Chapter 11
Other Insurance
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Chapter Goals
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Determine when insurance should be used.
Describe the role property and liability insurance has
in managing potential losses in real property and
legal liability.
Indicate how personal insurance can reduce losses
in human exposures.
Explain how significant the federal and state
government are in limiting risks.
When Is Insurance Suitable?
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Insurance can be attractive when infrequent but
severe losses that can cause hardship to you are
present.
Hardship means the losses can have a material
impact on the household's overall financial condition
or current cash resources (severity).
Insuring against all losses is extremely costly and
therefore inefficient.
When losses happen very often (high frequency),
insurance companies end up adding on their
overhead costs to the losses.
When Is Insurance Suitable?, cont.
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Loss frequency and severity:
High Severity
Low Severity
High Frequency
Retention
Retention
Low Frequency
Purchase Insurance
Retention
Risk Management and Insurance
Terms
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Business Risk: A risk taken for potential reward.
Pure risk: A risk that carries no financial reward.
Uncertainty: No knowledge of outcomes.
Risk: The exact outcome is unknown but the
probabilities of alternative outcomes are known.
Perils: Exposures to the risk of loss.
Hazards: Exposure to increased probability of peril.
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Physical hazard: A deficiency in physical property that
increases the possibility of loss.
Moral hazard: Hazard that arises from actions taken by the
insured person which increase the possibility of loss.
Morale hazard: Hazard that arises from a person behaving
negligently because he or she has insurance coverage.
Risk Management and Insurance
Terms, cont.
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If insurance companies had perfect information, they
could place clients in risk classes based on
probabilities of losses at the beginning of the
business relationship and provide less expensive
policies for the average client.
But due to asymmetric information, insurance
applicants know more about themselves and their
probability of future actions than their company does.
Under adverse selection the customer base drawn to
an insurance product may differ and be less
attractive than that of the population as a whole.
Risk Management and Insurance
Terms, cont.
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To minimize costs, the industry has instituted the
following practices:
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Insurable interest: You can only insure against loss of items
that you yourself would suffer a loss on, should they be
damaged or eliminated entirely.
Indemnity: Your maximum reimbursement in the event of
loss of an asset you own is the value of the item.
Screening and segregation of applicants: Involves
separating people based on their risk categories.
Deductibles: The insurance company reimburses
individuals’ claims only for the amount above an established
minimum.
Coinsurance: The policyholder pays a certain percentage of
the outlay along with the insurance company; often this is
subject to an overall cap on payments by the holder.
Risk Management and Insurance
Terms, cont.
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Coinsurance can take the following forms:
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Exclusions: Eliminating certain conditions from insurance
company payout when a new contract is drawn up.
Waiting periods: Before reimbursements are allowed.
Prespecified Limits: Establishes the amount the insurance
company is willing to pay contractually.
Experience-Based Alteration in Policy Costs: Charges rates
to policy holders based on their loss experience after they
have become clients.
Use of Group Policies: can reduce adverse selection.
 Monitoring costs for moral and morale hazards are
covered, at least in part, by the business itself.
 Employees may be more straightforward with their
employer.
 Reduced processing and marketing costs.
Risk Management and Insurance
Terms, cont.
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Mutual insurance companies: Owned by the
policyholders.
Stockholder-owned insurance companies: Run for
the benefit of the stockholders.
The actions of stockholder-owned companies in their
attempt to maximize profits may conflict with the
interests of policyholders.
Stockholder-owned company actions in attempting to
maximize profits for their owners may conflict with
the interests of policyholders.
Recently, several large insurance companies have
switched from mutual to stockholder status.
Needs Analysis
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Some of the many factors that enter into household
insurance decision making include:
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General Characteristics: The term “need” has to do with
whether the household believes purchasing the insurance is
essential.
Tolerance for Risk: Households with low tolerances for risk
will be more attracted to insurance.
Personal Likelihood of Occurrence: When a person believes
he or she is at more risk for a negative occurrence than the
population at large, and the insurance cost has not been
raised for that increased occurrence, they are more likely to
take out insurance.
Types of Insurance Coverage
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Property Insurance
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Homeowners insurance covers both real property
and personal property related to the home are
covered.
