole, such as:

x Adverse selection. x Size of the group. x Nature of the group. x Financial stability of the group. x Number and frequency of new entrants to the group.

Although medical underwriting is not required, group plans still usually require evidence of insurability for any employee who wants to join a contributory group (where employees pay part of the premium) after the initial time of eligibility.

10.2.1 Group vs. Individual Insurance In addition to the lack of medical underwriting, group insurance has the following advantages over individual policies:

x There are tax benefits in the deductibility of the payment of premiums and the tax-free distribution of benefits of group insurance policies.

x Contributions to retirement plans provide long-term benefits to both employees and the employer.

x Benefits are provided at a much lower cost than if the individual had to purchase them.

x A good group policy promotes loyalty between the employer and the employees.

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x Increased loyalty builds morale, teamwork, and productivity because employees do not have the financial (or mental) burden of obtaining and paying for these benefits individually.

x Group insurance provides Life insurance, Hospital, Major Medical and Disability Income benefits to people who could not otherwise afford the insurance, because all or a significant portion of the premium is paid by the employer or sponsoring organization.

x Family members or dependents can be covered under both an individual Life or Accident and Health policy and Group Life or Accident and Health contracts.

x Group coverage can be tailored to meet the needs of a specific group, both in the types of coverage written and the amounts of coverage, i.e., levels of benefits. In addition, co-ops, labor unions and fraternal may choose a self-insured medical and disability plan.

One of the biggest disadvantages of group insurance is that if the insured changes jobs or leaves the group, he or she may not be covered under the group contract and may be faced with the possibility of paying much higher premiums for individual coverage.

10.2.2 Franchise Plans Also called “wholesale plans,” FRANCHISE PLANS provide coverage to associations, professional societies and small businesses. In a typical franchise plan:

x The organization becomes the sponsor of the plan. x All members are underwritten individually. x All members receive individual policies. x Benefits vary according to individual needs.

Franchise plans can be contributory or noncontributory, and receive premium discounts. These benefits make this type of plan popular with employers and groups that do not meet the requirements or definition of a true group. While tax advantages can vary depending on the structure of the plan, participants normally find that the premiums are treated as individual –not group – contributions.

NOTE: COBRA, the “Consolidated Omnibus Budget Reconciliation Act of 1985,” extends group health coverage to terminated employees and their families for up to 36 months. (Please see Section 7.24).

10.2.3 The Master Contract The goal of Group Insurance is to provide coverage for members of a defined group of people under a MASTER CONTRACT or MASTER POLICY. While individual insurance is a legal contract between the insured and the insurer, group insurance is a contract between the insurer and a “sponsoring organization.”

Some examples of sponsoring organizations are employer-employee groups, trade associations, professional organizations, unions, lodges, fraternities and other special interest groups.



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Underwriters look at the group as a whole, rather than the individual members of the group. The policyholder (sponsoring organization) selects the types and amount of coverage the group will have, determines the insurer, and pays all or a portion of the premium. Upon enrollment, a CERTIFICATE-OF-INSURANCE is given to each member of the group to:

x Provide evidence of coverage. x Summarize the plan benefits. x List the terms of coverage and rights.

10.2.4 Premiums Group premiums are based on the entire group. Coverage may be: Contributory Employees (members) pay part of the premium. Non-Contributory Employers or the sponsoring organization pay all of the premiums. In order to have a contributory plan, at least 75% of all eligible employees (members) must be covered. For a noncontributory plan, all employees (members) must be covered.

10.2.5 State Regulation Most states have standard provisions for Group policies. These include:

x Providing individual certificates as evidence of coverage. x A Grace Period (typically 31 days). x Incontestability (one or two years after policy is effective, two years after

insured’s effective date of coverage). x Entire contract (application must be attached). x Evidence of individual insurability if individual joins plan after enrollment

period. x Misstatement of age results in premium (and benefits) being adjusted to

correct age. x Conversion rights, if individual coverage or master plan is terminated.

10.3 Group Underwriting Requirements The following requirements are used as guidelines in the underwriting process:

10.3.1 Predetermined Coverage Individual coverage must be based on some plan other than individual selection. Most plans are based on occupation classification, number of years of service, or income.



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10.3.2 Enrollment Percentage Employers and sponsoring organizations are required to meet the guidelines of member participation percentage and premium payments (75% or 100%).

10.3.3 Non-Discrimination Requirement A group cannot discriminate in a way that increases the opportunity for adverse selection against the insurance company. They cannot provide different levels of benefits to members of the group who are in the same classification (occupation or income level).

10.3.4 Employer Control The employer or sponsoring organization is usually in charge of enrollment, premium payment, benefit selection and all other areas of administration that are not the function of the insurance company. It is also the employer’s responsibility to see that plan administration is handled in a confidential, legal, and objective manner.

10.3.5 Insurance Incidental to the Group The group has to have been formed for a purpose other than that of obtaining group insurance benefits.

10.3.6 Eligibility The nature and function of the group must fall within the underwriting guidelines of the insurer in order to qualify for benefits. Two of the criteria that are used to determine eligibility are occupation classifications and geographic location.

10.3.7 Composition of the Group The group must be structured in such a way that there will always be new younger members joining the group and older members leaving (distribution of risk). In addition to the requirements outlined above, the California Insurance Code states that an insured who is no longer eligible for group insurance must be provided a notice of the right to convert to an individual policy within 15 days before the end the required 31-day conversion period. If this requirement is not met, the individual will be given an additional period of up to 25 days after the notice is actually given, so long as this period does not extend for more than 60 days after the end of the original 3l-day conversion period.

10.4 Eligible Employee Groups To be eligible for Group Health Insurance, an employee group policy must:

x Cover 2 or more public or private employees. x Be issued to the employer and paid by the employer or employer and

employee jointly. x Insure all employees or all of any class(s) thereof. Classes are

determined by conditions pertaining to employment.



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x Have a plan that precludes individual selection on which the amounts of insurance provided are based.

x Be written for the benefit of persons other than the employer (usually for the employees or their dependents).

x Be offered to all eligible employees and be written to insure not less than 75% of all eligible employees, when written as a contributory plan. (The policy will terminate if, subsequent to issuance, the number of insured employees falls below 2 lives or 75% of the number of eligible employees.)

10.5 Coverage of dependents Eligible dependents include:

x The insured member’s spouse. x Unmarried children from birth through 26 years of age. x Unmarried children from birth through 26 years of age if the dependent

child is attending an educational institution. x A child 26 years or older who is incapable of self-sustaining employment

by reason of mental retardation or physical handicap and chiefly dependent on the employee for support and maintenance.

For a handicapped child over the age of 26, proof of incapacity and dependency must be furnished to the insurer by the employee within 31 days of the child’s attainment of that age, and as subsequently may be required by the insurer but not more frequently than annually after the two-year period following the child’s attainment of the limiting age. Group insurance premiums covering dependents may be paid:

x By the employer. x By the employee. x By the employer and employee jointly.

10.6 Incontestability The validity of a group policy shall not be contested, except for nonpayment of premiums, after it has been in force for two years from its date of issue. No statement by an insured employee relating to his or her insurability shall be used in contesting the validity of the insurance after it has been in force for two years during the employee’s lifetime prior to the contest, unless it is contained in a written application, signed by the employee.

10.7 War, Military and Aviation Risks An employee group policy may state that the insurer is not liable, or is liable for a reduced amount, for any losses:

x Relating from war or any act of war. x Relating to military or naval service. x Relating to aviation exposures.



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The Commissioner may set reasonable rules and regulations relative to the provisions permitted by this section.

10.8 Misstatement of Age If the incorrect age is given on a group insurance application, the premium and/or benefit must be equitably adjusted based on the correct age. (For individual insurance, only the benefits are adjusted.).

10.9 Certificate of Insurance The document is “evidence of coverage” for an individual covered under a group health insurance plan. It is evidence of the coverage and the certificate, which can range from a wallet card to a “contract-like,” outlines the policy coverage, exclusions, deductibles, age limits, notice and proof of loss requirements, the insurer’s right of examination, and conversion privileges.

10.10 Conversion Privilege Group health insurance plans usually allow an insured to convert coverage to an individual policy without evidence of insurability. This privilege can be exercised when the insured is no longer eligible for coverage because:

x Employment is terminated (COBRA). x The insured’s “class” is no longer eligible for coverage. x The insured’s dependent child reaches the age at which he or she is no

longer eligible for coverage as a dependent.

The insured (or dependent) has 31 days from the time of ineligibility to exercise the conversion option without having to provide evidence of insurability. During this time, the individual is still covered under the group plan. Insurers are permitted to evaluate the individual during this time and charge an appropriate premium for the converted insurance. New premiums will be based on an individual rate, rather than a group rate, and will most likely be higher.

10.11 Policy Replacement: Group Accident and Health Policies Any Group Accident or Health policy that provides specific indemnity during a hospital stay, or hospital, medical or surgical expenses must allow for Extension of Benefits upon Discontinuance of the policy for any employees who became disabled while covered by the policy and who are still disabled. DISCONTINUANCE is the termination of a policy or coverage by an insurer for an employee unit under a group disability policy, non-profit service contract or self-insured welfare benefit plan. EXTENSION OF BENEFITS means that continued coverage of a specific benefit must be provided after Discontinuance for any employee or dependent who was totally disabled on the date of discontinuance.



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The Extension of Benefits may be terminated when the employee is no longer disabled or when a succeeding carrier provides benefits. The coverage provided by a succeeding carrier is called REPLACEMENT COVERAGE. Carriers who provide replacement coverage within 60 days must immediately cover all employees and dependents covered under the previous policy on the date of discontinuance at a level of benefits equal to those offered by the discontinued policy. Succeeding carriers are not, however, required to provide benefits for conditions that caused an employees or dependent’s total disability.

10.12 Blanket Insurance BLANKET INSURANCE is written for groups whose membership changes frequently (students, camp attendees, members of volunteer groups, etc.). It can also be used to cover publication groups and independent contractors. Blanket Insurance has the same requirements and provisions as other forms of group protection. The Commissioner does not fix rates, but they must be approved and they must be less than the usual rates for equal protection. The term of a blanket policy may not exceed one year. Blanket Insurance coverage is automatic unless a written request for exclusion is submitted by more than 10% of a defined covered group. If the total requests for exclusion exceeds 10%, coverage will either not be issued or not be renewed.

10.13 Multiple Employer Trusts (METs) METs are legal entities that provide pensions, group health insurance and other types of employee benefits to groups of two or more unrelated companies. Employer contributions are paid to a common pool from which benefits are paid. This approach gives MET members similar rates and benefit levels – a coordination of benefits- to those received by larger corporations. A “sponsor” (insurance company, agent, broker or third party administrator) usually sets underwriting guidelines, rules and requirements for METs. The sponsor also will typically develop and administer the plan.

NOTE: A third party administrator (TPA) is an outside organization that receives a fee for handling plan paperwork and/or processing claims.

10.14 Regulation of Qualified Plans The 1974 Employee Retirement Income Security Act (ERISA) provides for the regulation of qualified retirement plans, including group insurance. ERISA establishes reporting and disclosure requirements for employer-sponsored plans including mandates regarding information that must be provided to plan participants. The 1974 EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA) provides for the regulation of qualified retirement plans and group insurance plan



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participants. ERISA establishes reporting and disclosure requirements for employer-sponsored plans. Specific ERISA regulations establish requirements for:

x Program eligibility x Tax rules x Contribution requirements x Vesting x Penalties for non-compliance with plan requirements

NOTE: ERISA requirements will change and be updated as laws (especially tax laws) change.

10.15 COBRA The CONSOLIDATED OMNIBUS BUDGET RECONCILIATION ACT (COBRA) is a federal law that guarantees continuation of employee health insurance (at group rates) when group coverage is terminated for any reason other than gross misconduct. All employers with 20 or more employees must offer this extension of coverage to former employees and their families for either 18 or 36 months while they make the transition to coverage under another job or private insurance. To be eligible, the employee must be a “qualified beneficiary” (covered employee, spouse of the covered employee or dependent children of the covered employee) on the day before the “qualifying event” (termination). For employers with less than 20 employees, Cal-COBRA (2-19 employees) is available to some eligible employees, spouses and dependent children of the covered employee. The following six qualifying events each provide coverage for a specific period of time:

18 Months

x Termination of employment, other than gross misconduct. x Reduction of hours worked to the point where the employee is no longer

eligible for group coverage.

36 Months x Death of the employee (coverage for spouse and dependent children). x Dependent child who no longer qualifies as a dependent x Medicare eligibility of employee. x Divorce or legal separation of employee (continued coverage for former

spouse). Employers are required by law to notify terminated employees of their eligibility for COBRA, after which the employee has 60 days to elect coverage. The following “disqualifying events” can result in the termination of coverage:



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x The first day when a premium is not made on time. x The day the employer terminates any or all group plans. x The first day when the individual is eligible for coverage under another

group plan. x The date the individual becomes eligible for Medicare.

10.16 24 Hour Coverage Twenty-four hour coverage involves the joint issuance of a workers compensation policy with a disability policy healthcare service plan project or other medical insurance. It does not include life insurance.

10.16.1 Accident and Health Agent Licensed to Sell 24 Hour Coverage 24-hour coverage is the joint issuance of a Disability policy and a Workers’ Compensation policy. Accident and Health agents who wish to sell this type of coverage must complete an approved continuing education course on workers’ compensation and employer liability. The required number of hours is equivalent to the hours of study required for these subjects by the curriculum board for the pre-licensing requirements of a property and casualty agent.

10.17 Workers’ Compensation Benefits Laws governing the legal relationships between employees and employers have changed dramatically since they were first questioned in the mid-1800s. At one time, employees could only seek damages for work related sickness or injury under “common laws.” This meant that employees had to prove that their injury or illness was work-related in court before they could receive any compensation. The courts eventually realized that employers had at least some obligation to employees and expected them to provide:

x A safe place to work. x Safe equipment to work with. x Enforcement for safety regulations. x Warnings about dangerous aspects of jobs. x Competent fellow workers.

When an employer violated any of these obligations, employees could try to establish negligence. The process, however, was difficult, costly and nearly impossible for injured workers. More importantly, the employer had a number of legal defenses, even if he or she were proven to be negligent. These were:

The Fellow Servant Rule Stated that when an injury was caused by the negligence of a fellow employee, it was not the fault of the employer who was, therefore, relieved of responsibility Contributory Negligence Stated that when an injured employee was even partially responsible for an injury, he or she lost all rights to damages.



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Assumption of Risk Stated that an employee knew in advance of the dangers associated with their job and were paid for assuming the accompanying risks.

In addition to these legal defenses, disabled workers had no assurance that they would be able to return to their jobs after recovery, and survivors of an employee, who died as a result of a job-related injury, had no rights whatsoever. The situation was made even worse by the fact that many employers began forcing employees to sign statements, releasing them from liability, before giving them a job. The industrial revolution brought an explosion of new factories that created many more hazardous jobs and job-related injuries. By the end of the 19th century, courts were becoming more aware of employees need for workplace protection, and they began enacting employer liability laws that changed common law defenses. The “fellow servant” definition was narrowed to exclude managers and supervisors, and contributory negligence was replaced by comparative negligence, that allowed a partially responsible employee to claim partial damage. Survivors of workers who died were also given the right to claim damages and the practice of requiring employees to sign release agreements was deemed illegal in many states. The concept of a worker’s compensation system began in Europe and gained attention in the US in the early 1900s. These early systems were built on the concept of “absolute liability,” which obligated the employers to compensate injured workers without regard for fault or negligence. Between 1902 and 1910, four states passed worker’s compensation laws, but all of them were declared unconstitutional. Finally, in 1911, Wisconsin passed the first worker’s compensation laws that remained in effect on a long-term basis. Soon, other states passed similar laws and began offering insurance policies to cover employer obligations, based on those laws. Most of the early worker’s compensation laws were elective rather than compulsory but, in 1917, the Supreme Court upheld the right of states to enact compulsory laws. This act dramatically changed the relationship between employee and employer and laid the foundation for our worker’s compensation of today.

EMPLOYEE BENEFIT PLANS: GROUP HEALTH INSURANCE

DISABILITY INCOME INSURANCE CHAPTER 11


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11 Disability Income Insurance Disability Income Insurance is often the most overlooked type of insurance policy. Even though it has been in existence for almost a century and plays a vital role in today’s economy, many individuals and businesses feel the coverage is too costly for the potential return. Still, policies have improved a great deal in the last 40 years. The purpose of disability insurance is to replace income when a sickness or accidental injury makes it impossible for an insured to work. Loss of time coverage is also a phrase used to describe disability income insurance. Some policies may restrict benefits payments only to disabilities arising from accidents. The risk of suffering a disability during one’s life is high and, while the risk decreases with age, increasing age tends to extend the recovery period. The effects of a disability can be devastating and sometimes result in a “living death”. When premature death occurs, life insurance benefits are paid, but with a disability, such benefits are of no value. Meanwhile, the disabled person’s normal monthly expenses continue, along with the medical expenses associated with the disability. The only remedy for this situation is to rely on:

x Savings x Business Assets x Other Personal Assets x Government Programs x Loans

Agents/Brokers need to consider the following information when designing a quote for disability income insurance. Determining the elimination period and benefit period are extremely important. For example, if you show a potential client an illustration that has a short elimination period (time frame before the first monthly payment) and a long benefit period (the period of time the monthly benefit will pay): For example, to age 65 or lifetime. This will demonstrate the highest premium. Take the time to determine the prospects needs and budget, better known as qualifying. Once you have determined that a prospect has a need for disability income insurance, you need to understand two important terms:

x Own Occupation x Any Occupation

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NOTE: Important underwriting information to determine a quote is age, health condition, vocation and avocation.

These two different policies will be the basis for the final premium for your prospect. The following is a description of these two forms of coverage: Own Occupation Definition Own Occupation definition defines disability as follows: “The inability to perform the material and substantial duties of your regular occupation,

the insurance company will consider your occupation to be the occupation you are engaged in at the time you become disabled, they will pay the claim even if you are

working in some other capacity.” If you are unable to perform your current occupation you will qualify for disability payment even if you have a different job. For example, if a dentist has an accident and losses a finger which will prevent him from completing his duties as a dentist he will qualify for disability payments even if he becomes a professor at a University. Any Occupation Definition This is the most restrictive definition; an “any occupation” policy defines disability as:

“The inability to perform the duties of any occupation.” This definition of disability is strict. To receive benefits according to this definition, you have to be unable to work in any occupation, not just your own. So if you are capable of performing any job you will not be entitled to disability benefits, usually it will take into account education and past work experience. Some disability plans are set up as Regular Occupation Definition for the first five years and then become Any Occupation policy.

11.1 Types of Disability The following types of disability may be eligible for disability income insurance coverage:

11.1.1 Total Disability The definition of “total disability” may vary from policy to policy and could mean any of the following:

x The inability to perform the duties of one’s own occupation. This requires the most expensive premium and is the most thoroughly underwritten policy, because the insurer cannot cancel the policy, even if the policyholder’s occupation changes to one with a greater risk factor.

x The inability to perform the duties of any gainful occupation for which the insured is reasonably suited by education, training or experience.



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Under this definition, if the insured can be placed in another position, in a related occupation, then he or she may not qualify for a benefit. The list of jobs that a person could qualify for by training, education or experience is very broad and would probably include many jobs that would be well below the policyholder’s regular pay scale.

Many policies require regular medical exams by insurer-approved doctors to validate a continued disability status. If the insured does not follow the requirements set by the insurer, it is possible that there will be a discontinuance of the benefit. Many policies will only pay if the condition of the insured satisfies one of the definitions shown above for total disability.

11.1.2 Partial Disability Following a period of disability, there is often a time during which the person is unable to perform one or more of the important daily duties and responsibilities of his or her occupation, with a corresponding loss of productivity. This is related to the individual’s ability to perform the responsibilities of his/her job, and most insurers pay limited benefits to the policyholder. The normal benefit is 50% of the weekly or monthly benefit that would be payable for a total disability. Partial disability benefits are normally payable for a relatively short period, ranging from 3 to 6 months. Some policies will only pay a partial disability claim if it begins within a stipulated period after an accident. Other policies will only pay a benefit if the partial disability immediately follows a period of total disability caused by sickness.

11.1.3 Residual Disability This type of disability definition applies to a person who returns to work after a total disability but cannot yet operate to his or her full capacity. Consequently he/she cannot earn as much as prior to their total disability. Coverage provides benefits Proportionate to the loss of earning power, regardless of the type of work done or the amount of compensation. The benefit is adjusted on a monthly basis until the insured returns to full capacity (% of lost income x full monthly benefit = paid benefit).

11.1.4 Recurrent Disability Sometimes an individual will return to work too soon after a total disability and suffer a relapse, traceable to the same cause as the original injury. This is usually classified as a recurrent disability and is also a form of partial disability. If the relapse occurs within a stated period of time (up to six months), then the recurrent disability will be considered a continuation of the first disability. Otherwise, the second event will be considered a new disability and be subject to a new elimination period.



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11.1.5 Presumptive Disability A type of total and permanent disability where the insured has a loss of sight, hearing, speech or the loss of any two limbs. This type of disability is presumed to be total, permanent and irreversible and the insured will not have to prove continuance of the disability. In many cases, a presumptive disability, while permanent, will still permit the insured to lead a productive life. If so, there is often a lump (“capital”) sum payment at time of loss. Whether the policy will continue to make additional benefit payments over an extended period of time would be dependent on the provisions and definitions of the policy.

11.1.6 Temporary Disability A temporary disability incapacitates an insured for a period of time, after which he or she will be able to return to work.

