RISK MANAGEMENT Chapter Nine

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

1. Explain the types of life insurance; calculate life insurance premiums.

2. Explain and calculate cash value and other nonforfeiture options.

LU 9-1: Life Insurance

LEARNING UNIT OBJECTIVES

LU 9-2: Fire Insurance1. Explain and calculate premiums for fire insurance of

buildings and their contents.2. Calculate refunds when the insured and the insurance

company cancel fire insurance.3. Explain and calculate insurance loss when coinsurance is

not met.

9-2

1. Explain and calculate the cost of auto insurance.

2. Determine the amount paid by the insurance carrier and the insured.

LU 9-3: Auto Insurance

Face amount –

The amount received (proceeds) upon the death of

the insured

Insured –

The policyholder receiving coverage

Premium –

Periodic payments you make for the cost of the

insurance (determined by actuaries)

LIFE INSURANCE

Beneficiary –

The person receiving the insurance proceeds at the

death of the insured

9-3

Step 2. Divide the amount of coverage by $1,000, and multiply the answer by the premium cost per $1,000.

Step 1. Look up the age of the insured and the type of insurance in Table 9.1 (for females subtract 3 years). This gives the premium cost per $1,000.

CALCULATING ANNUAL LIFE INSURANCE PREMIUMS

9-4

LIFE INSURANCE RATES(TABLE 9.1)

9-5

CALCULATING ANNUAL LIFE INSURANCE PREMIUMS

Example: At age 40 the annual premium per $1,000 of insurance is $3.52 (Table 9.1) for a 5-year term policy. The annual premium for $200,000 of coverage is calculated as follows:

$200,000 (coverage) $1,000

= 200 x $3.52 = $704 annual premium

Term Insurance -- Pays face amount only if you die within the period of the insurance. The cheapest coverage.

9-6

Straight Life (Ordinary Life) -- Provides permanent protection. The insured pays the same premium each year or until death. Has a built-in cash savings feature.

CALCULATING ANNUAL LIFE INSURANCE PREMIUMS

9-7

$200,000 (coverage) $1,000

= 200 x $14.54 = $2,908 annual premium

Twenty-Payment Life -- Similar to straight life but insurer pays premiums for only the first 20 years.

$200,000 (coverage) $1,000

= 200 x $18.61 = $3,722 annual premium

Universal Life - A whole life insurance plan with flexible premium schedules and death benefits. Greater risk to the holder because premiums are subject to interest rate fluctuations.

Twenty-Year Endowment -- Most expensive. Combination of term and cash value. After 20 years your protection ends and you receive the face value of the policy.

CALCULATING ANNUAL LIFE INSURANCE PREMIUMS

9-8

$200,000 (coverage) $1,000

= 200 x $33.36 = $6,672 annual premium

NONFORFEITURE OPTIONS (FIGURE 9.1)

The value of an insurance policy that has built up cash value and provides an opportunity for insurance coverage without

additional premiums.

9-9

NONFORFEITURE OPTIONS BASED ON $1,000 FACE VALUE (TABLE 9.2)

9-10

NONFORFEITURE OPTIONS

Assume Bob purchased a straight life policy and decided to stop the policy after it was in force for 15 years. What would be his options?

1. Cash value

3. Extended term insurance

2. Reduced paid-up insurance

= 200 x $148 = $29,600

$200,000 $1,000

= 200 x $371 = $74,200

Continue this $200,000 policy for 20 years and 165 days

$200,000 $1,000

9-11

FIRE INSURANCE

Table 9.3 - Fire insurance rates per $100 of coverage for buildings and contents

9-12

CALCULATING FIRE INSURANCE PREMIUMS

Calculate the premium of a building with an insured value of $190,000 and a Class B, Area No. 2 rating. Insured contents are $80,000.