Real property: Dwellings and other structures that
are affixed to land.
Personal property: Assets that are not affixed to the
land and therefore are usually portable.
Originally the individual risks involved with the home
were separately insured; now they are usually
combined in a single policy.
Property Insurance, cont.
Types of policies:
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Name
Type Dwelling
Type Coverage
HO1
HO2
HO3
HO4
HO5
HO6
HO8
Homeowner
Homeowner
Homeowner
Tenant
Homeowner
Condominium and Cooperative
Homeowner
Basic coverage
Broad coverage
Special coverage
Contents broad form
Comprehensive coverage
Unit owner’s form
Modified Coverage
Property Insurance, cont.
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Contract terms: Property insurance
generally have structured terms.
contracts
Coverage Type
Explanation
A
The dwelling and other property attached to it such
as a garage.
B
Structures not attached to the dwelling.
C
Personal property.
D
Outlays for expenses when damage does not allow
occupation.
E
Personal liability, which includes the cost of
litigation and the proceeds of the suit.
F
Medical payments to injured parties.
Property Insurance, cont.
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Amount of Coverage:
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Actual cash value approach uses replacement cost but
takes into account depreciation.
Replacement cost method does not deduct depreciation.
When you coinsure part of the cost in the event of loss, the
policy states what percentage of replacement cost you are
required to maintain to receive full payment from the insurer.
If you are below that figure you will absorb part of the loss
according to the following formula:
Amount of
Insurance in Force
Insurance
Reimbursement
Amount of Loss
Amount of
Insurance Required
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Where:
Amount of
Insurance Required
Coinsurance
Percentage
Replacement Cost
Property Insurance, cont.
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Earthquake insurance may be available through a
rider to the policy. Flood insurance is supervised and
underwritten by HUD.
Title insurance reimburses you for loss in the event
the title you received is defective in whole or part.
Personal property is often included under a policy
but with significant limits on coverage available.
A floater covers the named items wherever they may
be located.
Payments as reimbursement for property losses are
not taxable. Property losses are tax deductible to
the extent they exceed $100 per occurrence and 10
percent of your adjusted gross income for the year.
Automobile Insurance
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The emphasis for automobile insurance has been
broadened over the past fifty years from protecting
yourself and your property to also paying for suits
from third parties.
The automobile policy is separated into six sections:
bodily injury liability, medical payments, property
damage, collision, uninsured motorist coverage, and
the comprehensive section.
Bodily injury liability covers injury to others caused
by you and injury to you and members of your family
when driving someone else’s automobile.
Automobile Insurance, cont.
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Medical payments reimburse you for injuries to the driver
and passengers within your car.
Property damage covers damage you or a designated
driver in your car makes to someone else’s property.
Collision covers damage to your car whether through
impacting another automobile or by the vehicle turning
over.
Uninsured motorist coverage reimburses you for
uninsured, underinsured, and hit-and-run drivers who
cause losses to you.
Comprehensive insurance covers auto-related losses that
arise from theft or damage to your property, but not those
that come from another automobile.
Automobile Insurance, cont.
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The price of automobile coverage depends factors
such as the type of the car; the age of drivers and
their previous accident and driving violations record.
Your rate can be changed to reflect your incidence of
accidents during the time you are covered by the
company.
No-fault insurance does not assign blame for an
accident, and each person is paid for damages by
his or her own insurance carrier.
The no-fault approach is intended to reduce litigation
expenses and help protect third parties.
Liability Insurance
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Liability insurance (third-party coverage) protects
you personally against having to pay for a variety of
potential losses to others.
Third-party liabilities occur through personal injuries
and property damage to others caused by you.
Such liabilities extend to your home and you and
other family members and to personal operations as
they pertain to exposures to others.
Third-party coverage stands in contrast to losses to
you or to your property directly, which is sometimes
called first-party coverage.
Umbrella Insurance
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Umbrella insurance (excess liability insurance): A
broadly diversified grouping of property and liability
coverages in addition to liability coverage under
existing home owners and automobile insurance
policies.
Umbrella insurance generally does not pay until the
limits of coverage in the primary insurance policy are
reached.