11.1.7 Social Security Definition of Disability The Social Security Administration approach to disability is rigid and conservative. A total disability is simply defined as:

x The inability to perform any substantial gainful employment that currently exists in the national economy.

x A disability that is expected to last at least 12 month or end in death. The federal administration typically denies two-thirds of filed disability claims. If approved, there is still a 5-month waiting period before the start of benefit payments.

11.2 Terms and Definitions It’s important to have a clear understanding of the following policy terms used in conjunction with disability coverage.

11.2.1 Injury vs. Sickness Disability benefits are paid in cases of accidental injury or sickness when the following definitions apply: Accidental Injury The result of an unintentional and/or unforeseen event. The event was not under the control of, or intentionally caused by, the insured .In a few policies, the causal event is the determining factor in authorizing a benefit payment, rather than the injury itself. Sickness Any condition, ailment, disease or illness that first manifests itself after the effective date of the policy and while the policy is in force. This definition may exclude work-related disabilities when the policy provides non-occupational coverage only. The benefits are usually the same for both accidental injury and sickness; however, the elimination period may differ as follows:



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Accidental Injury No elimination period or a reduced-time waiting period. Sickness A specified waiting period (30 days or six months).

NOTE: Insurers will not pay a claim for Disability Insurance if it found that the accident was found to be self-inflicted.

11.2.2 Short-term vs. Long-term Disabilities Disabilities are classified as either short-term or long-term. Short-term Disability Short-term disability coverage is usually a part of a Group Disability Policy. Short-term benefits are generally provided for no more then one year. Elimination periods are 30 days or less. Long-term Disability A long-term disability usually has a longer elimination period (90 days to 6 months or more) and a longer benefits payment period (2 years, 5 years, or to age 65). Long-term disability coverage takes over where short-term disability coverage ends, although some conditions may apply.

11.2.3 The Concept of Morbidity The basis for the underwriting of disability insurance is the concept of “morbidity.” Just as it is defined in health insurance, morbidity is the frequency of illness and accidental injury that occurs within a specific group over time.

11.2.4 Integration of Benefits Integration (or Coordination) of plan benefits avoids over-insurance by “sharing the risk” with other insurers. Integration applies to:

x Benefits for income provided by another employer plan. Coverage by more than one disability income policy, salary continuation agreements, etc.

x Benefits that the insured is entitled to under Social Security Disability Income.

x Benefits payable under Workers Compensation and State Disability programs.

11.2.5 Elimination Period (Time Deductible) Also called the “WAITING PERIOD,” this is the time during which the insured must be totally disabled before income benefits will be paid. The typical elimination period is from 30 to 60 or 90 days and, in some cases, it may be as much as one year. Generally, it is regarded as a cost-sharing device or self-insured retention period. It is normal for the elimination period to be waived in cases of accidental injury, but not sickness.



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Probationary Period Probationary Period is the timeframe until coverage becomes effective; 30, 60 or 90 days. There are three questions that should always be asked when considering the purchase of a Disability Income Insurance Policy:

1. How long will the insured have to wait before benefits will be paid? 2. How much will the insured receive each month in benefits? 3. How long will the benefits be paid?

NOTE: A claim by the insured must be submitted to the insurer prior to payment of a disability benefit.

11.2.6 Benefit Period The BENEFIT PERIOD is a predetermined period of time that the benefit will be paid to the insured after the elimination or waiting period is satisfied. The benefit period could be for less than a year or it could last the remainder of a lifetime, providing that the person remains disabled and unable to earn an income. The longer the benefit period (typically being 1, 2 or 5 years; age 65 or lifetime) the higher the premium, as the insurer is accepting the risk for a longer time period.

NOTE: The shorter the elimination or waiting period and the longer the benefit period, the higher the premium will be. Conversely, a longer elimination period and shorter benefit period will result in a lower premium. This is why it is imperative that an agent collects sufficient information about the prospect’s financial exposure, versus available resources, to fund premiums.

11.2.7 Short-Term Benefits Short-term disability policies typically have a short elimination period (30 days or less) and benefit period (six months to one year). Benefits are limited to a percentage (usually 60% to 70%) of the insured’s gross monthly income. This lower payment is designed to provide income and, at the same time, provide an incentive to return to work. Short-term benefits often “fill the gap” in coverage while an insured is waiting for Social Security disability benefits to begin (there is a five month waiting period).

11.2.8 Long Term Benefits Long-term disability policies usually carry a 90-day to six-month waiting period and provide benefits for a longer period of time (two years, five years, or to age 65). Benefits are typically limited to a percentage of the insured’s gross monthly income (usually 60% to 70%).



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11.2.9 Lump Sum Benefits Lump sum benefits are usually paid if the insured has a PRESUMPTIVE DISABILITY. The insurer understands that the insured will probably not be able to work again and, therefore, offers a lump sum payment based on:

x The disability. x The age and gender of the insured. x The type of policy (length of exposure by the insurer).

NOTE: Benefits for policies covering some business buy-sell agreements are also paid in a lump sum.

11.2.10 Occupational vs. Non-occupational Coverage Disability income coverage may be written on an “occupational” or “non-occupational” basis. OCCUPATIONAL COVERAGE is the most expensive type of coverage, providing benefit payments for accidents occurring on or off the job. NON-OCCUPATIONAL COVERAGE only provides payment for a disability that is not work related.

11.2.11 Benefit Amount The BENEFIT AMOUNT is the amount that will be paid to a covered individual each month of a disability. Most policies have a minimum amount, usually ranging from $50-$100, while monthly maximums do not usually exceed $10,000.

11.2.12 Limits of Coverage The benefit amount is limited to a percentage of gross monthly income, usually between 60-70% of earned income. The primary reason for this limitation is to motivate the recipient of a monthly benefit to return to work as soon as he or she is able to do so.

11.3 Standard Exclusions and Limitations The following exclusions typically apply to disability income insurance coverage:

x Attempted suicide x Injured while committing a felony x Overseas resident x Aviation, with certain exemptions x Pilot or crew of scheduled airlines x War x Military Service x Intentional self-inflicted injuries

Benefits may be reduced or denied, if the disability occurs during the course of foreign travel.



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11.4 Taxation of Benefits The TAXATION of disability income benefits depends on who pays the premiums. Premiums paid entirely by the insured are not tax deductible, but any benefit paid is not taxable as income. If the employer pays any portion of the premiums, that portion of the payable benefit, attributable to the employer contribution, is taxable as income. The portion paid by the insured is not subject to income taxation. Premiums paid by the employer are not tax deductible, unless an employee receives benefits from the plan. When the employee receives benefits, the premium paid for that employee then becomes an employer tax deduction).

11.5 Optional Benefits & Riders Disability policies, as a rule, don’t have a great number of riders available. The following types of optional benefits and riders are commonly found in disability income insurance policies:

11.5.1 Rehabilitation Benefits Many individuals receiving disability income are never able to return to their normal occupation due to their physical or mental condition. The rehabilitation benefit provides continued disability income, while the insured completes vocational training to prepare for a new career, so long as:

x The insured is still disabled. x The insured participates in the approved training program.

Some insurers pay a lump sum amount for vocational training, while other insurers continue to pay monthly benefits.

11.5.2 Future or Automatic Increase Option This option (also referred to Guaranteed Insurability Option or Guaranteed Purchase Option) gives the insured an opportunity to purchase additional amounts of disability insurance at a later date. In most cases, a designated time is given as to when and how much coverage may be purchased. For example, one might have a 3% increase each year for 5 years. If the insured takes advantage of this option, there is no medical requirement. However, the insured must prove that he or she has enough income to substantiate the increase amount. This is a recommended option, as it allows one’s disability benefits to keep up with the policyholder’s increases in income and obligations. This is usually a lower cost, lower benefit option than the Cost of Living Benefit Rider.

11.5.3 Cost of Living Benefit This rider increases benefits to keep up with inflation and cost of living increases.



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11.5.4 Lifetime Benefit A Lifetime Benefit Rider may apply to accident only or accident and sickness benefits and pays benefits to an insured from age 65 to the end of life. Policy provisions often limit the lifetime benefit by:

x Defining when an illness must begin to be covered. x Restricting the length of the benefit period. x Reducing benefits after a certain period of time.

11.5.5 Social Security Riders The Social Security Administration defines total disability as:

x The inability to perform any substantial gainful employment that currently exists in the national economy.

x A disability that is expected to last at least 12 months or end in death. While most individuals are not aware of these stringent definitions until they become injured or fall ill, the following Social Security riders provide some protection against being left without coverage:

x All or Nothing Rider – The insurer will pay a benefit if Social Security pays nothing. However, if Social Security pays benefits, the insurer pays nothing.

x Offset Rider – This rider will offset the amount Social Security pays by obligating the insurer to pay a specific amount stated in the policy. Remember that if Social Security does pay a benefit, the insurer will reduce the amount they pay to the insured.

Once a disabled person has been approved for a Social Security disability, there is still a five-month elimination period before he/she will receive monthly benefit payments. Because of this gap, many disability income insurance companies offer riders that pay the policyholder a specified amount for every month that there is no collection of a Social Security benefit payment. Even when the disability policy has a 90-day elimination period, this means that the policyholder can still collect for the fourth and fifth month of the Social Security elimination period.

11.5.6 Social Insurance Supplements To avoid over-insurance, some insurers anticipate Social Security or workers compensation benefits when deciding how much coverage they should provide. If workers compensation benefits are not payable, and an insured does not qualify for Social Security, this coverage could be inadequate. This potential problem can be avoided through the offset provisions (described above) or through “social insurance supplements” that pay only when other benefits are not available. Social insurance supplements prevent over-insurance and allow benefit integration by providing total disability benefits until workers comp or Social Security benefits begin. If either of these benefits stops, the social insurance



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supplement will begin again, so long as the insured is still disabled and the benefit period has not been exhausted. Additional Monthly Benefit Rider (AMB) Also called a Social Security Rider, this option provides short-term coverage (six months to one year) while the insured is waiting for Social Security benefits to begin. Hospital Confinement Rider If the insured is hospitalized, this option pays a benefit, so long as the insured is an inpatient. While most disability benefits will not begin until the elimination period has expired, the “hospital confinement rider” provides total benefits immediately, so long as the insured is hospitalized (includes transplants). Non-disabling Injury Rider This option does not pay a disability benefit, but will pay for emergency room or outpatient medical expenses traceable to an injury that does not result in a total disability. There may be some coverage duplication with an existing health insurance policy. Waiver of Premium This rider waives the premium in the event of a disability and is retroactive to the start of the disability period. Previously paid premiums will be returned to the insured in one lump sum.

11.5.7 Return of Premium This rider returns a percentage of premiums paid, less claims paid, at future dates, such as every 5 years. Usually, this is an expensive rider and only returns an average of 60% to 80 % of premiums paid, under rather rigid restrictions. To collect, policyholders often refrain from reporting legitimate claims Accidental Death and Dismemberment (AD&D) Accidental Death and Dismemberment policies or riders provide a benefit that is paid when death or dismemberment is the result of an accident. Dismemberment refers to loss or loss of use of sight, hearing, speech or limb(s). This provision usually states that the loss must occur within 90 days of an accident. Benefits for dismemberment are usually paid according to a schedule found in the policy, with the amounts being determined by the severity of the loss. Benefits for accidental death are usually paid in a single payment, referred to as a “capital” or “principal” sum. The insured’s death benefit will be paid to a beneficiary.

11.6 Disability as Employee Benefit Disability insurance is often offered as part of a corporate employee benefit package. Specific uses of disability income as an employee benefit include:



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11.6.1 Sick Pay Plans This is a formal program for continuing the compensation of key employees, owners and stockholders of a company in the event of a disability. This type of plan may be:

x Funded with a disability income policy. x Unfunded with the benefits paid from corporate income.

If a sick pay plan is established according to appropriate IRS guidelines, it can be tax-deductible. Specific requirements include:

x The plan must be effective before a disability begins. x The establishment of the plan must be in writing and part of the corporate

minutes. x The plan must be communicated in writing to all employees.

11.6.2 Group Plans The majority of employees own life insurance, rather than disability income insurance, even though the majority of wage-earners need disability income protection every bit as much as high earners. Many employers recognize this and offer group disability income coverage as a fringe benefit. A group disability plan is often used in place of a formal salary continuation plan. This type of plan offers occupational or non-occupational coverage for all employees, or for those key individuals not covered by a sick pay plan. Group plans can be:

x Short-term plans that provide 60% to 70% of earned income for a period of six months to one year. These plans typically have a short elimination period (30 days or less).

x Long-term plans that provide 60% to 70% of earned income for a period of two to five years up to age 65. These plans typically have a longer elimination period (90 days to six months).

While employers, in return for a tax deduction, usually pay for group disability plans, they may also be set up as a payroll deduction plan. Some employers self-insure a portion of the disability benefit, paying the employee directly for the first three months, whereupon the insurance carrier provides the benefit. Eligibility may also be conditioned on the length of the employee’s tenure with the company.

11.7 OBRA Impact On Disability Benefits The 1989 Omnibus Budget Reconciliation Act (OBRA) extended the minimum COBRA coverage for an additional 11 months for qualified disabled individuals. The conditions are:

x The disability must meet the Social Security definition of disability. x Termination may not have been for gross misconduct.



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x The individual must request OBRA coverage within the first 60 days following receipt of the SSDI determination letter.

x There may be a charge equal to 150% of the COBRA premium for coverage.

OBRA is basically an 11-month corridor, designed to provide COBRA coverage to the disabled individual. When a person becomes SSDI qualified, he/she is also eligible for Medicare – 24 months from the date of the first month payment. As there is a 5-month waiting period from SSDI qualification until the first month of payment, the actual waiting time is 29 months (COBRA + OBRA).

11.8 Residual Disability Income Just as the inability to perform duties of an occupation triggers the benefits of a traditional disability income policy, residual disability benefits are triggered by a loss of pre-disability income. Many traditional disability income policies provide a partial disability benefit equal to 50% of the insured’s total disability benefit, payable for up to six months. The residual disability policy provides a long-term partial benefit relative to the loss of pre-disability earnings. Most mandatory and optional disability income provisions apply to residual disability contracts but there are several that are unique to the residual policy.

11.8.1 Definition of Total and Residual Disability In a residual policy, total disability may be defined as the inability to perform the duties of your occupation. When this is the case, 100% of the total disability benefit is paid even if the insured begins to work in another occupation.

11.8.2 Your Own Occupation (least restrictive definition) The “your own occupation” definition in the policy may entitle an insured to residual benefits if there is at least a 20% loss of pre-disability income following a total disability. If this definition is removed from the policy, residual disability will be defined as the ability to perform some, but not all, of the duties required in the insured’s occupation; and residual benefits will still be paid so long as the insured’s income is reduced by at least 20% of pre-disability income. With this definition, a proportionate benefit is paid relative to the amount of lost income due to disability. (In other words, 100% of the total disability benefit is paid for disabilities resulting in 100% loss of pre-disability income; 80% of the total disability benefit is paid if the insured suffers an 80% loss of pre-disability income, etc.)

11.8.3 Qualification Period The qualification period is the period of time the insured must be totally disabled before becoming eligible for residual benefits. In addition, the insured must also satisfy the policy’s elimination period. Many companies offer residual policies without qualification periods.



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The elimination period doubles for the qualification period; thus, when a residual policy has a 0-day qualification period, satisfying the elimination period makes the insured eligible for total or residual benefits.

11.8.4 Pre-Disability Earnings The insured’s pre-disability income is used to calculate residual benefits. It will usually be based on an average income for a specified period of time such as one, two or three years.

11.8.5 The Marketplace – Business Disability Income Uses There are several types of Disability policies now available in the marketplace that provide for the protection of business income. Examples include:

x Business Overhead Expenses: Pays a monthly benefit towards the insured’s business overhead expenses if he or she becomes disabled for a period of time. The benefit is based on actual expenses – not anticipated profits. It is designed for single proprietor and small businesses, where revenue generation is limited to a small number of people.

x Key employee and Partner Policies: Purchased by a business naming a specific employee, executive or partner. The purpose is to protect the business and its income stream, if the insured is injured or disabled at any time. This provides business protection and allows operations to continue without interruption when disability strikes down a key person.

x Business Disability Buyout: Following the same principles as Buy/Sale life policies, this type of coverage is a common method used to insure that necessary funds will be available to “buy-out” the business interests of a partner or co-owner. A buy-sell agreement establishes a pre-determined business price and a buyer for the business interest.

x Individual Disability Income Insurance: For most employees an individual disability income policy is often the best way to ensure adequate income in the event of disability. Such a policy will replace from 50% to 70% of income.

MEDICARE HEALTH INSURANCE CHAPTER 12


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12 Medicare Health Insurance MEDICARE, also called Health Insurance for the Aged, went into effect on July 30th, 1965, when the Social Security Act was amended to include health and medical care benefits. The purpose of this federal program is to provide hospital and medical expense insurance to:

x People 65 and over. x People (of any age) with chronic/permanent kidney disease and End

Stage Renal failure. x Certain disabled people (usually those receiving Social Security benefits

for at least 24 months). There are 4 types, or parts, of Medicare, of which A and B are Original Medicare

Part A: Hospitalization Insurance Part C: Medicare Advantage Part B: Medical Insurance Part D: Prescription Drug Plans

12.1 Part A: Hospitalization Insurance “PART A” MEDICARE HOSPITALIZATION INSURANCE pays for inpatient hospital care fees, services and follow-up care. The program is financed through a portion of all covered worker’s Social Security payroll tax and deductible amounts payable by Medicare enrollees. Benefits are automatically provided, with no monthly premium payments to an individual at the age of 65, who has qualified for Social Security benefits.

12.2 Part B: Medical Insurance “PART B” MEDICAL INSURANCE coverage provides medical insurance covering the costs associated with care received from physicians, surgeons, and other health services not covered by PART A HOSPITALIZATION Insurance. This supplementary program is voluntary and paid for by the enrollee’s monthly premiums and general revenues, rather than through Social Security tax.

12.3 Eligibility The following specific requirements define Medicare eligibility:

x People ages 65 or older that are entitled to monthly Social Security or Railroad Retirement benefits, or are eligible under either system to a monthly benefit, although not receiving it.

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x People ages 65 or older that are entitled to monthly Social Security benefits based on a spouse’s work record. The spouse must be at least 62.

x People ages 65 or older who have worked long enough in the federal, state or local government to be insured for Medicare purposes.

x People of any age who have worked long enough to meet the requirements for, or are already entitled to Social Security Disability Benefits - and have been receiving benefits for 24 consecutive months.

x People ages 65 or older who are not eligible for Social Security benefits, but are willing to pay a premium for Part A Medicare benefits.

12.4 Part A: Hospitalization Insurance Deductible and Coinsurance Amounts

PART A will pay 100% of all covered services for the first 60 days of hospital confinement, except for a one-time deductible for each benefit period ($992 as of 2007). A benefit period begins the first day a patient enters a hospital or skilled nursing facility and ends when he or she has been out of the hospital for 60 consecutive days. After 60 days, any new hospital or skilled nursing facility admission is considered to be the start of a new benefit period. Every individual also has a nonrenewable reserve of 60 additional hospital days, with coinsurance each day, which can be used once during a lifetime. For example:

x From 61 to 90 days, the patient pays $248 per day. x From 91 to 150 days, the patient pays $496 a day. However, make note

that after the 90th day, the patient is using up his/her lifetime reservoir of hospital days. After the 150th day, the patient must pay the entire cost.

12.5 Part A Coverage Part A coverage provides for inpatient and post-hospital skilled nursing facility care and home healthcare. Specific benefits include:

12.5.1 Inpatient Hospital Care Each individual is covered for up to 90 days in a participating hospital during each benefit period. There is a lifetime reserve of 60 days if more than 90 days of hospital care is needed during any single benefit period.

12.5.2 Skilled Nursing Facility Care There is a 100- day benefit period for care in a skilled nursing facility. Covered services include a semi-private room, nursing services, rehabilitation services, drugs, medical supplies, and appliances. There is no patient charge for the first 20 days. Patient cost, however, is $124/day for days 21 through 100 and 100% of the cost thereafter.



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12.5.3 Home Healthcare Coverage is provided for home healthcare visits from a participating home healthcare agency. There is no limit to the number of covered visits.

12.5.4 Hospice Care Benefits are provided for terminally ill patients if the care is received in a Medicare approved facility. Hospital Insurance pays for two 90-day periods and one 30-day period during each benefit period. Coverage can be extended to unlimited hospice stays, in some cases. Part A Does Not Cover:

x Inpatient physicians’ and surgeons’ services. x Private duty nursing. x Charges for a private room (unless medically necessary). x In-room conveniences, such as a telephone or television. x The first three pints of blood received during a calendar year. There is a

three-pint “deductible” on blood transfusions, (unless replaced by a blood plan).

12.6 Part B: Medical Insurance PART B MEDICAL INSURANCE is optional for everyone who enrolls in PART A. The Federal government pays about 75% of the cost of the program, and the rest is covered by the enrollees’ monthly premium. Rates may be increased if program costs increase. . There is a seven-month “initial enrollment” (IEP) period that begins on the first day of the third month before the individual’s 65th birthday. There is a special enrollment period (SEP) for individuals, covered by a group health insurance plan, who did not enroll in Part B when they turned 65. The “special enrollment period” lasts for 7 months and starts the first month the person is not covered by a group health plan.A Medicare beneficiary, who declines Part B enrollment during the initial enrollment period, may subsequently enroll in Part B during any Annual or General Enrollment period (AEP). The General or “Open” Enrollment period is from January 1st to March 31st each year. When enrolled in this manner, the coverage period begins on July 1st of that year.

12.7 Part B Charges Since January of 1996, the method used to calculate PART B benefits has been based on a fee schedule of reasonable charges, created by the Health Care Financing Administration and Social Security. After an annual deductible of $131, PART B MEDICAL INSURANCE will pay 80% of all approved charges for the remainder of the year. The charge on which Medicare will base its benefit is known as the “allowable charge.”