Premium =

9-13

Premium = Insured value$100 x Rate

Premium =

Total premium = $950 + $480 = $1,430

= 1,900 x $.50 = $950

= 800 x $.60 = $480

$190,000 $100

$80,000 $100

FIRE INSURANCE SHORT-RATE AND CANCELLATION TABLE (TABLE 9.4)

9-14

CANCELING FIRE INSURANCE (REFUNDS)

Short-rate premium = Annual premium x Short-rate

Short-rate premium = $1,430 Annual premium x .67 Short-rate

Refund = Annual premium – Short-rate premium

9-15

Refund = $1,430 Annual premium -- $958.10 Short-rate premium

If the insured cancels or wants the policy for less than a year, use the short-rate table (Table 9.4).

Refund = $471.90

Short-rate premium = $958.10

CANCELING FIRE INSURANCE (REFUNDS)

Calculate the refund if the policy is canceled after 7 months by the insurance company.

Charge = $1,430 Annual premium x

Refund = $1,430 Annual premium -- $834.17 Charge

7 months elapsed 12

Charge = $834.17

9-16

Refund = $595.83

Step 2. Multiply the fraction by the amount of loss (up to the face value of the policy).

Step 1. Set up a fraction. The numerator is the actual amount of the insurance carried on the property. The denominator is the amount of insurance you should be carrying on the property to meet coinsurance (80% times the replacement value).

CALCULATING COINSURANCE CLAUSE PAYMENT FOR INSURANCE

COMPANYCoinsurance -- the insured and the insurer share the risk. Encourages property owners to purchase adequate coverage.

9-17

COINSURANCE

Suppose we carry $60,000 of fire insurance on property that will cost $100,000 to replace. The coinsurance clause is 80%. If we suffer a loss of $20,000, how much will the insurance company pay?

9-18

Coverage _ What you should have carried

$60,000 $100,000 X .80

x $20,000 =

Coverage _ (Replacement value x Coinsurance clause %)

x Loss = Insurance company payment

$15,000

AUTO INSURANCE

Liability Insurance (Compulsory Insurance) - Covers any physical damages that you inflict on others or their property. (Mandatory)

Bodily Injury – Covers injury or death to people in passenger car or other cars, etc.

Property Damage – Covers injury to someone else’s property, i.e., autos, trees, buildings, hydrants, etc.

Comprehensive -- Covers damages resulting from theft, fire, falling objects, etc.

Collision -- Provides protection against damages to your car caused by a moving vehicle. Covers the cost of repairs less the deductible (amount of repair you cover first before the insurance company pays the rest).

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AUTO INSURANCE EXAMPLE

1. Bodily injury, 250/500

2. Property damage, 5M

3. Collision, $100 deductible

4. Comprehensive, $200 deductible

5. Substitute transportation

6. Towing and labor

9-20

Calculate the annual auto premium for Shirley who lives in Territory 5 (suburbia), is a driver classified 17 (inexperienced operator licensed for less than 6 years), and has a car with age 3 and symbol 4 (make of car). Her state has compulsory insurance, and Shirley wants to add the following options:

COMPULSORY INSURANCE(TABLE 9.5)

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CALCULATING PREMIUM AND OPTIONAL

INSURANCE COVERAGETable 9.6 Bodily injury

Table 9.7 Damage to someone else’s property

9-22

CALCULATING PREMIUM: COLLISION (TABLE 9.8)

9-23

CALCULATING PREMIUM (TABLES 9.9 AND 9.10)

9-24

CALCULATING AUTO PREMIUM(TABLE 9.11)

Calculate the annual auto premium for Julie Fox who lives in Territory 5, is a driver classified 17, and has a car with age 3 and symbol 4. Her state has compulsory insurance, and Julie wants to add the following options:

1. Bodily injury, 250/500

2. Property damage 5M

3. Collision, $100 deductible

4. Comprehensive, $200 deductible

5. Substitute transportation

6. Towing and labor

CompulsoryBodily $ 98 (Table 9.5)Property $160 (Table 9.5)OptionsBodily $228 (Table 9.6)Property $168 (Table 9.7)Collision $191 (Table 9.8)

($148 + $43)Comprehensive $ 56 (Table9.9)

($52 + 4)

Substitute trans. 16 (Table 9.10)

Towing & labor 4

Total annual premium $921 9-25