In today’s litigious society with large awards being
made, umbrella insurance can reduce your exposure
to catastrophic losses.
Umbrella Insurance, cont.
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Umbrella insurance generally has a minimum
coverage of $1 million and rises in increments of $1
million.
The scope of umbrella coverage is often greater than
that of comprehensive personal liability insurance.
Umbrella insurance may be offered by your auto
insurer or your homeowner insurer, giving you
broader coverage and higher limits than in the
normal automobile policy or homeowner’s policy.
Normally, an umbrella policy requires certain basic
coverage to qualify for its usage.
Health Insurance
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Health insurance provides direct payment or
reimburses you for medical expenses in connection
with illness or accident.
The majority of individuals and their families receive
their medical coverage through the workplace or the
government.
The structure of the healthcare industry has changed
significantly in recent decades as large corporations
and others sought ways of reducing their expenses
as their cost of coverage rose.
This led to a change from the individual doctor to the
group practice, the rise of HMOs, and more
emphasis on decision making by the insurance
company.
Health Insurance, cont.
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Types of providers:
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Blue Cross Blue Shield: A traditional provider that has been
given nonprofit status by individual states.
Health Maintenance Organizations (HMOs): Provide a full
range of medical services for a flat fee.
Point of Service Systems (POS): Patients can choose either
POS or non POS healthcare providers.
Preferred Provider Organizations (PPO): PPOs use primary
care physicians but they are not used as gatekeepers
whose approval is needed in order to be reimbursed for
additional services.
Individual Contracts: May separately cover hospitalization,
surgery, and ongoing medical expenditure or cover all in the
form of a major medical policy.
Health Insurance, cont.
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All three types of medical coverage include:
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Major medical policies:
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A basic medical expense policy for doctors.
Nonsurgical costs whether in or out of the hospital.
A basic hospital policy for hospital costs such as room,
board and ancillary services.
A basic surgical policy to pay for the surgeon’s costs,
whether in or out of the hospital.
Can provide broad coverage and are used for expensive
care.
Usually have deductible and participation requirements.
Generally have high maximum payments allowed. May be
the sole coverage a person has or, in some cases, may
provide additional coverage.
Health Insurance, cont.
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For those who select individual policies or who are
given a choice, some features in which policies differ
include:
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Deductible copayment and coinsurance clauses.
Ease with which you can be approved for services.
Inclusion of such things as prescription drug costs.
Exclusions.
Stated lifetime limits.
Benchmarks for reimbursement levels.
Ability to interact with a skilled employee representative and
receive an appropriate response to questions about
coverage and disputed reimbursement allowances.
Disability Insurance
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Disability insurance provides cash flows to
compensate you when you are unable to work due to
an accident or illness.
Private insurance:
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Short-term disability policies provide income for illnesses for
up to a few years.
Long-term disability covers longer periods most commonly
ranging from 10 years and usually up to ages 65 or 70.
Disability Insurance, cont.
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Important features that differentiate private long-term
disability policies include:
Definition of Disability:
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The strongest definition of disability is own occupation,
where payments are made when you are unable to work in
your existing occupation.
A broader definition would have payment begin when you
are unable to work at any occupation that you are qualified
for based on your education experience and training.
The more restrictive the definition the better because it can
allow payments to begin even though you can work in
another occupation.
Elimination Period: the time before disability
payments begin, which is often three to six months.
Disability Insurance, cont.
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Residual Benefit: A partial payment when you have
returned to your job but with a shorter work week
and reduced income.
Preexisting Condition: May state that it will not pay
out benefits for illnesses or injury that occurred
within a period of time before the policy was taken
out or may be stated in the policy as permanently
excluded from reimbursement.
Rehabilitation Benefit: Some policies will reimburse
you for outlays that help to rehabilitate you and may
serve to bring you back into the workforce more
quickly.
Disability Insurance, cont.
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Cost-of-Living Rider: Can adjust the amount of the
initial payment and or the ongoing payment once
disabled for the effects of inflation.
Due to insurance company concerns about potential
worker incentives to profit from illnesses most
coverage of disability policies is limited to 60 percent
to 70 percent of income.
Disability income is taxable if the policy was paid for
by the company and is tax free if the policy was paid
for by the policyholder with aftertax money.