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Payment is the lesser of: x The actual amount charged for the medical service. x The customary charge or average amount charged in the same type of

service between July 1st and June 30th of the preceding year. x The prevailing charge, based on the actual amount charged for similar

services in the area where the insured lives.

After the deductible is paid, there is an 80/20-coinsurance split for services. (Medicare pays 80% and the patient pays 20 %.). Many physicians will accept an assignment that transfers the rights of a Part B policy from the individual to Medicare. In doing so, they will accept the Medicare approved charge as a full payment for services. If a pathologist or a radiologist performs services on an inpatient basis and will accept a Medicare assignment, Medicare will pay 100% of the reasonable charges. Medicare will also cover the cost of a surgical second opinion, if Medicare requires it, with no 20% co-payment. Services of other specialists will also be paid on the same 80% of reasonable charges basis. Shortly after the Medicare patient has received a physician service, he/she will be mailed a Medicare Summary Notice (MSN) listing all the supplies and services that were billed to Medicare for the previous 90 days. The MSN also shows any portion of the bill that may be owed by the patient.

12.8 Claims and Appeals When a doctor refuses to accept a Medicare assignment, he or she must fill out a claim form and submit it to the Medicare carrier in the patient’s area, along with an itemized bill for services. Upon receiving the claim, the carrier will prepare an EXPLANATION OF MEDICARE BENEFITS form that outlines the specific services covered and the amounts approved for each service. If a claim is denied, the patient can appeal the decision by filing a written request for review within six months of the date he or she receives the EXPLANATION OF MEDICAL BENEFITS form. If, after reviewing the claim, the carrier declines to make a change, the patient can make a further appeal to the Medicare office, providing that the amount in dispute is at least $100.is appeal will include a hearing, in which the patient must appear in person to present evidence that supports his/her claim. After this hearing, a final decision will be sent to the patient.

12.9 Part B Benefits Part B provides additional medical insurance for outpatient or inpatient services, provided by a physician or surgeon, diagnostic tests, physical and occupational therapy, and medical supplies not covered by Part A coverage. Specific benefits include:



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Doctor’s Services Including surgery, diagnostic tests, X-rays that are part of the treatment, medical supplies provided in a doctor’s office, services of the office nurse, and drugs that are part of the treatment and which cannot be self-administered. Outpatient Services Emergency room or outpatient hospital services for diagnosis and treatment. Home Health Visits Unlimited approved home health visits, if the insured does not have Medicare hospital coverage. Other Medical and Diagnostic Services Coverage includes ambulance transportation, home dialysis equipment, supplies and support services, independent laboratory tests, oral surgery, outpatient physical therapy, speech pathology, X-rays, and radiation treatments. Drugs and Biologicals Medicines administered at the hospital or at a doctor’s office that cannot be taken at home. Outpatient Treatment of Mental Illness Outpatient treatment for mental illness is covered, with a 50% co-payment instead of the usual 20%. Special Practitioner Services Includes fees for special practitioners, who are not doctors but who are approved by Medicare. These include certified nurse midwives, physician’s assistants, clinical psychologists, and certified nurse anesthetists. EXCLUSIONS -PART B MEDICAL INSURANCE does not cover:

x Private duty nurses. x Skilled nursing home care. x Long-term custodial care (over 100 days per benefit period). x Intermediate nursing home care. x Physician’s charges (over approved Medicare amount). x Most outpatient prescription drugs. However, as of 2006, Medicare has

initiated a new prescription drug coverage program. x Care received outside the United States (limited coverage for Canada and

Mexico). x Dental Care. x Routine physicals. x Immunizations (flu shots are usually covered). x Cosmetic surgery. x Eyeglasses, contact lenses, and hearing aids.



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12.10 Comparison of Part A and Part B Benefits TABLE 12.1: Medicare Benefits & Coverage

Part A Part B Inpatient Hospital Services and Fees

x Room & Board x Nursing Care

Skilled Nursing Care x After hospital release

Home Health Services x After hospital release

Hospice Care x For terminally ill patients

Physician & Surgeon Services x In hospital, clinic or other location x Inpatient or outpatient

Medical & Health Services x X-Rays x Diagnostic & lab tests x Medical Supplies x Ambulance Services x Medical Equipment Rental Costs x Physical Therapy x Occupational Therapy

12.11 Physician Payment Doctors and other suppliers who have met the qualifications for and been credentialed by Medicare are called PARTICIPATING PHYSICIANS (providers). These doctors are listed in the Medicare Participating Physician/Supplier Directory that is available, at no charge, from the local Social Security office. Allowable, or recognized charges are the maximum amounts that Medicare allows for a given procedure, treatment, or service. This amount is used as the basis for Medicare’s 80% coinsurance. When a nonparticipating physician is involved, Medicare’s allowable or recognized charges are 5% lower than in participating physician cases. There is also a limit placed on the amount non-participating physicians can charge above the Medicare-allowed charge. This limit is currently 115% of the approved fee.

12.12 Part C: Medicare Advantage Soon after the introduction of the original Medicare, several Managed Care Organizations (MCOs) contracted with the Centers for Medicare and Medicaid Services (CMS) to provide Original Medicare services (Part A and Part B) to Medicare beneficiaries. MCOs are designed to coordinate the availability of health care services with the goal of reducing inefficiencies and minimizing costs. In practice MCOs conduct oversight reviews of the care rendered to Medicare patients. The MCOs also enter into contractual relationships with healthcare providers who agree to adhere to fixed fee schedules for their services. At first the providers of these coordinated services were Health Maintenance Organizations (HMOs). However, Preferred Provider Organizations (PPOs) and other types of managed care delivery systems soon entered the picture and it became common usage to refer to these organizations as MCOs. Also available are Private Fee for Service Plans and Special Needs Plans (SNF).



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While HMO and PPO plans are familiar models, some may not be as familiar with Medicare private fee for service plans. These are Medicare Advantage plans offered by private insurance companies. However, with these plans Medicare pays the company an established fee for each enrollee but the insurer sets the fee paid by the enrollee. These plans and the fees charged are partially based on demographics, thereby restricting the areas of operation. Simply put, the plan member can visit and receive services from ay provider or hospital who agrees – before rendering treatment- to accept the Medicare Private Fee for Service plans fees, terms and conditions of payment. The Special Needs Plans are still an evolving part of the Medicare Advantage program. Introduced in 2003, these plans are directed to satisfy three types of identified patient needs:

1. Institutionalized 2. Dual eligible 3. Chronic and severe disabling illnesses

The program has been extended to the end of 2010 and the SNF guidelines are presently under review Similar to the Special Needs program is the Medicare Advantage Demonstration Model for End Stage Renal Disease patients. This is a specific illness that allows a diagnosed person to enroll in Medicare at any age. The problem is that the course of treatment while on going and expensive is excluded from Medicare Advantage and Medicare Supplement programs. To solve this problem, certain Medicare Advantage Plans have partnered with the Centers for Medicare and Medicaid Services in a 4-year pilot program to accept such enrollees. California presently has two such plans, both of which end their initial pilot program in December 2009. The Balanced budget Act of 1997 expanded the presence of managed care as a Medicare alternative by creating the Medicare+Choice program informally called Medicare Part C. The Medicare Prescription Drug Improvement and Modernization Act of 2003 revised the Medicare +Choice plan and renamed it Medicare Advantage. MCOs that function under the Medicare Advantage program must be certified licensed and comply with federal and state laws. The present trend is for more of the general population to be enrolled in managed care plans, through group employee programs, while only about 10% of Medicare beneficiaries are enrolled in Medicare HMOs or MCOs. This ratio may rapidly change, however, in the next few years as the federal government has mandated significant cutbacks in Medicare fee for service programs and is introducing many new incentives to popularize and encourage enrollment in Medicare MCOs.

12.13 Medicare Part D: Prescription Drug Plan The Medicare Prescription Drug, Improvement and Modernization Act of 2003 dramatically changed the Medicare program. The most significant change was the provision for comprehensive prescription drug coverage beginning in 2006.



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On January 1, 2006, Medicare put into effect a prescription plan, known as Medicare Part D. It allows seniors and the disabled, who are under the Medicare program, to get subsidized drug coverage through private insurance companies and Medicare managed care plans. This benefit is known as a Prescription Drug Plan or PDP. In California, Medicare beneficiaries have more than 60 plans offered by eighteen companies to choose from—each with its own premiums, lists of covered drugs and participating pharmacies. It is estimated that the program will cost the federal government at least $720 billion during the first 10 years and will save most beneficiaries about $1,300 per year. People with limited incomes and resources could benefit even more. However, savings can vary widely depending on factors such as what kind of drug coverage someone currently has or how much they spend on prescription drugs. A person who spends $1,500 per year on prescriptions, for example, can save about $500 on the new plan. Another person who spends just $500 may actually pay more out of pocket because of premiums and drug co-payments. Eligibility Eligibility extends to all Medicare beneficiaries. However, there is no automatic enrollment. Enrollees have to choose a plan and sign up with a private insurer or with Medicare. Choosing a Plan – Premiums, Deductibles and Co-payments For most people the first $250 is not covered (annual deductible) but 75% of the next $2,000 ($251 to $2,250) is paid by your Medicare plan. Having reached the $2,250 amount, the recipient will have to pay the next $2,850. After meeting that level of participation, the Medicare plan will pay 95% of the patient’s covered drug costs, thereby helping people with catastrophically high drug costs in any given year. The maximum out-of pocket for the recipient would be $3,600.There are 2 classes of plans among the dozens of offerings. The one selected will depend on whether the participant is buying just a drug plan or adding it to a current managed care plan. Seniors who stay in Medicare’s traditional fee for service plan can only buy what is called a stand-alone prescription drug plan. Private firms provide the plans. While their plans must meet Medicare’s rules, each company may differ on costs, coverage and drug choices. Those who are in Medicare Advantage plans –about 25% of all beneficiaries -will now have their drug benefit added to their current plan. Whether the Medicare Advantage HMO premium rises and by how much depends on the plan. If the Medicare enrollee already has pharmaceutical coverage through an employer or union for example, the insurance carrier must inform him/her how their coverage compares to standard Medicare D coverage



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In choosing a plan, the Medicare recipient: x Should list the prescription drugs currently used - including their names,

strength and monthly quantities. x Determine whether a plan under consideration covers his/her prescription

drugs by brand name or by a generic name. x Should know what the selected plan will cost—this requires knowledge of

the (1) The monthly premium and (2) His/her percentage share of the cost. x Should contact the pharmacies that the beneficiary normally uses and

determine whether the selected drug plan is accepted by those pharmacies.

It should be noted that Medicare recipients who are in a plan that does not offer drug coverage might enroll in stand– alone prescription drug plan. All companies that offer Medicare drug plans must offer at least one plan that offers the same amount of coverage as the basic Medicare prescription drug plan. Enrollment Penalty and Non-Credible Coverage A person who has enrolled in Medicare may sign up in an initial enrollment period. After that, there may be a cumulative penalty of 1% for each month that passes until enrollment. For example, a Medicare qualified person who waits 3 years to sign up may find that their premium is 36% higher for the rest of his/her life. However, the penalty does not apply, if the Medicare subscriber has prescription drug coverage (creditable coverage) as good as Medicare’s program. The penalties do apply if the Medicare recipient only has non-credible coverage Employer Drug Programs – Credible Coverage Approximately 30% of Medicare recipients have prescription drug coverage through their former employer. Such coverage is often superior to that provided by the government program. Federal regulations require that employers, who presently provide prescription drug coverage, must inform their Medicare-eligible plan participants (active and retired) and the Centers for Medicare Medicaid Services (CMS) whether or not their prescription drug plan qualifies as “creditable coverage”. Creditable coverage is defined by CMS as prescription drug coverage with an actuarial value equivalent or exceeding the value of standard Medicare D coverage. This notification is important as it protects the interests of Medicare eligible individuals who are covered today under a group prescription drug plan but may need to move to another Medicare Part D prescription drug plan in the future. Since there is a penalty for not enrolling when first eligible, the creditable coverage disclosure ensures that a Medicare beneficiary will not have to pay higher premium charges for enrolling in a Medicare D plan after the initial enrollment period. The recipient must have the creditable coverage for at least 63 days.



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Drug Coverage Each private insurance carrier will have their own formulary—drugs that they will cover. Medicare patients that already take expensive drugs, or require frequent dosages, should examine each plan’s list carefully before making a decision to sign up with a particular carrier. The patient should also confirm that their pharmacy is covered by the plan and if there are further discounts for the use of generic brands. If the Medicare recipient’s plan selection later drops a drug that he/she needs, the insurance company must give the covered party a 60-day written notice. The Medicare beneficiary may then switch plans but they may have to wait until the next enrollment period. Plans may be switched once a year. Drug plans must cover basically all drugs in six categories: antidepressants, antipsychotics, and anticonvulsants, antiretrovirals (AIDS treatment, immunosuppressants and anti-cancer Plans must also cover at least 2 drugs in each drug class in their formulary. The drug plans must also have: Medicare approved transition plans for beneficiaries who have a condition that has been stabilized by medications not on the plan’s formulary; easily available information on their pharmacy network and formulary; an exception process when a non-covered drug is medically necessary.

SENIOR HEALTH PRODUCTS, MEDICAID/MEDI-CAL & CHAPTER 13 MEDICARE SUPPLEMENT INSURANCE


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13 Senior Health Products, Medicaid/Medi-Cal & Medicare Supplement Insurance

MEDICAID is Title XIX of the Social Security Act. It was created in 1965 to provide matching federal funds to individual states for medical public assistance plans for needy individuals, regardless of their age. In the State of California, this plan is referred to as MEDI-CAL.

13.1 Medi-Cal Eligibility The following types of needy individuals typically qualify for Medi-Cal benefits:

x Those who receive public assistance through the Supplemental Security Income/State Supplemental Payment program (SSI/SSP).

x Low-income individuals under the age of 21. x Individuals 65 years of age or older. x People who are blind. x Disabled individuals. x Those receiving Aid to Families with Dependent Children (AFDC)

assistance. x Refugees in this country 18 months or less. x Pregnant women. x People in skilled nursing or intermediate care facilities. x Children under the age of 21 in foster care. x People needing kidney dialysis.

13.2 Program Benefits A Medi-Cal card entitles an individual to payment for inpatient and outpatient hospital and physician services. The following other services are also covered under Medi-Cal:

x Laboratory tests. x X-ray services. x Nursing Facility treatment for individuals 21 and older. x Home Health Care for persons eligible for skilled nursing facility services. x Radiation treatment. x Blood. x Eyeglasses. x Check-ups. x Family planning services and supplies. x Rural health clinic services.

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x Federally qualified health center services. x Nurse midwife services. x Services of certified pediatric or family nurse practitioners. x Prenatal care. x Early and periodic screening, diagnostic, and treatment services for

children under age 21. x Assurance of the availability of necessary transportation.

13.3 Medi-Cal Costs Those who use Medi-Cal must pay a one-dollar co-payment each time a medical service or prescribed drug is received and a $5 co-payment if they visit an emergency room for a non-emergency. Applications for Medi-Cal are available through the Welfare Department of each county in the State of California. If an individual has any type of private disability or health insurance, the benefits of these plans must be exhausted before Medi-Cal will pay. Medi-Cal does offer healthcare coverage to some people who make too much to be on welfare but not enough to pay for private health insurance. These recipients are often required to “share the cost” by paying a certain amount each month towards their health care before Medi-Cal takes over further costs.

13.4 Medicare Supplement Insurance (Medigap) To cover costs not covered by Medicare, commercial insurance companies and Blue Cross/ Blue Shield organizations have developed specialized insurance contracts that “close the gaps” in coverage. These policies are called Medicare Supplement or MEDI-GAP policies. The primary function of these policies is to:

x Pay some or all Medical deductibles and co-payments. x Pay those services not covered by Medicare.

Every insurer that provides Medicare Supplement coverage must meet all the requirements of a MEDICARE SELECT POLICY PROVIDER. As such, each insurer agrees to offer coverage through a “preferred provider” network that agrees to:

x Establish alternative or discounted rates of payment. x Offers insureds special advantages for selecting member providers. x Withholds advantages from insureds that select non-member providers.

Medicare Select Medicare Select is a type of Medicare Supplement policy that can cost less than standard Medicare Supplement plans. However, the policyholder can only go to certain doctors and hospitals for care. A Medicare Select plan must provide full coverage for services provided by a non-member provider in emergency situations or when there is a need for immediate care. Full coverage must also be provided for s\services that are not available from member providers.



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When purchasing Medicare Supplement Insurance, it is important to remember that while the Medicare program is federally funded and regulated, Medicare Supplement policies are approved by the State Department of Insurance. This approval only means that the contract has met the state’s legal requirements and does not entitle agents or companies to claim that they represent the Medicare program or any government agency.

13.5 Medicare Supplement Contract Benefits Medicare supplement policies usually cover the Medicare, Part A (hospital) and Medicare, Part B (medical) insurance deductibles, and the 20% co-payment required under Part B. These include:

x Part A coinsurance amounts, plus coinsurance coverage for days 61-90 of hospitalization and for the 60 reserve days.

x Hospitalization benefits for 365 days after Medicare benefits end. x Part B coinsurances amounts (typically 20% of Medicare-approved

expenses). x The first three pints of blood each year.

The National Association of Insurance Commissioners (NAIC) has a model regulation, used by most states, that requires Medicare Supplement policies to include these “core” benefits and any other benefits provided under the ten standardized contracts described in Section 13.8 of this chapter.

Insurers selling Medicare Supplement policies may offer:

x Only core benefits (Plan A on chart in Section 12.8) or x Core benefits plus broader benefits (Plans B-J on chart in section 12.8)

NOTE: Insurers selling Medicare supplement plans must offer Plans A and either Plan C or F. Insurers selling Medicare Supplement policies may offer only core benefits (Plan A on chart in Section 13.8) or core benefits plus broader benefits (Plans B-J on chart in section 13.8).

13.6 What Medicare Supplement Contracts May Not Cover The following exclusions or limits of coverage may apply to certain Medicare Supplement contracts:

13.6.1 Pre-existing Conditions An exclusion regarding pre-existing conditions states that there will be no coverage provided for six months after policy issuance for any condition for which the insured received advice, diagnosis, or treatment within the six month period prior to the issuance of the policy.

13.6.2 Maximum Benefits Some contracts restrict the number of days for which benefits will be paid or the dollar amount that will be paid for treatment.



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13.6.3 Right to Renew Some companies do not automatically grant policyholders the right to renew their contracts. This means that in order to obtain continued coverage, evidence of insurability is required. If the policyholder is qualified, a new policy is written.

13.7 Federal Requirements for Medicare Supplement Insurance The Omnibus Budget Reconciliation Act of 1990 (OBRA 1990) states that Medicare Supplement Insurance may not be denied on the basis of the applicant’s health status, claims experience or medical condition during the first six months after an individual age 65 or older enrolls in Part B of Medicare. This is a form of guaranteed issue coverage This law also states that:

x Medicare Supplement and other Health Insurance cannot be sold to someone who already has a contract that provides the same type of Supplement benefits.

x Insurers must suspend insurance benefits (to a maximum of 24 months) upon request of the policyholder, while the policyholder’s benefits under Medicaid (Medi-Cal) are providing coverage.

x Medicare Supplement Policies cannot exclude or limit benefits for losses incurred from pre-existing conditions for more than six months from the effective date of coverage.

x If a Medicare Supplement policy that has been in force for at least six months is replaced, a new Medicare Supplement policy must waive any pre-existing condition periods, waiting periods, elimination, and probationary periods that apply to pre-existing conditions.



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13.8 Standardization of Plans TABLE 13.1: Medicare Supplement Standard Policy Formats

Plan A Plan B Plan C Plan D F F* Plan G Plan K Plan L Plan M Plan N Basic,

including 100%

Part B co-insurance.

Basic, including

100% Part B co-insurance.

Basic, including


Basic, including


Basic, including


Basic, including


Hospitalization and

preventative care paid at 100%; other

basic benefits paid at 50%

Hospitalization and

preventative care paid at 100%; other

basic benefits paid at 75%

Basic, including


Basic, including

100% Part B co-insurance except**

Skilled Nursing

Facility Co-insurance

Skilled Nursing


Skilled Nursing


Skilled Nursing


50% Skilled Nursing


75% Skilled Nursing


Skilled Nursing


Skilled Nursing


Part A Deductible

Part A Deductible

Part A Deductible

Part A Deductible

Part A Deductible

50% Part A Deductible



Part A Deductible

Part B Deductible

Part B Deductible

Part B Excess (100%)

Part B Excess (100%)

Foreign Travel

Emergency

Foreign Travel

Emergency

Foreign Travel

Emergency

Foreign Travel

Emergency

Foreign Travel

Emergency

Foreign Travel

Emergency Out-of-Pocket

limit at $4,620; paid at 100%

after limit reached

Out-of-Pocket limit at $2,310; paid at 100%

after limit reached

*Plan F also has an option called a high deductible Plan F. This high deductible plan pays the same benefits as Plan F after one has paid a calendar year $2,000 deductible. Benefits from high deductible plan F will not begin until out-of-pocket expenses exceed $2,000. Out-of-pocket expenses for this deductible are expenses that would ordinarily be paid by the policy. These expenses include the Medicare deductibles for Part A and Part B, but do not include the plan’s separate foreign travel emergency deductible. **Plan N includes Basic, including 100% Part B co-insurance, except up to $20 copayment for office visit, and up to $50 copayment for ER.