Disability Insurance, cont.
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The Social Security system pays disability income to
people who because of illness or accident are
unable to work for at least two years, or whose
illness will result in death.
There are eligibility requirements including a time
frame for previous contributions to the Social
Security system, a history of working prior to
disability, and a period of six months before
payments begin.
Eligibility has become more stringently enforced and
is defined as the inability to be gainfully employed in
any position in the workforce.
Amounts paid are comparable to what you would
have received if you were retired.
Long-Term Care Insurance
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Long-term care insurance reimburses you for
expenses incurred when you are unable to perform
certain activities of daily living on your own.
You qualify for long-term care payments when you
are unable to perform a number of the activities of
daily living (or ADLs).
An alternative way of qualifying is through cognitive
impairment.
Policies generally have caps on the total amount that
will be paid in any period as well as overall limits.
Common policy coverage periods can range from
three to six years to a lifetime.
Government Insurance
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Social insurance is insurance provided by
governments.
It can be distinguished from public assistance
because employers and employees fund social
insurance payments directly, generally through
mandatory payroll withholding.
The justification for these programs includes
absence of adverse selection, and income
redistribution, which helps establish a minimum
quality of life for all citizens.
The principal government insurance programs are
Social Security, worker’s compensation, disability
payments, and unemployment insurance.
Worker’s Compensation
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Worker’s compensation provides income to people
who are disabled because of work related activities
and payments to their families in the event of death.
The system is regulated by individual states, which
impose their own requirements.
The majority of the policies are offered by private
companies with the states and company selfinsurance providing the rest.
Individual businesses are required to participate.
Medical care and rehabilitation costs are also
covered.
Worker’s compensation is no-fault.
Medicare
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Medicare coverage is provided for all people and
their family members age 65 or over who are
covered by Social Security.
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Part A is given to all and includes hospital care for the first
60 days for a deductible of $912. There is a maximum
coinsurance charge of $228 a day for days 61-90 and $456
a day for days 91-150.
Part B is a supplement that covers doctor’s charges and
related expenses. To qualify for the benefit a monthly
premium is charged. Only certain expenses are covered
and sometimes in limited fashion.
Effective January 1, 2006, Medicare under Part D has been
expanded to offer prescription drug coverage.
Medicaid
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Medicaid is run by individual states and is supported
by a combination of federal and individual state
funds.
It is intended to cover those people who cannot
afford coverage themselves.
Medicaid not only covers those traditionally thought
of as disadvantaged, but many younger people or
those who otherwise don’t qualify for Medicare.
Unemployment Insurance
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Unemployment insurance provides payments when
you have been terminated from your previous job.
It is a benefit organized by the federal government
but largely run by the individual states. It is funded
by individual businesses.
The benefits amount varies by state and may be a
fixed sum or a percentage of your income to a sum.
It generally lasts for 26 weeks, but may be extended
in times of high unemployment. You must have had a
history of working prior to the application, be
interested in obtaining a new job, and not turn down
a position that is appropriate for you.
You will not qualify if you were fired for misconduct or
are leaving because of a labor dispute.
Social Security Survivor’s Benefits
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Survivor benefits are benefits given to family
members when a qualified wage earner dies.
The children each receive 75 percent of what a wage
earner would receive at age 65.
Payments to children end at age 18. Elderly parents
(over 62) who were supported by the wage earner
also each receive the 75 percent payment.
If there is only one dependent, he or she receives
82.5 percent.
The widower’s benefit is 100 percent of the age 65
payment if the spouse was 65 or over. A surviving
spouse under age 65 or caring for a child under age
16 receives between 71.5 and 83 percent.
Chapter Summary
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Insurance is most suitable when frequently of loss is low but its
severity is high.
Insurance can be separated into property and liability, life and
health, and government social insurance.
Property and liability insurance is involved with protection of real
and personal property while liability protects you against losses
to others.
Property insurance includes home, home’s possessions, auto,
liability, and umbrella insurance.
Life and health protects human assets of household members
against loss.
Personal insurance includes life, disability, health, long term
care.
Government insurance includes Worker’s Compensation,
Medicare, Medicaid, unemployment and social security.