The OBRA 1990 law mandated that Medicare Supplement policies be standardized. To comply with this law, the NAIC has developed 12 standard policies, one of which must serve as the underlying basic policy for all Medicare Supplement contracts. The features of these policies, known by letter designations A-J, are outlined in the chart shown above. Plans K and L These are plans added on in recent years. The basic benefits for Plans K and L are similar to the basic benefits offered in Plans A through J. These plans, however, have lower monthly premiums and have higher out-of – pocket costs OBRA 1990 also requires that benefits provided by an employer are primary to Medicare, except for retirees and those people with end-stage renal disease (ESRD).If a person is entitled to Medicare because of ESRD and is covered by an employer group plan, the employer plan is responsible for payments for the first 30 months.

http://www.medigap360.com/medicare-supplement-plan-a.php

http://www.medigap360.com/medicare-supplement-plan-b.php

http://www.medigap360.com/medicare-supplement-plan-c.php

http://www.medigap360.com/medicare-supplement-plan-d.php

http://www.medigap360.com/medicare-supplement-plan-f.php

http://www.medigap360.com/medicare-supplement-plan-f.php

http://www.medigap360.com/medicare-supplement-plan-g.php

http://www.medigap360.com/medicare-supplement-plan-k.php

http://www.medigap360.com/medicare-supplement-plan-l.php

http://www.medigap360.com/medicare-supplement-plan-m.php

http://www.medigap360.com/medicare-supplement-plan-n.php



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Employers may not offer incentives to employees, who are eligible for Medicare, to terminate their group coverage in order to avoid having the group insurance coverage become the primary source of benefits. There is a $5,000 fine for violation of this requirement.

13.9 Discrimination Providers of Medicare Supplement policies must allow an open enrollment period during which any person age 65 or older may obtain coverage within six months after first enrolling for Medicare, Part B benefits. Providers may not:

x Deny or impose conditions on coverage. x Discriminate in price because of health status, condition or claims

experience. x Discourage sales during the enrollment period (including altering the

commission structure). In addition, the first year commission must be no more than 200% of the commission paid in the second year.

13.10 Replacement No agent, broker or insurer shall encourage an insured to replace a Medicare supplement policy unnecessarily or 3 times or more in one year. If a replacement is proposed, the application or a supplementary form must provide the following statements and questions:

1.1.1 Statements You do not need more than one Medicare supplement policy. If you are 65 or older, you may be eligible for benefits under Medi-Cal or Medicaid and may not need a Medicare Supplement policy. Benefits and premiums under your Medicare supplement policy will be suspended during your enrollment in Medi-Cal or Medicaid for up to 24 months. You must request this suspension within 90 days of becoming eligible for Medi-Cal or Medicaid. If you want to discuss buying Medicare supplement insurance with a trained insurance counselor, call the California Department of Insurance toll-free number (1-800-927-HELP) and ask how to contact your local Health Insurance Counseling and Advocacy program (HICAP) office. HICAP is a free service, provided by the State of California.

1.1.2 Questions Do you have any other Medicare supplement insurance, including an HMO contract? If so, with what company? Do you have any other health or disability coverage? If so, with what company? What kind of policy? Would the benefits duplicate the benefits in this Medicare supplement policy? Do you intend to replace any health or disability insurance coverage with this policy? Are you eligible for or receiving benefits from Medi-Cal?



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In addition to the statements and questions listed above, agents must list any other disability policies his or her agency has sold to the applicant. This list must include policies in force and those sold within the last five years that are no longer in force. If a sale involves a replacement, the insurer or agent must furnish the applicant with a NOTICE OF REPLACEMENT. Direct Response insurers must deliver the replacement notice with the policy or certificate. Other insurers must furnish the notice prior to issuing or delivering the policy.

LONG-TERM CARE INSURANCE CHAPTER 14


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14 Long-Term Care Insurance With the aid of technology and today’s advanced healthcare systems, many people are living into their 80s, 90s and beyond. While Medicare, Medi-Cal, and Medicare Supplements provide numerous benefits for senior citizens, there is still the reality that many older Americans will be confined to a nursing home long enough to exhaust their coverage. Long-term Care Insurance (LTC) is a relatively new category of coverage designed to address this potential problem.

The chance of a person, now age 65, residing in a nursing home at some time is one in three; and at age 75 two out of every three people will be so confined. More than nine million people live in nursing homes today. By 2050 that number is expected to climb to 20 million. The average annual cost of a nursing home confinement can range anywhere from $30,000 to $100,000 per year, and home care can easily cost more than $1,000 per month. Most people pay for these ever-increasing costs by:

x Exhausting personal assets (their own and their family’s). x Qualifying for Medical by transferring or liquidating their assets. x Purchasing a LTC insurance policy that provides extended daily coverage

for nursing home confinement and/or at-home care. Long-term care policies can be purchased individually, as part of a group contract, or as a rider attached to a Life Insurance policy. In 1994, a number of insurance carriers that offer LTC insurance in California created an organization called “The California Partnership for Long Term Care.” This alliance between carriers and a number State Agencies provides Medi-Cal asset protection, as well as LTC benefits for California residents.

14.1 Who Should Purchase Long-Term Care Insurance The most likely candidates for a LTC policy would be individuals who:

x Have the resources to pay the premiums. x Wish to preserve their assets or estate. x Want to maintain their financial independence in the event of a nursing

home confinement.

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Suitability Standards For the purposes of consumer protection, every insurer or other entity marketing long-term care insurance contracts in California is required to:

x Develop and use suitability standards to determine whether the purchase or replacement of long-term care insurance is appropriate for the needs of the applicant

x Train its agents in the use of its suitability standards x Maintain a copy of its suitability standards and make them available for

inspection upon request by the Commissioner

The agent and insurer must develop procedures that take into consideration, when determining whether the applicant meets the standards developed by the insurer, the following:

x The ability to pay for the proposed coverage and other pertinent financial information related to the purchase of the coverage

x The applicant’s goals or needs with respect to long-term care and the advantages and disadvantages of using insurance to meet these goals or needs

x The value, benefits, and costs of the applicant’s existing insurance, if any, when compared to the values, benefits, and costs of any recommended purchase or replacement

In summary, the client’s suitability for coverage should take into consideration:

1. The client’s income today. 2. Future income at retirement. 3. Source of premium:

a. If client funds premium, what % of income will be needed? b. If family funds premium or any part of premium, what dollar amount

can they support? c. How long can the family support the premium?

4. Value of assets that the client wishes to shelter or protect? 5. Health considerations and family history. 6. What elimination period can the client afford to fund the cost of today, or in

the future, taking into consideration inflation? The issuer, and where an agent is involved, the agent, must make reasonable efforts to obtain the above required information. These efforts must include presentation to the applicant, at or prior to application, of the Long-Term Care Insurance Personal Worksheet which was developed by the National Association of Insurance Commissioners. An insurer must use its suitability standards in determining whether issuing long-term care insurance coverage to any applicant is appropriate. Agents must use the suitability standards developed by the insurer in marketing long-term care insurance.



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14.2 Types of LTC policies LTC policies are designed to provide: Institutional Care Nursing home or convalescent facility, extended care, skilled nursing facility or custodial care. Home Care Home health care, homemaker services, personal care, hospice or respite care. Community-Based Care Adult day care, hospice or respite care. The first page and outline of coverage for a policy limiting benefits to institutional care must be called a NURSING FACILITY ONLY policy. A policy limiting coverage to home care must be called a HOME CARE ONLY policy, and a policy that provides both institutional and home care must be called a COMPREHENSIVE LONG-TERM CARE policy Tax Qualified vs. Non-Tax Qualified LTC Policies Federal law provides for favorable tax treatment to owners of eligible LTC insurance policies. The requirements of federally “tax qualified (TQ)” policies may be more restrictive than the eligibility requirements for California policies issued prior to January 1, 1997. At that time, contracts sold in California were automatically granted “qualified” status regardless of their benefit structure or eligibility requirements. It’s important for agents to remember that an insured who requests material changes in a contract issued prior to 1997 may sacrifice his or her “TQ” status. Material changes include:

x The amount or timing of benefits x Premiums x Named insured (under an individual contract) x Eligibility for membership (for group coverage)

Because federal and state laws are different, people who purchase federally tax qualified policies may need a greater level of disability before qualifying for benefits than individuals who purchased coverage that conformed to the more permissive eligibility requirements of the California Insurance Code. Additionally, the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA) mandates that certain consumer protections be included in all policies that are intended to federally tax qualified, but these standards do not apply to policies that are not federally tax qualified.



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To remedy some of these discrepancies, the California legislature passed a number of laws that have had a profound impact on long-term care insurance in the state. The upshot of all this legislation is that California consumers may purchase policies that meet the eligibility requirements of the California Insurance Code (Non-TQ) or policies that meet the requirements to be federally tax qualified. New California laws require insurers to offer TQ long-term care insurance policies that qualify for favorable tax treatment under federal law and Non-TQ policies that meet state code requirements. There are also a number of other provisions to assure that consumers are informed and educated about their choices. Agents need to be aware of the differences between qualified and non-qualified long-term care insurance contracts and of the potential tax consequences of each type of policy. While they should be able to explain these differences to prospects and clients, they should not give professional tax advice.

14.3 Benefits of Long-term Care LTC policies cover medically necessary diagnostic, therapeutic, rehabilitative, maintenance, or personal care services in a facility other than an acute care unit of a hospital. There are three levels of nursing home care and a variety of home-based care for which benefits are paid. These are:

14.3.1 Skilled Nursing Home Care This type of care is ordered by a doctor, performed or supervised by skilled medical professionals, and is available 24 hours a day. It is usually provided in a nursing home.

14.3.2 Intermediate Care A doctor often orders this level of care for rehabilitative treatment. Skilled medical professionals in a nursing home, who treat conditions that require daily care, but not 24-hour supervision, usually provide it.

14.3.3 Custodial Care (Non-skilled) This type of care is given to meet daily personal needs, such as bathing, dressing or eating. It is provided under a doctor’s orders but does not require medical training or personnel to administer. Custodial care can be given in a nursing home, assisted living, adult day care center or respite center.

14.3.4 Home-Based and Community-Based Services This type of service is provided to people who need care, but are able to function without being confined to a nursing home. In-home services are usually provided by registered nurses, licensed practical nurses, licensed vocational nurses or physical therapists provided by Home Health Care Agencies (HHCAs). In most cases, home health care must begin within a fixed period of time after a nursing home stay, and benefits are typically 50% of the daily nursing home benefit.



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In many cases, the individual is able to tend to many of their personal needs (personal care) in the home environment (home care), with support, such as medication management from family members. Community-based organizations that may also be recommended by doctors and other medical professionals include:

x Hospice Care for terminally ill patients. x Adult Day Care, to provide social, health and therapeutic activities for

elderly persons with mental or physical impairments. x Respite Care, which gives substitute care and relief for a primary

caregiver.

All of the facilities and personnel providing these types of care must be state approved.

14.4 Policy Provisions and Limits Most LTC contracts include the following provisions and limitations:

14.4.1 Daily Benefits/Policy Maximum Limits Most contracts are structured as “indemnity” plans that pay a specified daily amount (usually $50 to $200 per day or more) for skilled nursing care. There may also be inside limits that apply to certain types of expenses.

14.4.2 Elimination Periods Benefits usually begin after specified periods of time, following the start of a nursing home confinement or after home health care visits begin. The typical elimination period is 30 days. Remember the relationship between elimination period, coverage and premium (See 8.1.12).

14.4.3 Deductibles Some contracts include a deductible that must be paid before benefits begin.

14.4.4 Pre-existing Conditions LTC contracts usually limit or exclude benefits for pre-existing conditions for six months following the issuance of the contract. A pre-existing condition is defined as any condition for which the insured received advice, diagnosis, or treatment in the six-month period prior to the issuance of the policy.

14.4.5 Renewability The majority of LTC contracts are written on a GUARANTEED RENEWABILITY basis. This means that the insurer must renew the contract with the same terms and benefits, but can increase the premiums, so long as it does so for an entire “class” of individuals (for example, all policyholders in a specific geographic area).



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Some LTC policies are written on an OPTIONALLY RENEWABLE basis that allows the insurer to renew, cancel or increase premiums, so long as they do so for an entire class of policyholders. As more and more companies enter this arena of coverage, there may eventually be “non-cancelable” contracts written. These contracts would guarantee both renew-ability and level premiums for the duration of the contract.

14.4.6 Waiver of Premium and Non-Forfeiture Many LTC contracts provide a provision stating that the premiums on the policy will be waived while benefits are being paid if the insured is confined to a nursing home and receives benefits for at least 90 days. Non-Forfeiture provisions give the insured a way to hold on to some policy values or benefits if they elect to stop paying premiums or surrender the policy. Many insurers have not yet incorporated these provisions into their LTC contracts because they would have to increase premiums to cover the increased risk. When they are incorporated into a policy, there are three ways in which non-forfeiture provisions can apply:

14.4.7 Cash Surrender Value Guarantees that an amount will be paid to the policyholder if a policy lapses or is surrendered.

14.4.8 Reduced Paid Up Results in a reduced amount of the daily benefit, with no further premium payments required.

14.4.9 Extended Term Provides full benefits for a limited period of time after premium payments end. As with the reduced paid up provision, no further premium payments are required.

14.4.10 Inflation Protection LTC insurers must offer policyholders the option of increasing benefit levels as the cost of services escalate and, if necessary, a signed rejection of the option. This increase in benefit levels must be offered without the insured providing evidence of insurability.

14.4.11 Alzheimer’s Coverage Requirement LTC coverage is usually provided to individuals with Alzheimer’s or any other organic disease. This includes mental or personality disorders that are the result of an accident. Coverage is usually excluded for individuals with alcoholism, mental retardation, nervous conditions, mental, psychoneurotic, or personality disorders.



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14.4.12 Extension of Benefits Beyond Termination of Policy The extension of benefits may be limited by the contract’s specific benefit periods, maximum benefits, waiting periods and/or other applicable policy provisions. Termination of an LTC policy must be without prejudice for prior institutionalization that began while the policy was in force and continues after termination.

14.4.13 Free Look (Return of Policy) If not satisfied, for any reason, applicants may return the policy within 30 days of delivery and receive a full refund of premium. Return of policy voids the contract from the beginning.

14.5 Prohibited Provisions LTC Insurance may not:

x Be canceled, non-renewed or terminated because of age or mental or physical deterioration.

x Contain a provision establishing a new waiting period if existing coverage is converted to or replaced by a new policy, except when new policy is voluntarily picked by an insured to increase benefits.

x Provide coverage for skilled nursing care only or provide significantly more coverage for skilled care than other lower level care in terms of aggregate days of covered care.

x Limit or deny benefits for progressive or degenerative illness (including, but not limited to, Alzheimer’s disease).

x Provide payment of benefits based on “usual and customary” or “reasonable and customary” standards.

14.6 Eligibility While LTC policies are usually available to individuals between the ages of 18 and 86, many group plans now offer benefits at younger ages. Qualifying for benefits will depend on how well a policyholder can handle a number of the following tasks called Activities Of Daily Living (ADLS).

Mobility The ability to walk. Dressing The ability to clothe one’s self. Personal Hygiene The ability to go to and from the toilet and bathe one’s self. Eating The ability to take in food and feed one’s self.



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Transferring The ability to move from one place to another.

The type of policy and whether Home Care or Institutional Care is being considered will determine the exact number of Activities of Daily Living required for eligibility. There are also several other limitations that are often considered when deciding whether or not an individual should be placed in a nursing home. These INSTRUMENTAL ACTIVITIES OF DAILY LIVING (IADLS) include the ability to:

x Do housework x Manage money

x Use the telephone

x Prepare meals

Individuals who can’t perform the IADLs or ADLs without supervision or assistance may not be able to think, perceive, reason or remember. This condition is defined as “Cognitive Impairment” and provides another criterion that insurers use to determine eligibility for a nursing home stay and benefits.

14.7 Replacement Policies If one LTC policy replaces another, the replacing insurer must waive any time periods applicable to pre-existing conditions and probationary periods that have been satisfied under the original policy. In recommending a replacement policy, agents must make a reasonable effort to determine the appropriateness of the replacement. Application forms must include questions to determine if the proposed insurance is intended to replace other LTC coverage that is in force. If so, the insurer must provide a NOTICE TO APPLICANT REGARDING REPLACEMENT OF ACCIDENT AND SICKNESS OR LONG TERM CARE INSURANCE. This notice must be provided prior to the delivery of the policy. No insurer, agent or broker shall unnecessarily cause a policyholder to replace a long-term care insurance policy. This prohibition includes replacement that will result in a decrease in benefits or an increase in premiums. It is presumed that any third or greater number policy sold to a client in a 12-month period is unnecessary unless the purpose of the replacement is for the sole purpose of consolidating policies within a single insurer. The sales commission on a replacement policy for long term care shall be calculated based on the difference between the annual premium of the replacement coverage and that of the original coverage. However, if the replacement product premium is less than or equal to the premium of the product being replaced, the sales commission shall be limited to the percentage of sale normally paid for the renewal of long term care policies. Commission is defined as pecuniary or non-pecuniary remuneration, including but not limited to, bonuses, gifts, prizes, awards and finder’s fee.



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Except for group coverage, the replacement notice must also include a statement, signed by the agent, stating that the agent is convinced that the replacement insurance materially improves the insured’s position. The notice must include the specific reasons the agent is making this statement.

14.8 Outline of Coverage An OUTLINE OF COVERAGE must be delivered to every LTC prospect at the time of solicitation. If an agent is soliciting the prospect, he or she must deliver the outline prior to presenting an application or enrollment form. For direct response sales, the outline must be presented with the application or enrollment form. The OUTLINE OF COVERAGE must contain the following:

x Description of benefits and coverage provided. x Statement of exclusions, reductions and limitations of the policy. x Statement of the terms under which the policy may be continued in force

or discontinued (including any provision granting the insurer the right to change premiums).

x Description of the insured’s rights regarding continuation, conversion and replacement.

x Statement that the outline is only a summary of provisions, not a contract. x Description of the terms for returning the policy or certificate and obtaining

a premium refund. x Brief description of the relationship of cost of care and benefits.

14.9 Marketing Standards Insurers offering LTC in California must establish marketing standards to assure fair and accurate comparisons of various LTC policies and to assure that excess insurance is not sold to a client. With respect to long term care insurance; all insurers, agencies, brokers and agents owe all policyholders and prospective policyholders a duty of honesty, good faith and fair dealing. The conduct of the agent/broker and insurer during the offer and sale phase of a policy, prior to its purchase, is a primary determinant of any breach of this duty. An agent or broker, who contacts a consumer as a result of receiving information generated by a cold lead device, shall immediately disclose that fact to the consumer.

14.10 Health Insurance Counseling and Advocacy Program (HICAP) In 1984, the State of California created the Health Insurance Counseling Advocacy Program (HICAP), to provide counseling and educational services to the public in the areas of health insurance, benefits, and costs contract provisions. The HICAP mission is to “provide accurate and objective counseling, advocacy, and legal assistance with Medicare, health insurance, and related coverage plans for



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Medicare beneficiaries, their representatives, or persons imminent of Medicare eligibility, and to educate the public about Medicare and health insurance issues.” HICAP falls under the California Department of Aging and local Area Agencies on Aging and is funded through the Department of Insurance, with an annual budget of three million dollars. The program also maintains direct links with the Department of Health Services and the Department of Corporations. There are 24 local contractors to handle intake, initial screening, and appointments. Depending on the nature of the inquiries and the need for services, individuals contacting HICAP are routed to:

x A counselor who specializes in Medicare, Medicare Supplements or Long-term Care Insurance.

x The Department of Insurance, when the situation involves code violations, agent advertising, sales and marketing practices or insurance company claim, product, or service problems.

x The Legal Services Staff or District Attorney, to handle problems regarding benefit and claim appeals, billing disputes, litigation work, or unfair business practices.

HICAP services are free of charge. The program does not endorse or sell specific products or insurance companies, and it is unbiased in providing information to all California citizens about all areas of Medicare, Medicare Supplement Plans, HMOs, and Health insurance. The statewide toll free number is 800-434-0222 and local programs can be located at www.calmedicare.org.

BASIC INSURANCE CONCEPTS AND PRINCIPLES CHAPTER 15


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15 Basic Insurance Concepts and Principles Note: Much of the information found in the first chapters is based on specific sections of the California Insurance Code. Where appropriate, this information is repeated in this book. INSURANCE is a formal social device (contract) for reducing risk by transferring the risks of several individuals to an insurer. An insurer (usually an insurance company) agrees, for a consideration (premium), to assume, for a specified extent, any losses suffered by the insured. People carry insurance to cover their homes, cars, businesses, health, life, property, and a host of other things that are important to them and carry an element of risk. To thoroughly understand the concept of insurance, we must first understand the difference between the insurer and insured, and the meaning of the term “risk.”

15.1 Insurer vs. Insured The INSURER is the insurance company, or carrier, that by contracts subject to Code restrictions, indemnifies losses, provides pecuniary benefits or renders services.

The INSURED is the policy owner.

15.2 Risk RISK is the uncertainty of loss, and it is present whenever two or more possibilities exist. In insurance, risk can be either pure or speculative. PURE RISK is the chance of loss only, with no chance of gain or profit. Death, sickness, and the likelihood of needing medical care are examples of pure risk.

SPECULATIVE RISK involves a chance of loss and also a chance of gain. Investing in the stock market and purchasing a lottery ticket are examples of speculative risk.

Speculative risks are illegal in insurance. Only pure risks are insurable.

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Note: Insurance transfers risk, but it never eliminates it entirely. Insurance pays benefits if a loss occurs, but does not guarantee there will not be a loss.

15.3 Perils A potential cause of loss is called a PERIL. Insurance indemnifies an insured when a peril that is insured against causes a loss.

15.4 Hazards A HAZARD increases the likelihood or severity of loss when a peril strikes. There are four types of hazards:

Physical Hazards Can usually be seen, touched, tasted or smelled. Bad brakes on a car, poor health or potholes in a driveway are physical hazards.

Moral Hazards Risks an insurance company incurs when assuming an applicant is trustworthy and honest. Dishonesty, addictions and/or illegal activity create moral hazards.

Morale Hazards Morale hazards occur when a person is indifferent to the consequences of his/her actions. Speeding and drunk driving are morale hazards.

Legal Hazards Come from court actions that increase the likelihood or size of a loss. They are usually associated with liability insurance. Lawsuits are legal hazards.

15.5 The Law of Large Numbers THE LAW OF LARGE NUMBERS helps predict the probability of loss when it is applied to the risks associated with perils that could occur for a large group of similar insured entities over a long period of time. It states:

“The larger the number [of persons insured], the easier to accurately predict

outcomes in a group and/or over time.”

15.6 Loss Exposure LOSS EXPOSURE is the potential for incurring a loss. The amount of loss exposure is a major guideline for determining the cost of insurance.

Insurance agents must be able to identify and analyze loss exposures and evaluate ways they can be addressed. This often involves reducing or avoiding risks to minimize exposures and reduce policy costs. However, care must be taken to be sure that premium savings do not eliminate the effectiveness of the policy.

15.7 Ideally Insurable Risk An IDEALLY INSURABLE RISK is one that presents only a chance of loss with no potential for gain. The risk of a loss must be:

Fire, death, lightening and floods are kinds of perils



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Uncertain In Property and Casualty insurance, the uncertainty is not when, but if. In Life insurance, the uncertainty is not if, but when. Accidental This refers to an unforeseen and unplanned event. Due to chance Refers to very random acts or events.

15.8 Insurable Events INSURABLE EVENTS are events that may be insured. They include any contingent or unknown event, past or future, except for lotteries, gambling or civil damage awards against unlicensed people. For insurance, to be legal the policy owner/insured must have an insurable interest in the event, property or person insured. Otherwise, the policy is void.

15.9 Insurable Interest INSURABLE INTEREST is the inherent or acquired right one has to be indemnified (restored to the condition one was in before the loss), in the event of a loss to an event, a person, or property.

Note: There must be a direct relationship between the insured and the policy owner. Contingent (third party) interests are not insurable.

Insurable interest has three components: x Legitimate financial interest x Potential for economic hardship x No possible gain or profit

In property and casualty insurance, insurable interest is measured by the dollar value at risk.

In life insurance, insurable interest must exist at the time of application, but not necessarily at the time of loss. It can be identified in two ways:

A Financial Relationship A business partnership, someone who provides financial support for another or a bank that lends someone money, are examples of financial relationships that could hold an insurable interest.

“Strong love and affection generated by blood or marriage” In life insurance, insurable interest must exist between the owner of the contract and the life being insured. Spouses, insuring each other, children, insuring their parents, and parents insuring their children, are good examples of this type of insurable interest.

A bank has insurable interest in the money it lends. An insurable interest must exist between the insured and the property or event being insured at the time the contract is signed and/or a loss occurs.



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Note: In life insurance, insurable interest must exist at the time of application, but not necessarily at the time of loss.

15.10 Indemnity The meaning of INDEMNITY is to restore someone to the approximate financial condition they were in prior to incurring a loss. The “restoration” may be cash payments, repair, or replacement of the damaged insured item.

15.11 Underwriting An insurance UNDERWRITER is a technician who evaluates risks and determines if that risk is within the scope of the insurer’s underwriting guidelines. Underwriters select the rate and issue the insurance if it meets the insurer’s guidelines.

15.11.1 Obtaining Reliable Information For Property and Casualty or Personal Lines Insurance, this usually begins with:

x A review of the application x Physical inspections of property to reveal hazards or potential hazards x DMV records x A review of consumer credit reports, that may include information about

the applicant’s background and reputation

Much of the same basic information is required for life, health and disability insurance. Underwriters may also require:

x A medical examination x Attending physician’s statements x Medical Information Bureau information x Responses to questionnaires x Telephone interviews with the applicant

15.11.2 Adverse Selection & Spread of Risk ADVERSE SELECTION is the tendency of those who are most in need of insurance to apply. Underwriting protects insurers from adverse selection by eliminating high-risk applicants. For instance, terminally ill people are more likely to want life insurance than healthy people. Similarly, people who live in flood areas will want insurance more than those who live in “safer” areas. SPREAD OF RISK is the way insurance companies manage and attempt to distribute its risks in a profitable way. The following are a few risk management concepts, other than insurance, that Insurers use to spread risk:

Avoidance Some risks are not worth the trouble for some insurers because they carry too much loss exposure

Reduction Reduce the likelihood or the severity of the loss exposure. Installing a sprinkler system would limit the loss if a fire should occur.



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Retention Instead of buying insurance, some people retain the risk and the loss themselves. Retention is self-insurance.

Transfer A “hold harmless” agreement transfers the risk from one person to someone else. This method is what people do when they purchase insurance.

Sharing By having five to six different insurers share a risk, a total loss could still occur, but the loss exposure would be shared by the entire group. This concept is used in the area of larger risks.

15.11.3 Company Underwriting All insurance companies use their own “normal standards” as guidelines or for deciding who is insurable and who is not. COMPANY UNDERWRITERS review each application to determine whether or not the applicant meets these standards. Those that do will be rated to determine the amount of risk. Risks may be rated by:

Class Compared to the risk for similar groups of insureds

Insured’s Experience Based on the insured’s past record of behavior and experience

Underwriter’s Experience Based on the underwriter’s best judgment

15.11.4 Field Underwriting FIELD UNDERWRITING is the screening process that every agent goes through when evaluating and qualifying prospects.

15.11.4.1 Classifying Risks After all essential underwriting information is gathered and analyzed, applicants are assigned one of the following risk classifications so appropriate rates (or denial of application) may be assigned:

Preferred Risk Applicant is above the standard health and moral guidelines.

Standard Risk Applicant falls within normal underwriting guidelines.

Sub-Standard Risk Applicant falls below normal guidelines (usually due to poor health).



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NOTE: A substandard risk classification may still be insured at times with special exclusions or increased rates.

15.11.5 Pre-selection/Post-selection PRE-SELECTION is the process undertaken by field underwriters (agents) to target prospects that are most likely to provide the insurer with low risk clients.

POST-SELECTION takes place in the insurance office, when company underwriters review and rate the applicant that the agent has pre-selected.

Note: The goal of both pre- and post- selection is to accurately rate the risk before the policy is issued, rather than “post-claim”

15.11.6 Post-claim Underwriting Post-claim underwriting is the rescission, cancellation or limiting of a policy or group certificate because the insurance company did not complete underwriting and/or answer all reasonable questions before writing a policy.

Note: It is illegal for any insurer to engage in post-claim underwriting for any type of insurance, especially senior products, such as Medicare or Long-Term Care insurance.

15.12 Benefits & Costs of Insurance The risks of being without insurance can be financially devastating. As the cost of goods and services increases, insurance benefits are no longer a luxury, but a necessity.

Lawsuits are more common than ever before. Buying a home or auto through a lender requires insurance. The cost of insurance coverage is always debated, but it’s been proven time and time again that one of the most effective ways for people to limit their exposure to loss is to purchase insurance. This can be expensive, but the real question is not whether we can afford it, but can we afford to be without it?

15.13 Deductibles A deductible is an amount of money (“dollar deductible”) that must be paid, or time that must pass (“elimination period”), before an insurer will provide benefits after a loss.

Note: The higher the deductible (either time or money), the lower the premium.

15.14 Reinsurance An insurer’s RETENTION LIMIT is the amount of risk an insurer would normally accept on a given contract. REINSURANCE is when the insurer, or CEDING COMPANY, shares the risk with another insurer, known as the REINSURER.



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Reinsurance is used when an insurance company is asked to take a risk that is greater than its retention limit. Companies reinsure risks that are in excess of the retention limit in one of two ways:

Treaty An agreement where the ceding company transfers all excess risk, up to the limits of the agreement, to a reinsurer.

Facultative When an insurance company has no agreements, or has used them all, facultative reinsurance can assume the excess risk and facilitate the issuing of the policy.

For either option, the ceding company (Primary Insurer) transfers its risk to the reinsurance company (another insurer), but retains the responsibility of paying any losses to the insured. In this way, the reinsurance company is invisible to the client.

15.15 Classes of Insurance The California Insurance Code lists approximately 20 classes of insurance that can be sold by a licensed California agent or broker.

Class License Life (includes Annuities) Life Property & Casualty P&C Marine P&C Title P&C Surety P&C Disability (health, accidental death and dismemberment, disability income, long-term care, and Medicare supplement)

Accident & Health

Plate glass P&C Liability P&C Workers’ Compensation P&C Common Carrier Liability P&C Boiler & Machinery P&C Burglary P&C Credit P&C Sprinkler P&C Team & Vehicle P&C Automobile P&C Mortgage Life Aircraft P&C Mortgage Guaranty P&C Miscellaneous P&C

Note: Annuities are not a class of insurance.

CONTRACT AND TORT LAW CHAPTER 16


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16 Contract and Tort Law A contract is a binding legal agreement that creates an obligation that courts will enforce. Insurance policies are legal contracts.

16.1 Elements of a Contract A contract is a binding legal agreement. To be valid, a contract must consist of the following elements to be enforceable:

x Agreement, also known as an “offer and acceptance” or “mutual consent” x Consideration or payment x Competent parties x Valid legal purpose

16.1.1 Agreement In an insurance contract, the applicant makes an OFFER to the insurer when he or she completes and submits an application. The insurer then accepts (or rejects) the offer. The AGREEMENT is made when the insurer makes an ACCEPTANCE to the offer. This process is also known as “MUTUAL CONSENT/ASSENT.”

16.1.2 Valuable Consideration Valuable consideration must be exchanged between the parties to an insurance contract. The insured agrees to pay a premium to the insurer, and the insurer promises to pay a valid claim.

16.1.3 Competent Parties In order for the contract to be valid, the parties must have COMPETENCE, also known as LEGAL CAPACITY. The parties to the contract must be:

Mentally or Emotionally Competent Of sound mind and be able to rationalize Physically Competent Not under the influence of drugs or alcohol, legal or otherwise Of Age Must be 16 or older, based upon the nearest birthday

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Consideration may be money, an act or service, a promise, or the giving up of a legal right.



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16.1.4 Valid Legal Purpose The contract must not violate any laws or be detrimental to the public good.

16.2 Parties Subject To a Contract California insurance policies are two-party contracts with the issuing insurer required to obtain a Certificate of Insurance from the Department of Insurance and meet mandated levels of capital and surplus. The other party to the contract is the insured or policyholder/owner, who must be a competent party as defined in Section 2.1.3 above.

16.3 Special Characteristics of the Insurance Contract In insurance, a contract is an agreement whereby:

x An agency or agent does business with an insurer x An insurer agrees, for a consideration, to provide benefits, reimburse

losses or provide services for an insured

The insurance policy is the written statement that outlines the terms of the contract. The following attributes differentiate insurance contracts from other types of contracts:

16.3.1 Contracts of Adhesion Insurance policies are “take it or leave it” contracts written by insurers. This means there are no negotiations between the insurer and prospective insured. ADHESION means that by accepting a contract, an insured agrees with the terms and must adhere to them. Therefore, if the contract is written in an ambiguous way the law will usually side with the insured, because the he or she did not write the contract and had no control of the content.

16.3.2 Conditional Contracts The insurance contract defines CONDITIONS for each party that must be met. Insureds must show proof of a loss – and at times, insurable interest – before insurers will pay a claim.

16.3.3 Aleatory ALEATORY means that, unlike most other contracts, an equal value is not exchanged between the parties. The actual performance of the contract depends on the occurrence of an uncertain event.

16.3.4 Unilateral Policies are UNILATERAL because only the insurer makes an enforceable promise. Insurance contracts remain unilateral as long as the insured pays the premium.

16.3.5 Personal Contracts An insurance policy is a personal contract between the insurer and the insured and cannot be transferred from one party to another without the express written permission of the insurer.

Life Insurance contracts, some types of cargo or transport insurance contracts and Marine coverages are exceptions to this rule.



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16.3.6 Utmost Good Faith UTMOST GOOD FAITH is a legal term meaning that all parties are entitled to rely on each other to be honest and to, in no way, attempt to misrepresent, disguise, deceive or conceal any information pertinent or material to the contract.

16.3.7 Indemnity INDEMNITY is the concept that when a loss occurs, the insured will be restored to the condition they were in before the loss occurred. Indemnity contracts pay the insured in cash or by the replacement or repair of something.

16.4 The Insurance Policy The written instrument in which a contract of insurance is set forth is the policy. An INSURANCE POLICY is the agreement (contract) between two parties, the insured and the insurer that, for consideration, the insurer will pay a claim providing that a loss occurs during the term of the contract. All conditions and policy limits are stated in the contract and must be agreed to prior to coverage being in force. The limit of liability of any policy is the maximum amount the policy will pay in the event of a claim.

16.4.1 Endorsement & Rider An ENDORSEMENT is an attachment to an insurance policy that changes its conditions by increasing or decreasing benefits or excluding specific types of coverage. When an endorsement is attached to a life insurance policy, it is called a RIDER.

16.5 Tort Law A TORT is a legal wrong, other than: (1) Crime, which is controlled by Criminal Law, or (2) Breach of Contract, which is controlled by Contract Law. Tort Law deals with legal liability. While the legal systems are similar from state to state, each state determines its own law of torts.

There are three areas of torts in liability insurance. These are:

x Intentional acts or omissions of employees x Cases of negligence x Cases of strict or absolute liability

16.5.1 Intentional Torts INTENTIONAL TORTS are “on purpose” and wrongful acts or omissions. While insurance does not usually protect individuals from the consequences of wrongful acts, it does protect employers from the consequences of the intentional acts of their employees. This protection includes insurance against:

x False arrest, detention or imprisonment, or malicious prosecution x Libel, slander or defamation of character x Invasion of privacy, wrongful eviction or entry x Personal injury (other than bodily injury or property damage)

Assault, battery, trespass, libel, and slander are examples of wrongful acts.



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16.5.2 Negligence NEGLIGENCE is defined as failing to act in a prudent manner through an act, error or omission that results in an injury to someone or damage to property. In insurance, elements of negligence are:

Duty There is a legal duty to do or not to do something Breach Something is not done Injury Bodily injury or property damage is caused Unbroken Chain There is an unbroken chain of events between the cause (proximate cause) and outcome.

16.5.3 Strict and Absolute Liability LIABILITY is a legally enforceable obligation. Strict and absolute liability is usually applied to claims against products. Under STRICT LIABILITY, a manufacturer can be held strictly liable, without regard to fault or negligence, if a claimant can prove that a product was defective and that the defect caused an injury. ABSOLUTE LIABILITY is imposed when conduct is so hazardous that those engaging in it are held fully responsible for resulting injuries or damages. Under absolute liability, the claimant does not have to prove the conduct was hazardous.

16.6 Proximate Cause A PROXIMATE CAUSE occurs when an insured loss occurs and an unbroken chain of cause and effect exists between the occurrence or negligent act and the resulting damage or injury.

16.7 Gross Negligence & Vicarious Liability GROSS NEGLIGENCE is any act or omission which is willful and intentional, rather than inadvertent, and which is committed with a conscious indifference to the consequences VICARIOUS LIABILITY is the liability imposed upon one party as the result of the actions of another. Under some circumstances, the law will hold a person liable for the negligence of someone else. For example, parents can be held liable for injuries or damages caused by their children.

Keeping dangerous animals and operating an unsafe workplace are examples of Absolute Liability.



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16.8 Types of Damage There are various types of “third party” damages that may or may not be covered by liability insurance.

SPECIFIC DAMAGES are measurable. Property damage or bodily injuries that result in medical expenses are specific losses for which a claim could be filed to cover specific damages. GENERAL DAMAGES may include a number of intangible elements that cannot be specifically measured in terms of dollar amounts. (A person could suffer general damages beyond specific damages that can be measured.) COMPENSATORY DAMAGES encompasses both specific and general damages. The purpose of compensatory damages is to reimburse someone for the tangible and intangible elements of a loss. PUNITIVE DAMAGES are a form of punishment that is often intended to serve as an example to others and to discourage bad behavior. These damages are often used as punishment for gross negligence.

16.9 Doctrines of Comparative vs. Contributory Negligence The doctrines of Comparative and Contributory Negligence are two methods of computing loss payment in the case of an accident.

CONTRIBUTORY NEGLIGENCE attempts to determine whether the injured party was careless or contributed in any way to his injury. A finding of Contributory Negligence will reduce or defeat the claim, even if the other party is also found to be negligent. Many states have adopted a less harsh version of Contributory Negligence, known as COMPARATIVE NEGLIGENCE. This doctrine is often used when both parties are found to be negligent. Although the guidelines vary from state to state, Comparative Negligence laws establish the amount of fault for an accident and loss payment in proportion to each party’s contribution to the accident.

16.10 Assumption of Risk Doctrine ASSUMPTION OF RISK is a common law concept that asserts that individuals accept risks for performing certain normal activities, such as walking along a public street or riding as a passenger in a car. Individuals can use this defense to avoid or mitigate liability in a lawsuit.

16.11 Pure No-fault vs. Modified No-fault Laws NO-FAULT INSURANCE laws allow auto accident victims to collect medical and hospital expenses directly from their own insurance companies, no matter who was at fault for the accident.

A passenger riding in a car which another person is driving “assumes the risk” of riding in the car and will probably not be able to take action against the driver if an accident occurs.



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PURE NO-FAULT insurance moves totally away from the Tort system because it eliminates the right of an injured party to sue the other party for damages. Instead, the injured party collects for damages from his or her own policy.

Note: There are no true no-fault plans available in the US today. However, many states have adopted “modified no-fault” plans that preserve the right to sue for additional compensation under certain circumstances.

16.12 Transacting Insurance Transacting Insurance is typically defined as including any insurance related solicitation, any preliminary negotiation, any execution of an insurance contract, any transaction subsequent to and arising out of an execution of an insurance contract, and any act of insuring. The Insurance Code considers any of the following activities “transacting” insurance:

x Solicitation (Asking someone to buy insurance.) x Negotiations that take place before a contract is written (Displaying

premiums and demonstrating illustrations.) x Execution of a contract of insurance (Indicating where to sign on the

application, collecting premiums, and/or delivering the policy.) x Transaction of matters subsequent to and arising out of a contract of

insurance (Service not limited to explaining benefits or recommending changes in the policy.)

Note: Any one engaging in the above activities needs to hold a valid insurance license.

Transacting insurance without a license A person may not act as an insurance agent, broker or solicitor without a valid license from the Commissioner. Anyone who acts, offers, or assumes to act in a capacity for which a license is required, without actually holding a license, is guilty of a misdemeanor subject to a fine up to $50,000 or imprisonment in county jail for up to one year or both.

16.13 Contract Terminology It is also important to understand the following terms when reading or writing an insurance contract:

16.13.1 Fraud FRAUD is defined as a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment, an intentional and deliberate act for unlawful gain or profit. The penalty for defrauding an insurance company is imprisonment for two, three, or five years, and/or by fine of up to $150,000 or twice the value of the fraud, whichever is greater.



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16.13.2 Concealment CONCEALMENT is neglecting to communicate or failure to disclose facts that are known (or should be known) and are material to a contract. Intentional or unintentional concealment entitles the injured party, insurer or insured, to rescind the contract. Information that need not be communicated includes:

x Information that is known x Information that should be known x Information that the other party waives x Information that is not material to the risk

16.13.3 Warranty, Expressed or Implied A WARRANTY is a promise or statement that is assured to be true. It may be express or implied.

EXPRESS WARRANTIES are written and “contained” in the contract. In insurance, all warranties must be expressed in writing. IMPLIED WARRANTIES are “included but not specifically stated” in the contract.

The agent/broker and carrier must adhere to the following warranty conditions in conducting the business of insurance:

x Warranties may relate to the past, present or future. x Unless the policy states that the violation of a specific provision will void

the policy, the breach of an immaterial provision does not void the policy. x A particular wording is not necessary to form a warranty. x Violation of a material warranty or provision, on the part of either party, will

entitle the other to rescind. x An express warranty made at or before the execution of a policy must

either be contained in the policy, or in another instrument signed by the insured party. If another instrument contains the information, the instrument must be referenced in the policy and made part thereof.

x When the performance of a future warranty becomes unlawful or impossible, the omission to fulfill the warranty does not void the policy.

x A policy statement that there is an intention to do or not do something, which materially affects the risk, is a warranty that such act or omission will take place.

x A warranty breach, without fraud, merely exonerates an insurer from the time that it occurs. Where the warranty is broken in its inception, it prevents the policy from attaching to the risk.

16.13.4 Materiality MATERIALITY is relevant information that would probably influence a party’s assessment of a proposed contract. In insurance, materiality is determined by three questions:

1. Are the facts important enough to influence the decision?



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2. Do they affect or influence insurability or the risks involved? 3. Does the information create any disadvantages to either party entering

into the contract?

The MATERIALITY of a given concealment or representation determines its importance.

16.13.5 Representations REPRESENTATIONS are oral or written statements made to the best of one’s knowledge and belief. A representation is false when the facts fail to correspond with the assertions and stipulations. If a representation is false in a material point, the injured party (insurer or insured) is entitled to rescind the contract. All answers to questions on applications are deemed to be representations. A representation may be altered or withdrawn before the insurance is effective but not afterward.

16.13.6 Misrepresentations MISREPRESENTATION is a representation that is found to be untrue. It is illegal for anyone who transacts insurance to cause or allow misrepresentations of:

x Policy terms x Benefits or privileges x Future dividends payable under the policy

The punishment for misrepresentation is a fine not exceeding $25,000, or in a case in which the loss of the victim exceeds $10,000, by a fine not exceeding three times the amount of the loss suffered by the victim, by imprisonment in a county jail for a period not to exceed one year, or by both a fine and imprisonment.

16.13.7 Twisting TWISTING is the act of making misleading statements or comparisons to induce someone to take out or refuse to take out an insurance policy, or to lapse, surrender or forfeit an existing insurance policy. This practice is illegal and those who engage in it are guilty of a misdemeanor and could be punished by a fine of up to $25,000 and up to one year in county jail. The Commissioner may suspend the license of any agent, broker or solicitor who knowingly engages in twisting for up to three years and may suspend the Certificate of Authority of any insurer who knowingly engages in twisting or allows an officer, agent or broker to do so.

16.13.8 Waiver and Estoppels A WAIVER is the act of waiving or excluding a right that is known to exist. ESTOPPELS are the legal right an insured has to prevent cancellation of a policy if an insurer persuades him or her to violate a contract condition. In such a situation, the insurer cannot void the contract because of the violation.



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16.14 Required Policy Specifications All insurance contracts must specify:

x The parties between whom the contract is made x The property or life being insured x The interest of the insured/owner in the property insured (if he or she is

not the absolute owner of the property) x The risks insured against x The period during which the insurance is to continue x A statement of the premium or, if the exact premium can only be

determined upon termination of the contract, a statement of the basis and rates upon which the final premium is to be determined and paid.

Note: This list does not include financial ratings, claims payment ratings or any of the marketing materials used in the presentation. (It is not required that this information be specified in the insurance policy.)

16.15 Right of Rescission (Free Look Period) Every individual life insurance policy, including individual life insurance policies with face values of less than ten thousand dollars ($10,000), delivered in this state shall have printed thereon, or attached thereto, notice that the owner, after policy receipt, may return the policy for cancellation by delivery or mail to the insurer (or the selling agent) within the time stated in the body of the policy for cancellation, if he or she is not satisfied with the contract for any reason. The time period, which must be clearly stated on the notice, must be no less than 10 days or more than 30 days (20 days if a replacement is involved). Such a delivery or mailing by the owner shall void the policy from the beginning, as if no policy had been issued. All premiums and any fees paid shall be refunded to the owner. The insurer has 30 days from receipt of the notification to submit full reimbursement to the client. The free look period begins when the policy is actually received by the policy owner. Insurers often require the policy owner to sign an “Acknowledgement of Delivery Receipt” at the time of policy delivery. These requirements are not applicable to policies issued in connection with a credit transaction, a contractual policy change or a policy conversion privilege provision. For variable life insurance policies, variable annuities and modified guaranteed contracts, return of the contract during the cancellation period shall entitle the owner to the refund of the account value and any policy fee, within 30 days from the date that the insurer is notified that the owner has cancelled the policy.

16.15.1 Sales to Seniors Any Life Insurance policy or annuity contract issued to a person 60 years of age or older must include a written notice and “right-of-return” statement, offering policy cancellation and full refund of premiums paid (or contract account value for variable life and annuities) any time during the first 30 days after policy issuance. During this 30 -day period, the premium for a variable annuity must be invested only in fixed-income investments and money market funds – unless the client specifically directs that the funds be invested in the mutual funds underlying the



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variable annuity product. In the latter case, the cancellation shall entitle the policyholder to the refund of the account value.

16.15.2 Disclosures Every individual Life Insurance policy and annuity contract (other than variable contracts) shall have the following notice, in 12-point bold print, with one inch of space on all sides, prominently displayed on the cover sheet or jacket.

IMPORTANT

YOU HAVE PURCHASED A LIFE INSURANCE POLICY OR ANNUITY CONTRACT. CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT FOR A FULL REFUND BY RETURNING IT TO THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY. AFTER 30 DAYS, CANCELLATION MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE.

Every individual variable annuity or variable life insurance contract, shall display the following disclosure in 12-point bold print, with one inch of space on all sides, prominently displayed on the cover sheet or jacket.

IMPORTANT

YOU HAVE PURCHASED A VARIABLE ANNUITY CONTRACT (VARIABLE LIFE INSURANCE CONTRACT OR MODIFIED GUARANTEED CONTRACT). CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT. DURING THAT 30-DAY PERIOD, YOUR MONEY WILL BE PLACED IN A FIXED ACCOUNT OR MONEY–MARKET FUND, UNLESS YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO, UNDERLYING THE CONTRACT DURING THE 30-DAY PERIOD. IF YOU DO NOT DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO, AND IF YOU RETURN THE POLICY IN THE 30-DAY PERIOD, YOU WILL BE ENTITILED TO A REFUND OF THE PREMIUM AND POLICY FEES. IF YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO DURING THE 30-DAY PERIOD, AND IF YOU RETURN THE POLICY DURING THAT PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE POLICY’S ACCOUNT VALUE ON THE DAY THE POLICY IS RECEIVED BY THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY, WHICH COULD BE LESS THAN THE PREMIUM YOU PAID FOR THE POLICY. A RETURN OF THE POLICY AFTER 30 DAYS MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE.

Acceptable methods of delivery, to start the free look period, includes any one of the following methods:



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1. Personal delivery, with a signed receipt 2. First Class mail with a signed receipt 3. Registered or Certified mail 4. Other reasonable means as determined by the Commissioner.

If one of these methods is not used, the burden of proof as to when delivery was made will fall on the insurer. The 30-day Free Look Period also applies to Long-Term Care and Medicare Supplement Policies.

16.15.3 Insurer’ Right of Rescission An intentional or fraudulent omission, on the part of the insured, to communicate matters proving the falsity of a warranty, is grounds for the insurer to rescind the insurance contract. Similarly, if there is a representation that is demonstrably false regarding a material point, the injured party can cancel the contract. The insurer has the right of rescission when intentional or unintentional concealment entitles the injured party to rescind the contract.

16.15.4 Adverse Selection & Spread of Risk ADVERSE SELECTION is the tendency of those who are most in need of insurance to apply. Underwriting protects insurers from adverse selection by eliminating high-risk applicants. For instance, terminally ill people are more likely to want life insurance than healthy people. Similarly, people who live in flood areas will want flood insurance more than those who live in “safer” areas. However, if the insurance company wrote a great deal of flood insurance in a flood zone area it would be subject to adverse selection. MANAGEMENT OF RISK is spreading the risk is the way insurance companies attempt to distribute risks in a profitable way. The following are a few risk management concepts, other than insurance, that both insurers and the public use to spread risk:

16.16 Other Important Policy Terms An understanding of the following other terms is also important when dealing with insurance policies.

16.16.1 Renewal As used in insurance, RENEWAL means to reestablish the status of a policy that has expired or is about to expire.

16.16.2 Non-renewal NONRENEWABLE is the termination of a policy by an insurer, or an insured, when the policy expires.

16.16.3 Lapse A policy will LAPSE (be terminated) for nonpayment of premiums.



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16.16.4 Grace Period In insurance, the GRACE PERIOD is a predetermined period of time, after the premium due date, when a policy remains in force and the premium may be paid. The usual grace period is 30 or 31 days.

16.16.5 Cancellation CANCELLATION is the voluntary termination of a policy by the insurer or insured, by mutual agreement, or as stipulated in the insurance contract.

16.16.6 Earned Premium EARNED PREMIUM is the amount of premium that is spent during the term of a policy. For example, if a one-year policy has been in effect for 9 months, 75% of the total premium has been earned.

16.16.7 Unearned Premium UNEARNED PREMIUM is the amount of premium that has been paid but not yet spent at any given time during the life of a policy. For example, if a one-year policy has been in effect for 9 months, 25% of the total premium is unearned.

THE INSURANCE MARKETPLACE: PRODUCERS CHAPTER 17


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17 The Insurance Marketplace: Producers There are several producer categories in the insurance marketplace. The following categories of people, companies and services are considered producers of insurance:

17.1 Distribution Systems There are four major distribution systems used to sell insurance. These are:

x Independent Agency x Exclusive Agency x Direct Writing x Direct Mail

17.1.1 Independent Agency An INDEPENDENT AGENT owns the renewal rights to policies that come up for renewal and has the right to place a renewing policy with any company to which he is appointed (with the consent of the insured).

17.1.2 Exclusive Agency An EXCLUSIVE AGENT, also called “captive” or “career” agent, does not own renewal rights because the insuring company retains them. An exclusive agent must write business with the appointing company or give that company the first right of refusal.

17.1.3 Direct Writing A DIRECT WRITING COMPANY uses its own employees to transact insurance directly with consumers.

17.1.4 Direct Mail DIRECT MAIL COMPANIES mail solicitations directly to the consumer. Direct mail offers come from the insurer instead of the applicant.

17.1.5 Direct Response Marketing DIRECT RESPONSE (WRITING) COMPANIES use employees to solicit and sell insurance. These agents usually receive a salary, or a salary plus commission. A direct writing company has complete control and ownership of its policies and renewals.

17.1.6 Home Service Marketing (Industrial Life) INDUSTRIAL LIFE Insurance was developed in the early 1900s to give minimum coverage to blue collar and factory workers. Coverage is usually low ($1,000 to a maximum of $10,000) and is intended to cover funeral expenses. Coverage is

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also often available for families (from birth to age 65 or 70) and there are no suicide or loan provisions. Industrial life insurance is often more expensive than other life policies because:


x Those who carry this type of insurance are often higher-than-average risks.

x The agent collects premiums at frequent intervals, at least monthly or weekly, so the insurance company’s administrative costs are higher. The requirement that premiums be collected in person is the reason this is frequently called “home service” marketing.

17.2 Producers A PRODUCER is an agent, broker, or solicitor who generates insurance policies. Every producer must accept a high level of legal, ethical and moral responsibility when dealing with clients and the companies they represent. Their statements and actions can have a substantial impact on an insured’s security and financial wellbeing.

17.2.1 Legal Relationships AGENTS represent companies to clients. BROKERS represent clients to companies. A broker does not represent the company.

Insurance Agents enter into a contract to represent an insurer. As such:

x Their actions are the actions of the company x Their knowledge is the knowledge of the company x Receipt of money by the agent is receipt of money by the company.

17.2.2 Fiduciary Responsibilities When underwriting insurance, both the agent and the broker act in a FIDUCIARY CAPACITY, or a position of financial trust. A great example of fulfilling ones fiduciary responsibility is to promptly submit all premiums to the insurer. Insurance Agents and Brokers act as a fiduciary because they hold a position of trust with their clients and the companies they represent. They are expected to act in an appropriate and ethical way, and to fulfill the following responsibilities regarding treatment of funds they receive:

x Agent/brokers must remit all funds received to the appropriate Insurer. Any person who uses or diverts those funds for their personal use has committed a crime under the charge of theft and may be punished under the Laws of California.

x When funds are received by a licensed agent/broker in the course of transacting business, he or she shall: o Remit and/or return premiums, less any commissions, to the insurer or

person entitled to the funds.



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o Maintain fiduciary funds for California business in a trustee bank account, (separate from any other accounts), or depository, and not commingle any other funds in an amount at least equal to premiums and return premiums, net commission received and remaining unpaid amounts to persons that are entitled to such funds.

Any alternate method of handling funds must be described in a written agreement authorized by every person that is entitled to the funds. Any agent/broker or surplus lines broker may deduct amounts due for unpaid premiums on the same policy from amounts due an insured.

17.3 Types of Producers The California Code recognizes the following types of insurance producers:

17.3.1 Insurance Agent (Property Casualty Agent) An INSURANCE AGENT is the person authorized by and for an insurer to transact all classes of insurance other than life and health insurance. This includes all types of Property and Casualty Insurance, which may be sold by a property and casualty licensee – a person authorized to act as an insurance agent, broker or solicitor.

17.3.2 Insurance Solicitor A SOLICITOR must be a natural person who assists an agent or broker in transacting all classes of insurance other than life. A solicitor may take applications, collect premiums, and solicit on behalf of the agent or broker, but cannot bind. Solicitors are paid on a commission or production basis. Those who wish to become a solicitor must meet the following requirements:

x Pass the same test as an agent and have a solicitor’s license x Complete the same 52 hour pre-licensing course x Hold a valid Property & Casualty license

Note: A solicitor may not be an agent or broker at the same time that they are a solicitor.

17.3.3 Personal Lines Agent The PERSONAL LINES AGENT/BROKER is licensed to only sell insurance that meets the needs of the individual or family – not commercial insurance. The most common examples are:

x Automobile insurance (including insurance for recreational vehicles used for non-commercial purposes)

x Personal watercraft insurance x Residential property insurance (including earthquake and flood insurance) x Inland marine insurance for personal property x Umbrella or excess liability insurance, providing coverage when written

over one or more underlying automobile or residential property insurance policies

A “natural person” is a human being, not a company



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Note: Personal Lines agent can upgrade to a full Property Casualty license by completing the required Pre licensing (20Hrs) and successfully passing the Commercial exam.

17.3.4 Limited Lines Auto Only Agent A LIMITED LINES AUTO ONLY AGENT is a person authorized by and for an Auto insurer to transact personal auto policies.

17.3.5 Life Agent Licensee A LIFE AGENT is a person authorized by and for a life and/or disability insurer to transact life insurance, fixed annuities, and/or accident and health insurance. A life agent may also be authorized to transact 24-hour care (seamless coverage). A life and accident and health agent cannot receive a fee unless it is based on a written agreement signed by the party being charged, and cannot charge a fee for soliciting or servicing insurance contracts written by the licensee or contracts for which the licensee receives compensation from the insurer.

17.3.6 Life and Disability Analyst A LIFE AND DISABILITY ANALYST is a person who, for a fee, advises a beneficiary of a life or disability insurance contract of his or her rights under the contract. An analyst must meet the following requirements:

x May not be an employee of an insurer x Must reside in California x Must be 18 years old x Must have knowledge of life and disability insurance x Must have a good reputation x Must pass the Life and Disability Insurance Analyst exam

Analysts may not charge a fee for soliciting or servicing insurance contracts they write or receive any compensation from an insurer. If an analyst is also licensed as a life and disability agent, a written statement must disclose this information and state that the individual receives commissions for the sale of products.

Analysts may not receive any fee unless it is based on a written agreement, signed in advance of the sale, by the party being charged. This agreement must state:

x That policy information and services may be obtained directly from the insurer without cost

x The service being performed for a fee x The amount of the fee

The licensed analyst must retain a copy of each agreement for three years.



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17.3.7 Life Only Agent A LIFE ONLY AGENT is a person authorized by and for a life insurer to transact life insurance and fixed annuities.

17.3.8 Accident and Health Agent An ACCIDENT and HEALTH AGENT is a person authorized by and for an accident and health insurer to transact accident and health, disability, 24 Hour care, supplemental benefits and Long Term Care policies.

Note: DUAL AUTHORITY - Both a licensed Life Agent or Accident & Health Agent may be authorized and/or appointed to transact Accident and Health Insurance by filing a “Notice of Appointment” for that purpose.

17.3.9 Special Life Licenses

17.3.9.1 Limited Life Agent - Limited to the Payment of Funeral & Burial Expense

Authorized by and for a life insurer to transact life insurance and fixed annuities not to exceed $15,000 in face amount. Commonly referred to as pre-need or burial insurance. 17.3.9.2 Life Settlement Broker Insurance needs, whether individual or business, often require modifications over time, usually due to shifts in the economic climate. One way to accomplish such changes would be through the use of a life settlement financial transaction, in which the owner of a life insurance policy sells it to a third policy - for an amount greater than the cash value offered by the life insurance company but for less than the face value. This allows the owner of the policy to receive a portion of the policy’s death benefit while he/she is still alive. The entity that buys the policy is called a life settlement provider. In addition, there are life settlement brokers who arrange the sale of the policy. Still considered a rapidly growing multi-billion new market, up until now there has been little or no regulatory oversight in California for these types of agreements. However, effective July 1, 2010, those brokering life settlements must meet the requirements of California Insurance Code sections 10113.2. Specifically, those brokering life settlements in California must be:

x Life agents, who have been licensed for at least one year and have complied with the California Department of Insurance’s fee and notification requirements.

x Life agents for less than one year or applicants that do not have a life agent license must complete 15 hours of continuing education related to life settlements and related transactions. They must also complete an application and pay the life settlement broker license fee prior to operating as a broker.



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x A life settlement broker license is not required for attorneys, CPAs and accredited financial planners representing the policy owner, who do not receive compensation from the life settlement provider. Viatical settlement brokers or providers, so licensed as of December 31, 2009, are considered to have complied with the requirements for a life settlement.

17.3.10 Insurance Broker Under California law, an INSURANCE BROKER is a person who transacts insurance – other than life and health insurance – with, but not on behalf of, the insurance company for compensation and on behalf of another person. Brokers are independent contractors who review the insurance needs of their clients and then “shop” the market place for coverage’s that best suit those needs. Unlike agents, brokers do not represent insurance companies. Instead, they represent clients or insureds. Since life and health agents always represent their insurers, there are no such entities as life brokers or health brokers. Brokers work for commission and fees, usually in the property and casualty field, and always based on a written agreement signed by the party being charged. There are some very large firms, known as “brokerage houses,” which operate nationwide and represent commercial clients. If a person is licensed to act as a broker/agent, he or she shall be deemed to be acting as an agent in all transactions with insurers for whom a notice of appointment of that licensee as its agent has been filed with the Commissioner and is then in force. A person licensed as a property and casualty broker/agent acting as an insurance broker may act as an insurance agent in collecting and transmitting premium or return premium funds, and delivering policies and other documents evidencing insurance.

17.3.11 Managing General Agent A MANAGING GENERAL AGENT is a licensed property and casualty broker/agent or life agent who:

x Has a written management contract and appointment on file with the Commissioner, with one or more admitted insurers

x Manages the transaction of a class or classes of insurance written by those insurers in a specific territory under that contract

x Has the power to appoint, supervise, and terminate the appointment of local agents

x Has the power to accept and decline risks x Collects premium money from producing broker/agents x Remits the money to those insurers according to the account current

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Note: Managing General Agents may accept or decline risks only on Property and Casualty policies. Life insurance companies only allow their underwriting department to accept or decline risks.

17.3.12 Employees as Producers DIRECT WRITING COMPANIES use employees to solicit and sell insurance. These agents usually receive a salary, or a salary plus commission. Mail order sales fall in the direct writing category. A direct writing company has complete control and ownership of its policies and renewals.

17.3.13 Administrator An ADMINISTRATOR is one who collects any charge or premium from, or who adjusts or settles claims on, California residents in connection with life, health or annuities coverage, other than:

x An employer on behalf of its employees x A union on behalf of its members x An insurance company x A life or health agent or broker exclusively selling insurance x A creditor on behalf of its debtors x A trust, its trustees, agents, and employees x A trust exempt from taxation under IRS Code Section 501(a) or 401(f) x A bank, credit union, or other financial institution x A company which advances and collects premium or charges from credit

card holders, provided it does not adjust or settle claims x A person who adjusts or settles claims as an attorney and does not collect

premiums in connection with life or health or annuity coverages x An adjuster x A nonprofit agricultural association

An administrator shall not act without a written agreement with the insurer, a copy of which must be retained as part of the official records of both the insurer and administrator for the duration of the agreement and for five (5) years thereafter.

A THIRD PARTY ADMINISTRATOR (TPA) is a firm that provides administrative services for employers and associations having group insurance policies. A third party administrator acts as a liaison between the insurer and the employer in matters such as certifying eligibility, preparing reports required by the state, and processing claims. The use of third party administrators is a common use for employers who self-insure.

17.3.14 Adjuster An ADJUSTER is a person, other than a private investigator who, for consideration, adjusts or otherwise disposes of property insurance policy claims. There are three types of adjusters who work in the insurance industry:

GEICO is an example of a Direct Writing Company.



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Insurance Company Adjusters Work for insurance companies and do not need to be licensed. Independent Adjusters Need a license and must pass adjuster’s test. They represent the insurer and may represent many insurers. Public Adjusters Need a license and must pass adjuster’s test. Must post a $5,000 bond. The public adjuster may represent an insured in a dispute that the insured has with his or her own insurance company.

Note: A lawyer may act as an adjuster incidental to his/her practice or profession without an adjuster’s license.

17.3.15 Surplus Lines Broker A SURPLUS LINES BROKER is a person licensed by the Insurance Commissioner to solicit and place insurance with non-admitted carriers. Surplus Lines Brokers are only found in the Property and Casualty field. To become a Surplus Lines Broker, candidates must apply to the Commissioner and post a $50,000 bond, in favor of the people of the State of California, to protect those from whom the broker collects money.

17.3.16 Return Premiums as Offset for Unpaid Premiums A broker agent may offset funds due an insured for return premiums on any policy against amounts due him/her from the same insured for unpaid premiums on the same or any other policy. Any insurer may pay premiums to any broker/agent for that purpose. It is illegal to advertise or promote a non-admitted carrier. Aiding a non-admitted carrier without a Surplus Lines Broker license is a misdemeanor, punishable by a $500 fine and an additional $100 for each month the violation continues.

17.4 Certificate of Authority An insurance company’s AUTHORITY TO TRANSACT comes as a result of the approval of their application by the Commissioner to become an admitted carrier. The transaction of insurance in California, without a Certificate of Authority covering the class or classes of insurance, is an unlawful act and is punishable by:

x Imprisonment in a state prison, or in a county jail, for a period of time not exceeding one year.

x Or by fine not exceeding $100,000. x Or by both such fine and imprisonment.



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The authority of agents and brokers is directly related to their licenses. Agents and brokers who are licensed by the California Department of Insurance. may only transact within the borders of the State of California and are restricted to transact only with companies that are admitted to do business in California.

17.5 Broker-Agent as Agent A person who has posted a bond to become a broker and who has also been appointed as an agent will be considered to be acting as an agent if they submit business to a company with which they are appointed. In other words, a person cannot act as an agent and a broker in the same transaction.

Any person licensed to act as a broker or agent is deemed to be acting as an agent in all transactions with insurers for whom a notice of appointment of that licensee as its agent has been filed with the Commissioner and is in force. A licensed Property and Casualty broker/agent acting as an insurance broker may act as an insurance agent:

x In collecting and transmitting premium or return premium x In delivering policies and other documents

Whenever a licensee (agent or broker) represents or recommends the products of another party or company, he or she is acting as an agent for that party. In insurance, acting as an agent without a license is illegal.

17.6 Agent vs. Broker vs. Solicitor An Agent operates under the authority of his contract with an insurance company to which he is appointed. A Solicitor operates under the authority granted to him by an appointing agent or broker. Under California law, an INSURANCE BROKER is a person who transacts insurance – other than life insurance – with, but not on behalf of, the insurance company for compensation and on behalf of another person. There is no such thing as a “Life Solicitor”

Note: Insurance companies will only pay commissions to licensed agents or brokers. Solicitors are paid by the agent/broker for whom they are doing business.

17.7 Agency Purpose, Duties & Authority An AGENCY is a relationship in which one person is authorized to represent and act for another person or corporation. The three agency systems used in insurance are:



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17.7.1 Independent Agency An INDEPENDENT AGENCY is an entity that enters into agency agreements as a contractor and represents more than one company at a time. The agency is allowed to search the market for the company and products that best fit their client’s needs. In addition, not being controlled by any one company, the agency owns the records of the policies sold and pays the cost of doing business out of commissions.

17.7.2 Exclusive Agency An EXCLUSIVE AGENCY, also known as a “Captive” or “Career” agency, represents a single insurer and submits business only to that company, unless that company rejects its “right of first refusal.” Controlling companies usually provide Exclusive Agencies with training, expense allowances, a minimum salary and benefits. Exclusive agencies do not own the records of the policies sold.

17.7.3 General Agency A GENERAL AGENCY has a group of agents working for him or her at a specific location. A General Agency is responsible for the agency operation within a geographic area and acts as a liaison between selling agents and the Home or Regional Office of the company he or she represents. The responsibilities of the General Agency usually include:

x Recruit, train, supervise and terminate the appointment of agents x Accept or decline risks in the field of property and casualty x Collect and remit premium money according to the account current system x Provide administrative support to agents

17.7.4 Types of Authority It is important for anyone involved in the insurance business to understand the meaning and difference between the following types of authority granted to producers.

Express Authority Granted to the agent under a written contract Implied Authority Not specifically stated, but included based on other statements in the contract Apparent Authority Appears to exist to the public, even if it does not in reality

The authority of insurance agents is a CONTRACT OF AGENCY between the agent and the principal. Under this authority, the agent, the general agent, and the insurance company are considered to be one and the same (“the Principal”), and are governed by “Agency Law.”

The principal is the individual or corporation where performance is guaranteed in the insurance policy.



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There are four major rules that are part of this relationship: x The agent legally represents the Principal x Contracts made by the agent are contracts of the Principal x Payment made to the agent is considered to be payment made to the

Principal x Agent knowledge is assumed to be Principal knowledge. The agent is

legally, morally and ethically required to disclose any material information discussed or acquired during the application process to the insurer

Specific duties and authority usually granted to all types of agency include the following:

17.7.5 Applications An APPLICATION is the document that a prospective policyholder completes to provide underwriting information to insurance company. The insurance agency and its licensed agents are authorized to solicit and submit policy applications for the company(s) they represent.

17.7.6 Binder/Covering note A BINDER is a temporary coverage agreement, executed by the agent or insurance company (usually the company) and delivered by the agent. This document puts the insurance in force until the premium is paid and is good until the insurer issues a policy or declines coverage. Only agents, not brokers, are granted binding authority. In Life Insurance, a COVERING NOTE is similar to a binder, except that an agent usually prepares it. Covering notes and/or binders are valid for 90 days and may be extended for up to 150 days.

17.7.7 Conditional Binding Receipt (Conditional Receipt) The CONDITIONAL RECEIPT provides that, if a premium is paid, policy coverage will be in force from the date of the application or medical exam, if required, so long as the insurer would have approved coverage. For Life and Health Insurance policies, a conditional receipt is not valid until it is delivered to the insured and the premium is paid.

17.7.8 The Master Contract The goal of group insurance is to provide coverage for members of a defined group of people under a MASTER CONTRACT or Master Policy. While individual insurance is a legal contract between the insured and the insurer, group insurance is a contract between the insurer and “sponsoring organization.”

17.7.9 Certificates of Insurance The CERTIFICATE OF INSURANCE is an evidence of coverage, provided by an agency and delivered by an agent. For group life and health insurance, members are usually insured by a group master policy, and each covered person receives a separate certificate of insurance summarizing coverage, benefits and

Groups can include employer-employee groups, trade associations, professional organizations, unions, lodges, fraternities and other special interest groups.



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rights under the policy. In this case, the certificate is proof that the individual receiving it has insurance coverage. In the property and casualty field, certificates of insurance are issued to a non-insured third party as evidence that another party has insurance coverage. Contractors often have to furnish certificates of insurance to property owners to prove that they have appropriate coverage before they begin work. Lending institutions may require a certificate of insurance as evidence that collateral is protected prior to granting a loan. Vehicle operators may have to furnish certificates of insurance in order to satisfy motor vehicle financial responsibility laws.

17.7.10 Renewal Responsibilities Insurers usually handle all policy renewals and cancellations directly with the insured parties. This does not, however, relieve the agent/broker from his or her duty to provide appropriate and timely follow-up.

17.7.11 Suspense/Diary System The SUSPENSE DIARY is the agent’s record keeping system for tracking client transactions and communication. Information in this system must be available for viewing by the Commissioner on request. The California Department of Insurance has strict guidelines regarding what, how, and how long information is kept and where it is to be located, usually at the place of business.

17.7.12 Lost Policy Release A LOST POLICY RECEIPT is issued by an agency and delivered by an agent to take the place of the insurance policy until the company can issue a new policy. For a new policy to be issued, the client must be in good standing and all due premiums must have been paid.

17.8 Errors & Omissions Insurance (Professional Liability) All those who transact insurance should purchase professional liability coverage before they begin to conduct business.

Professional liability insurance comes in two forms:

17.8.1 Errors and Omissions (E&O) ERRORS AND OMISSIONS insurance covers the insured for any loss due to an error or oversight on his part. All California agents and those who transact insurance business are required to obtain E&O coverage before they conduct business. E&O will pay a third party, if that third party suffers a loss because the agent was negligent. The type of negligence that is covered is the kind we could all be guilty of if we are not diligent in the process of assisting the insured in getting insurance. Errors and omissions insurance will not pay if the agent is criminally negligent or guilty of gross negligence.

There are no standardized policies and E&O insurance usually carries a high deductible.



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17.8.2 Malpractice MALPRACTICE insurance is similar to Errors and Omissions with regard to negligence, but will also cover for any bodily injury caused by the insured in the performance of their duties. This is not available to insurance agents, but is found in the medical field.

17.9 Admitted Insurer An admitted insurer is one that:

x Is approved and/or entitled to transact insurance in California x Has complied with the law and satisfied all the conditions required to

transact insurance

17.9.1 Insurer Requirements The definition of an insurer, by the Department of Insurance Code is quite simple. Any person capable of making a contract may be an insurer – subject to the restrictions imposed by the Code. This definition includes a person, entity, association, organization, partnership, business trust, limited liability company or corporation.

17.10 Non-admitted Insurers Non-admitted insurance companies are not entitled to transact insurance or advertise their services in the State of California because they fail to comply or meet financial or business practices requirements. Non-admitted carriers may, however, transact insurance in California with:

x A citizen of California, with respect to that citizen’s own property x A surplus lines broker x A special lines surplus lines broker (applies to Property and Casualty

insurance)

The Surplus Lines Law gives preferential treatment to admitted property and casualty carriers by restricting non-admitted carriers access to the California insurance market in only one of those three ways. A Surplus Lines broker may only be used if no admitted carrier will accept the risk. The following acts are misdemeanors in California, except when performed by a Surplus Lines broker:

x Acting as an agent for a non-admitted insurer x Advertising the services of a non-admitted insurer x Helping a non-admitted insurer transact business in California

Penalties for violating these laws include the penalty for the misdemeanor plus a fine of up to $500 ($100/month or portion of a month during which the violation occurs). Surplus lines brokers must also use a discloser form that informs their clients that:



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THE INSURER IS NOT SUBJECT TO THE FINANCIAL SOLVENCY REGULATION AND ENFORCEMENT THAT APPLIES TO CALIFORNIA LICENSED INSURERS. THE INSURER DOES NOT PARTICIPATE IN ANY OF THE INSURANCE GUARANTEE FUNDS CREATED BY CALIFORNIA LAW. THEREFORE, THESE FUNDS WILL NOT PAY YOUR CLAIMS OR PROTECT YOUR ASSETS IF THE INSURER BECOMES INSOLVENT AND IS UNABLE TO MAKE PAYMENTS AS PROMISED.

17.11 Sales & Loan Requirements Lenders may require that insurance be purchased as a condition of a loan. They may not, however, require that the insured get that insurance through a specific agent, broker or company. Lenders may not reject an insurance policy that satisfies a specific loan condition. Similarly, no person who sells real property shall require, as a condition of the sale, that the buyer must negotiate the purchase or renewal of any insurance coverage for such real property through a particular insurance agent, broker or solicitor.

17.12 Free Insurance Free insurance is a prohibited practice and in violation of the California Insurance Code. An insurance agent or insurance company may not offer free insurance coverage as an inducement to lease, rent or purchase real or personal property or services.

17.13 Code Requirements for Those who Transact Insurance The California Insurance Code provides strict guidelines regarding agent/agency names, titles, locations, display of license, record keeping, etc. Specific regulations include:

17.13.1 Agency Name, Use of Name The Commissioner reserves the right to approve any fictitious name other than the bona-fide natural name of any insurance agent or broker. Insurance agents and brokers do not need the approval of the Commissioner to use any earned professional designation, such as C.L.U. (Charter Life Underwriter), C.P.C.U. (Charter Property and Casualty Underwriter). However, the use of the name “underwriter” by agents or brokers in any other context is prohibited. Grounds for denial also include:

x Such name is deemed an interference with or is too similar to a name presently in use by another licensee.

x The use of the name may be misleading to the public. x The name would imply that the licensee is an insurer, motor club or

hospital insurance plan, or that he/she may engage in insurance activities not covered under a currently held license.



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17.13.2 Advertisements Regarding Qualifications to Advise on Workers’ Compensation

Broker/agents are guilty of a misdemeanor if they represent themselves as qualified to advise the public on insurance or to administer workers’ compensation and:

x Advise the employer to purchase excess or aggregate stop-loss workers’ compensation insurance

x Advise an employer of a non-admitted insurer from whom aggregate excess or aggregate stop-loss workers’ compensation might be purchased

Workers’ Compensation coverage in California can also be obtained through the State Compensation Insurance Fund (SCIF); a competitive state fund established more than 75 years ago. The SCIF competes with independent insurance companies for a share of the Workers’ Compensation insurance business. Even though the fund is run by the state, it cannot monopolize the business. Workers’ Compensation insurance should not be confused with Employer’s Liability, which protects the employer against a variety of common law exposures by filling the gaps in compensation coverage and covering claims that are not subject to Workers Compensation laws. It also covers lawsuits brought against employers in the U.S. by employees who are not covered by Workers’ Compensation.

17.13.3 Use of Corporate Name A Property and Casualty Broker/Agent or Life Agent, who has a service contract, is a stockholder or member of an incorporated association or company that provides services to agents may use the name of that organization on stationery, marketing information and other printed material as long as his or her name is clearly identified as part of the business relationship.

17.13.4 Display of License Property and Casualty agents/brokers must prominently display their license in their place of business, and in a way that will allow anyone to easily inspect it, determine its currency and validity, and understand the capacity in which the holder is authorized to act. The penalty for violation of this section of the code is $200 for the first offense, $500 for the second offense and $1,000 for all subsequent offenses.

17.13.5 Office Location California insurance agents must keep a principal place of business in California. The address of the office must appear on all license and renewal applications.



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17.13.6 Change of Address When applying to take an insurance exam, applicants are asked to provide their home, business and mailing address. If any of these addresses change, the Commissioner must be notified, in writing, immediately.

17.13.7 Premium Finance Disclosures Agents are required to disclose the commissions they will earn from premium finance agreements. They do not need to disclose the commissions they will earn from the sale of insurance policies.

An insured is entitled to a return of the premium:

x When there is fraud or misrepresentation by the insurer. x When the contract is voidable due to facts of which the insured was

ignorant. x When by any default of the insured, other than fraud, the insurer did not

incur any liability under the policy.

In the case of over-insurance by several insurers, the insured is entitled to a return of the premium, proportioned to the amount by which the aggregate sum exceeds the insurable value.

17.13.8 Unearned Premium When an insurer makes changes to a policy that result in unearned premium, he or she must refund that premium to the insured according to the following schedule:

25 days For unearned premium created when an insurer endorses, rejects, declines, cancels or surrenders a policy. 15 days If the unearned premium is sent to the agent of record. The agent must pay interest if the premium is kept after 15 days, unless the insurer is in liquidation or under a conservator. 120 days After policy coverage ends due to cancellation.

If unearned premium is not assigned as security to a premium finance company or is less than $25, it may be applied to policy renewal or other premiums due so long as written notice is given to the insured within 30 days. If the amount of unearned premium is less than five dollars, no written notice is required. The insured may request a refund of the unearned premium in writing.



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17.13.9 Records Detailed records must be kept for each of the following:

x Agents and brokers must retain informational records for 18 months. x Detailed Bank and Financial records must be kept 5 years. x Life Insurance agents must keep records for 5 years. x Premium Finance records must be kept 3 years. x Insurance companies must keep records for 2 years.

It is the duty of all California admitted insurers, transacting Life and or Disability insurance, to maintain certain records pertaining to the insurance records of its agents and to make such information available upon request by the Department of Insurance. These records may include, without being limited to certified document copies or originals. The records must be delivered within 30 days of receipt of request, and may be carbons, facsimiles, microfilm copies or electronic data-processing records. When pertinent to the transaction, such records should include names, dates, amounts and policy numbers.

Records should be composed of the following:

x Original application for each insurance policy sold in California. x Premiums received by the insurer for each insurance policy. x Production records for insurance policies sold by each agent in the current

year and for each of the preceding five years. x For each insurance policy, the amount of commissions paid and to whom. x Records or memoranda identifying any non-compensated agent involved

in any aspect of an insurance policy transaction. x Written communications, of any type, sent by the insurer to any prospect,

applicant or insured, or received from same by the insurer. This is not intended to include any printed material of the insurer, in distribution through the efforts, directly or indirectly, of the insurer’s life agents.

x Written comparisons of benefits, limitations, exclusions and costs of existing accident, sickness or long –term care coverage and proposed coverage.

x A copy of the Outline of Coverage or disclosure statement, required by law or regulation.

x Correspondence copies between the policyholder/applicant, or someone acting on his/her behalf, and the agent/insurer.

Records shall be maintained for five (5) years following the actual delivery of the insurance policy to the insured party. If no policy was issued, then the period begins from the date of the application. It shall be the obligation of the agent to maintain at his/her place of business, copies of records, correspondence and other related information- as transmitted to an insurer- for a minimum of 5 years. This material should be maintained in an orderly fashion and be made available to the Department of Insurance upon demand.



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If and when the Commissioner determines that any broker/agent has failed to keep the required records, he/she may require the broker/agent to complete those records within 60 days. Failure of the licensee to comply may result in the suspension or revocation of the broker/agent license.

17.13.10 Filing License Renewal Application Agents and brokers must renew their license every two years, by the last day of the month it was originally issued. The appropriate fees must be paid and continuing education must be completed as of the last day of the month for which the previous license was issued. The licensee has a 60-day grace period, during which he or she may continue to transact business so long as fees are paid and continuing education is completed in a timely fashion.

17.13.11 Printing License Number on Documents Licensees must include their license number and the word insurance in type the same size as a indicated phone number, address or fax number (in at least in 10-point font) on all written proposals, business cards, newspaper ads, and other advertising or written presentations to clients of insurance.

17.14 Broker Fees Brokers must provide a written disclosure of fees, as well as the method of determining those fees, in excess of those that would be paid to an agent in commissions. The Commissioner may permit a broker to charge a fee for services beyond the scope of services customarily provided in connection with the solicitation and procurement of insurance. Only insurance brokers, not agents, may charge fees.

17.15 Effective Date of Coverage for Insured/Applicants The EFFECTIVE DATE OF COVERAGE is the date on which the protection of an insurance policy or bond goes into effect. All life agents and all property and casualty broker/agents shall provide all insureds or applicants, at the time of application or receipt of premium, the effective date of coverage (if known). There must also be disclosure of any circumstances under which coverage will be effective if there exist conditions precedent to coverage. This applies only to personal lines of insurance.

17.16 Internet Advertising A California insurance agent/broker, who advertises insurance on the Internet and transacts insurance in California, shall identify all the following information on the Internet, regardless of whether the insurance agent or broker maintains his/her Internet presence or if the presence is maintained on his/her behalf:

1. His or her name as it appears on his/ her insurance license, and any fictitious name approved by the Commissioner

2. The state of his/her domicile and principal place of business. 3. His/her license number.



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17.17 Illustrations In order to protect consumers, it is the intent of the Department of Insurance to establish regulatory standards for illustrations and disclosures associated therewith, as used by insurance companies. For example, as far as possible, insurers are urged to do away with footnotes, caveats and insurance technology not used by that segment of the market to which the illustrations are directed in the course of a presentation.

The basic rules are as follows:

x Insurers shall notify the Commissioner of any policy forms using illustrations.

x A policy form identified by the insurer as one marketed with illustrations must be so presented to the individual or group that is the subject of the marketing effort.

An approved application should include:

x Name of insurer x Name and business address of producer x Name, age and gender of proposed insured, unless it is an approved

composite illustration. x Underwriting or rating classification x Generic name of policy x Death Benefit x Dividend option

The insurer and his/her agents shall not:

x Represent the policy as anything other than a life insurance policy x Use non-guaranteed elements in a misleading manner x State that the payment of a non-guaranteed element is guaranteed x Use an illustration that is not in compliance x Use an illustration that depicts policy performance in a more favorable way

than is produced by the insurer whose policy is being illustrated x Provide an incomplete illustration x Represent that policy payments will not be required for each policy year in

order to maintain the illustrated death benefits (unless that is a fact). x Use the term “vanishing premium” to imply that premiums are paid up, to

describe a plan which uses non-guaranteed elements to pay a portion of future premiums

x Use an illustration that is not “self-supporting” or “lapse-supported”

Interest rates used to determine illustrated non-guaranteed elements shall not be greater than the earned interest rates. A basic illustration shall show the date on which it was prepared, have numbered pages and, if the age of the proposed insured is shown – it shall be issue age plus



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the number of years the policy is assumed to be in force. Where applicable, the illustration should show premium outlay, guaranteed death benefits and values available upon surrender. Guaranteed elements should be specifically referred to before corresponding non-guaranteed elements. The illustration should also show value available upon surrender, policy benefits, riders or options and definitions of column headings. If an insurer or agent uses a basic illustration and the policy is applied for as illustrated, a copy of that illustration shall be signed and submitted to the insurer at the time of the policy application.

17.18 Code Specifications for Application & License Upon filing an application for license, the Commissioner may make an investigation and may require the filing of supplementary documents, affidavits and statements, as may be necessary to obtain the full disclosure of information needed to determine whether all prerequisites have been met. And, if the applicant is otherwise eligible, the Commissioner may issue a permanent license.

17.18.1 Denial of Applications, Suspension or Revocation of License After providing an opportunity for a hearing, the Commissioner may deny an application for a license in any of the following circumstances:

x The applicant is not properly qualified to perform the duties of a person holding the license applied for.

x The granting of a license would be against the public interest. x The applicant does not intend, actively and in good faith, to conduct as a

business with the general public the transactions which would be permitted by the issuance of a license

x The applicant is not of good business reputation. x The applicant is lacking in integrity. x The applicant has been refused a professional, occupational or vocational

license, or has had such a license suspended or revoked, for reasons that should preclude the granting of a license applied for.

x The applicant seeks the license for the purpose of avoiding or preventing the operation or enforcement of the insurance laws of this State.

x The applicant has knowingly or willfully made a misstatement in an application to the Commissioner for license, or in a document filed in support of such application, or has made a false statement in testimony given under oath before the Commissioner or any other person authorized by the Commissioner.

x The applicant has previously engaged in a fraudulent practice or act, or has conducted business in a dishonest manner.

x The applicant has shown incompetence or untrustworthiness in the conduct of any business, or has, by commission of a wrongful act or practice in the course of any business, exposed the public to the danger of loss.



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x The applicant has knowingly misrepresented the terms or effect of an insurance policy or contract.

x The applicant failed to perform a duty expressly imposed by a provision of the Code, or has committed an act expressly forbidden by the Code.

x The applicant has been convicted of a felony or a misdemeanor, denounced by the laws regulating insurance, or a public offense having as one of its necessary elements a fraudulent act or an act of dishonest gain acceptance, custody or payment of money or property.

x The applicant has aided or abetted any person in an act or omission, which would constitute grounds for suspension, revocation or refusal of any license issued to such other person.

x The applicant has permitted any person in his or her employ to violate any provision of the Code.

x The applicant has violated any provision of law relating to conduct of business, which could lawfully be done only under the authority conferred by the license applied for.

x The applicant has submitted to the Commissioner a false or fraudulent certificate regarding educational courses completed.

The Commissioner may, without a hearing, deny an application if the applicant has:

x Committed a felony, as shown by a final judgment of conviction. x Committed a misdemeanor, denounced by any law regulating insurance,

as shown by final judgment of conviction. x Had a previous application for a license denied for cause within the five-

year period prior to filing the current application. x Had a previous application for a license suspended or revoked for cause

within the five-year period prior to filing the current application.

Federal Law (Title 18 Section 1033) prohibits anyone who has been convicted of a felony involving dishonesty or a breach of trust from conducting the business of insurance, unless they have first obtained the permission of the Insurance Commissioner. Punishment for a violation of this law can be a fine or imprisonment for not more than 10 years.

Note: Conviction includes having been found guilty by a judge or jury or the filing of a plea of guilty or nolo contendere (no contest).

17.18.2 Suspension or Revocation of License The Commissioner may suspend or revoke any permanent license for any of the same grounds for which an application for license may be denied.

17.18.3 Filing of Notice of Appointment Every insurance producer, including life only and accident and health agents and property and casualty agent/brokers, must have a notice of appointment filed with the Department of Insurance. The authority to transact



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insurance under an appointment becomes effective as of the date the notice is signed. A life only and accident and health agent, property and casualty agent/broker, Personal Lines Agent/Broker or travel insurance agent must have his or her Notice of Appointment executed by an insurer, or its authorized representative, that is admitted to transact one or more class of insurance covered under the desired license. Other insurers may file additional Notices of Appointment before a license is issued and thereafter, as long as it remains in force. Life only, accident and health Agents and Property and Casualty Broker Agents may be authorized to transact disability insurance on behalf of an insurer, authorized to sell disability insurance by the filing of a Notice of Appointment for that purpose. By filing a Notice of Appointment, the submitting person or organization is declaring that:

x The applicant is of good reputation x The applicant is worthy of the license sought

17.18.4 Solicitation by Life Agent prior to appointment A licensed Accident and Health Agent may present a proposal for insurance to a prospective insured on behalf of an insurer and/or submit an application to an insurer without an appointment so long as the insurer submits a Notice of Appointment to the Commissioner within 14 days of receipt of the application.

Note: A Life Agent who is not appointed to a specific insurer may not present a proposal or submit an application to an insurer that requires all agents to represent that insurer or group only.

17.18.5 Inactive License The holder of an INACTIVE LICENSE may not transact insurance authorized under that license. If renewal fees are paid and continuing education requirements have been fulfilled in a timely manner, the license will remain valid and may be reactivated or renewed at any time prior to its expiration by filing of a new appointment or bond.

17.18.6 Termination of License Appointments remain in force until a license is:

x Cancelled x Terminated x Expires

Anyone holding an insurance license may cancel it at any time by simply submitting it to the Commissioner or, if the license is being held by the licensee’s employer, providing written notice to the Commissioner.

All licenses issued to natural persons (individuals) terminate upon the death of the individual.



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An organization is no longer eligible to hold a license if: x A partnership dissolves or changes in structure x An association is terminated x A corporation is dissolved

A continuing partnership may continue to operate for 30 days after registering a change in membership, paying the required fee and furnishing a bond, so long as one person continues to act as the agency or broker.

17.18.7 Unlicensed Producer x A person may not act as an insurance agent, broker or solicitor without a

valid license from the Commissioner. x Anyone who acts, offers, or assumes to act in a capacity for which a

license is required, without actually holding a license, is guilty of a misdemeanor subject to a fine up to $50,000 or imprisonment in county jail for up to one year or both.

x Federal Law -Under Title 18 Section 1033, prohibits anyone who has been convicted of a felony involving dishonesty or a breach of trust from conducting the business of insurance, unless they have first obtained the permission of the Insurance Commissioner. Punishment for a violation of this law can be a fine or imprisonment for not more than 10 years.



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17.19 Insurance Pre-licensing Education Requirements In the chart on the next page there are listed the requirements for each California Licensing exam. The Pre licensing education can either be completed in a classroom or online.

License Type

Pre-licensing Education Required

Lines of Authority

Number of exam questions

Exam Time

Life/ Accident & Health Agent (Life Only and Accident & Health )

12 hr code 40 life 52 total

Life, Health, Annuities, Disability Income Long Term Care

150 3 Hours

Life Only 12 hr code 20 life 32 total

Life ,Annuities NO Long Term Care

75 1 ½ Hours

Accident & Health 12 hr code 20 Health 32 total

Health , Disability, Long Term Care

75 1 ½ Hours

Property/Casualty Agent/Broker

12 hr code 40 Property & Casualty 52 total

Everything but LIFE and HEALTH Products

150 3 Hours

Property Agent/Broker 12 hr code 20 Property 32 total

BOP, Comm. Pkg, Comm. coverage, Crop, H/O,D/F, EQ, Flood, Inland Marine, Livestock, Personal Lines

75 1 ½ Hours

Casualty Agent/Broker

12 hr code 20 Casualty 32 total

Auto, EPLI, CGL, Umbrella, WC, Professional Liability

75 1 ½ Hours

Personal Lines 12 hr code 20 hr Per Lines 32 total

Auto, Home Owners, umbrella

90 2 Hours

Limited Lines Auto Only 12 hr code 20 Auto 32 total

Auto Only

60 1 ½ Hours

Commercial Lines Only as an add on to PL to upgrade to a full P/C

20 Commercial 20 total

Commercial Lines Workers Comp

60 1 ½ Hours

Life - Limited to the Payment of Funeral Burial expense

None

Life policies up to $15,000 in Value

90 2 Hours

Note: The 12-hour Code & Ethics portion of the Pre Licensing does not have to be repeated if the candidate is applying for either license as a second license. Note the agent must have completed the 12- hour code course prior to obtaining the first license.

17.20 Continuing Education (CE) Requirements All licensees must complete continuing education requirements on an ongoing basis. Continuing Education is not an option. All agents/brokers must participate or



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their license will be deemed inactive and they will be unable to write business. Specific continuing education requirements are listed in the chart on the next page.

Failure to Renewal License on Time Any person failing to Pay the renewal fees on time and / or meet the continuing education requirement shall have his or her license automatically terminated. All company Appointments also expire when the license expires. The process to reactivate a terminated license is costly and time-consuming. In order to reactivate a terminated license, the licensee must pay the renewal fee, the 50% penalty fee and complete the required continuing education. Additionally, the licensee must submit new action notices to re-establish company appointments.

Note: The total number of CE hours required each 2- year renewal period is per license number. You may hold more than one license but only are issued a single license number.

17.20.1 Mandatory Continuing Education courses Ethics Education All agent/brokers must satisfactorily complete four hours of ethics continuing education every 2 -year license term. Licenses will not be renewed until this requirement has been met.

License Type CE hrs Required

CE Requirement

Life / Accident & Health Agent (Life Only & Accident &Health )

24 24/ per 2year License term

Life Only 24 24/ per 2 year License term Accident & Health 24 24/ per 2 year License term Property & Casualty 24

24/ per 2 year License term Property 24 24/ per 2 year License term Casualty 24 24/ per 2 year License term Personal Lines 24 24 per 2 year License term Limited Lines Auto Only 20 20/ per 2 yr license term

Commercial Lines

0 None There is no Stand alone Commercial License This can only be added on to a PL to upgrade to a P/C license

Life – Limited to the Payment of Funeral & Burial expense

0 None



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The Ethics requirement for Personal Lines or Auto Only agents is 2 hrs of Ethics each 2 yr renewal term. Annuity Education Life /Accident & Health agents and Life Only agents who sell annuity products must satisfactorily complete an initial 8 hr hours of training in an approved annuity course. In each subsequent renewal period an additional 4 hr course must be completed. This mandated course must have a completion date that falls within the dates of the renewal period for which they are being applied.

Long Term Care Life/ Accident & Health Agents, and Accident/Health Agents selling Long-term Care (LTC) or California Partnership for Long-term Care policies must Complete 8 hours of education in CA Long Term Care each year for the first 4 yrs of licensure. After 2 renewal periods (4 yrs) this requirement is reduced to 8 hrs of LTC education each 2 yr renewal period. The requirement for the California Partnership is 8 hours of CA Partnership education each 2-year renewal period. Homeowners Valuation Training Property & Casualty and Personal Lines agents/ brokers who transact Homeowners insurance are required to complete a mandatory one time, 3 hour Homeowners valuation course specific to the standards and training for estimating the replacement value on homeowners' insurance. This course must be completed before transacting any Homeowners insurance.

Note: All of these mandatory courses are part of, not in addition to, the regular required CE hours. The only course that is mandatory to keep your License in force is the Mandatory Ethics. If you DO NOT Sell Annuities, Long Term Care or Partnership products you are not required to complete those courses. LIFE ONLY agents can only market Long Term Care as a RIDER attached to life policy.

THE INSURANCE MARKETPLACE: INSURERS CHAPTER 18


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18 The Insurance Marketplace: Insurers An INSURER is an insurance company and is often referred to as a CARRIER. Insurers may be a person, an association, an organization, a business trust, a partnership, a limited liability company or corporation. An ADMITTED INSURER is authorized to transact business in California. A NON-ADMITTED INSURER is not authorized to transact business in California. Carriers may be admitted or non-admitted. An insurer may also be described as:

Domestic The home office is in the State of California, whether or not it is an admitted carrier Foreign The home office is in another state, whether or not it is an admitted carrier Alien The home office is in another country

18.1 Types of Insurance Most insurance products fall into one of the following five classes:

18.1.1 Life Insurance LIFE INSURANCE is any type of insurance that guarantees a specified individual, the beneficiary, a sum of money to be paid on the death of the insured. The major difference between life insurance and all other insurance is that it provides protection for an event that is sure to happen. The only uncertainty is when, how, where and to whom it will happen each year.

18.1.2 Annuity ANNUITIES are investment products, sold by insurance companies, that can provide fixed or variable payments, either immediate in the future, for a specific number of years or for the life of the recipient. Annuities are usually set up to pay individuals after retirement or when they can no longer earn a satisfactory income.

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18.1.3 Health/Disability Insurance HEALTH AND DISABILITY INSURANCE covers any type of insurance that provides protection against financial loss or medical expenses caused by an illness or injury.

18.1.4 Property Insurance This class of PROPERTY INSURANCE protects the insured from losses incurred when property is stolen, damaged or destroyed by an insured peril. Buildings other than land, personal property, building contents, equipment, inventory or stock can be covered by property insurance.

18.1.5 Casualty Insurance CASUALTY INSURANCE is usually packaged with property insurance and covers the liability of a person, organization or business for negligent acts or omissions that cause bodily harm or property damage to a third party.

18.2 Government Insurance In specific cases, Federal, State and Local governments act as insurers for those who cannot otherwise afford insurance. Coverage is paid through tax revenues and include:

x Social Security (including Medicare) x Service members’ Group Life Insurance (SGLI) x Veterans Group Life Insurance (VGLI) x Medicaid (known as “Medi-Cal” in California) x Workers’ Compensation

The major differences between government insurance and other types of coverage are:

x Participation is mandatory for eligible citizens x Benefits are prescribed by law and changes in benefits result from

changes in law x Goal of social insurance is to meet the public’s needs rather than to be

equitable, so people with less usually receive greater benefits x Governments are the only carriers of government insurance, so it is not

available in the private sector

Note: The Department of Insurance has jurisdiction over entities that provide coverages designed to pay for healthcare provider services and expenses, UNLESS the healthcare providers are appropriately licensed or certified by other governmental agencies.

18.3 Types of Insurers Generally speaking, most insurers fall into one of the following categories:



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18.3.1 Stock Company A STOCK COMPANY is an incorporated firm owned by stockholders (shareholders). The insurance policies are issued through the corporation. Stock companies usually issue NON-PARTICIPATING, or “non-par,” policies that do not pay policy dividends.

18.3.2 Mutual Company A MUTUAL COMPANY is owned by policyholders, who contribute capital through the purchase of policies. The policyholders vote for a board of directors that directs the affairs of the company. Mutual companies usually issue policies that allow policyholders to share in any divisible surplus through the payment of dividends. The insurance code does contain provisions whereby a mutual company may be converted into an incorporated stock company – a process called demutualization.

18.3.3 Lloyd’s of London LLOYD’S OF LONDON consists of a group of individuals who form a syndicate to insure against hard-to-place risks. Lloyd’s is not an insurance company. If a loss occurs, each individual is personally liable for his share of the loss.

18.3.4 Reciprocal Company A RECIPROCAL COMPANY is an unincorporated group run by an attorney-in-fact. Members are called subscribers. Each member subscriber shares the risk for all fellow subscribers. The minimum number of members is 25. Reciprocal companies are also referred to as “inter-insurers.”

18.3.5 Fraternal Benefit Society A FRATERNAL BENEFIT SOCIETY is an incorporated society, order, or supreme lodge that is formed and operated solely on behalf of the members. Fraternals are nonprofit religious, charitable or benevolent organizations, and issue no capital stock. They have a representative form of government and a ritualistic work order. Fraternals issue par policies and must meet similar requirements as other types of insurers, but not exactly the same. Fraternals issue assessable policies.

Note: Every insurer will only provide coverage up to a certain “retention limit.” A retention limit is defined as the maximum amount of risk an insurance company will accept.

18.4 Operating Channels The following four channels are critical areas of operation for most insurance companies:

18.4.1 Marketing/Sales MARKETING departments keep insurers current, regarding new strategies and market trends that can help companies reach clients and prospects. After the



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strategy is defined, a marketing plan is developed and submitted for approval by Department of Insurance before program implementation.

18.4.2 Underwriting The job of the UNDERWRITING department is to facilitate a profitable distribution of the company’s risk exposure within the underwriting guidelines set forth by the insurer.

18.4.3 Claims The CLAIMS department must settle or deny claims from insureds fairly, accurately and in a timely manner. This department is critical in the survival of every insurer.

18.4.4 Actuarial ACTUARIAL departments consist of professional statisticians who:

x Determine the rates insurers charge for their insurance products x Track the expenses of the insurers x Advise the company regarding profit and loss scenarios

18.5 Insolvency An insurer becomes INSOLVENT when it goes bankrupt or can no longer meet these financial obligations to policyholders. To be solvent, an insurance company must:

x Be able to cover its liabilities. x Be able to reinsure outstanding risks. x Have additional assets equal to the required paid in capital (the amount

necessary to pay all claims and overhead costs). Paid in capital is the lesser of the value of the company’s assets in excess of all liabilities (net worth) or the combined total of all issued shares of stock, including treasury shares.

When an insurer goes bankrupt or can no longer meet these financial obligations to policyholders, it becomes insolvent. This would include any impairment in minimum paid in capital required in the aggregate by any insurer for the classes of insurance it transacts anywhere. An insurance company cannot escape insolvency by being able to provide for all liabilities and reinsurance. The insurer must also be able to meet the paid in capital requirements It should be noted that it is a misdemeanor to refuse to release books, records or assets to the Commissioner’s office, once a seizure order has been handed down in an insolvency hearing.



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18.6 Conservation CONSERVATION is when the Commissioner of Insurance has taken over the business assets of an insolvent insurer to reorganize it. The Commissioner of Insurance may file an application with the Superior Court to issue an order for the Commissioner to become Conservator of a financially impaired or insolvent insurer. As such, the Commissioner will be vested with all of the insurer’s assets, books, records and property, and will conduct their business if any of the following conditions exist:

x The person or entity has refused to submit its books, papers, accounts or affairs for the reasonable inspection of the Commissioner.

x The person or entity has rejected or refused to observe an order of the Commissioner to make good any deficiency in its capital or reserve.

x The person or entity has, without first obtaining the Commissioner’s consent in writing, transferred its entire property or business or entered into a merger, consolidation or reinsurance transaction of its property or business with the property or business of another person or entity.

x The person is found, after an examination, to be in hazardous financial condition.

x The person has violated its charter with state law. x Any officer refuses to be examined, under oath, regarding its affairs. x Any officer or attorney in fact has embezzled, sequestered or wrongfully

diverted any assets of the person. x A domestic insurer does not comply with the requirements for a Certificate

of Authority or its Certificate of Authority has been revoked. x The last report of examination shows the person to be insolvent.

If the Commissioner determines that it is futile to proceed as Conservator, he or she may apply to the court to liquidate the business of the insurer. After a full hearing, the court may order liquidation, with the Commissioner as liquidator.

18.7 The California Insurance Guarantee Association The CALIFORNIA INSURANCE GUARANTY ASSOCIATION ACT provides protection to claimants or policyholders because of insolvency of an insurer and provides an association to assess the cost of insolvency among insurers. All authorized insurers are members of the association; however, life, disability, title, surety, credit, mortgage guaranty, workers’ compensation and ocean marine insurers are excluded. Association administration and assessment is divided into two separate accounts, automobile and all other. Each member insurer is assessed an amount for each account, based on the percentage of business transacted in California. The Association is governed by a Board of Directors, consisting of five to nine individuals selected by member insurers, with the approval of the Commissioner. The Association’s power covers claims of insolvent insurers before an order of liquidation through 30-days after the order is signed. Claims amounts must be in excess of $100 and not more than $500,000.



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18.8 California Life & Health Guarantee Association The CALIFORNIA LIFE & HEALTH GUARANTEE ASSOCIATION is a non-profit organization that resulted from a merger of The California Life Insurance Guaranty Association and The Robbins-Seastrand Health Insurance Guaranty Association. California residents, who purchase life and health insurance and annuities, should be advised that insurers who are licensed to transact insurance in California are required to join the California Life and Health Insurance Guarantee Association.

The purpose of the Association is to provide protection to Life and Health policyholders, within limits, in the unlikely event that a member insurer should become financially unable to meet its obligations. If this happens, the Association will assess the other member insurance companies for the money required to meet the claims of insured parties living in this state and, in some instances, may keep coverage in force. It should, however, be noted that the protection afforded by these member insurance companies is not without its limits and is not a substitute for consumer diligence in selecting an insurance carrier. Specifically, the Association may:

x Guarantee or reinsure an impaired or insolvent insurer’s covered policies x Provide money x Assure payment of the insurer’s obligations, pledges or guarantees x Loan money x Provide substitute benefits for the insurer’s contractual benefits for

covered claims x Enter into contracts x Sue (or be sued) x Employ people to handle financial transactions and other functions x Advise and assist the Commissioner of Insurance in dealing with an

impaired or insolvent insurer x Fulfill all the functions of a life or health insurer, except the issuance of

policies

The California Life & Health Guarantee Association is funded by member assessments that fall into two classes:

Class A Assessments to meet administrative, legal and other general costs Class B Assessments to assist impaired or insolvent insurers

When dealing with impaired or insolvent insurers, the Association is considered to be a creditor and is subject to regulation and examination by the Commissioner.



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Those protected by the Association are known as COVERED PERSONS. Association coverage typically applies to individual residents of California, although non-residents are covered in the following cases:

x The issuing insurer is domiciled in California x The insurer never held a Certificate of Authority in the state in which the

covered person resides x The resident state of the covered person has a Guarantee Association

similar to that of California x The Covered Person is not eligible for coverage under the Association in

their state of residence

The beneficiaries, payees or assignees of insured persons are protected as well, even if they live in another state. Policies included under the terms of the Association are called COVERED CONTRACTS and include:

x Individual (non-group) Direct Life, Annuity, Health, and Supplemental policies and contracts.

x Direct Group Life, Health, Annuity and Supplemental policies and contracts.

Association coverage is not provided for:

x Contracts not guaranteed by the insurer or for which the insured has assumed the risk – such as a variable contract sold by prospectus.

x Contracts of Reinsurance. x Policies issued by a health care service plan (HMO, Blue Cross, Blue

Shield), a charitable organization, a fraternal benefit society, a mandatory state pooling plan, a mutual assessment company, an insurance exchange or a grants and annuities society.

x Contracts with interest rates that exceed statutory limits. x Guaranteed investment/Interest Contracts. x Employer self-funded contracts. x Contracts that pay dividends or fees for administration of the contract. x Contracts issued by insurers that do not have a Certificate of Authority. x Annuity contracts issued by charitable organizations that are not insurance

companies.

Covered claims receive Association protection to the following limits for each type of insurance:

Health Insurers Limited to $200,000, or less, of the policy obligations, based on the amount that would normally have been paid by the health insurer.



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Life Insurers Payment will not exceed the lesser of:

x 80% of the limit of contractual obligations. x $250,000 in Life Insurance Death Benefits on any one life, but not more

than $100,000 in net cash surrender and withdrawal values. x $100,000 in the present value of annuity benefits for any one life (including

net cash surrender and withdrawal values).

Note: The California Life & Health Insurance Guarantee Association is not liable for more than $250,000 in benefits for any individual or for more than $5,000,000 for any one owner of a firm, corporation or legal organization.

18.8.1 Association Restrictions While the California Life & Health Guarantee Association’s mission is to protect the public, not all claims are fully covered. Therefore, it is unlawful for insurers to proclaim their membership in the organization or to use it in advertising. In June of 1991, the Association developed a SUMMARY DOCUMENT AND DISCLAIMER that describes its purpose and limitations. This document must be provided to all covered Life and Health and Annuity policyholders at the time they receive their policy and must also be made available at any time on the request of the policyholder. In the event that the Association does not cover a policy, the insurer must provide a separate written disclosure notice to the policyholder at the time the policy is issued.

CA Life & Health Pre-Licensing

Documents

Transcript of CA Life & Health Pre-Licensing